A Collateral Theory of Endogenous Debt Maturity

Abstract

This paper studies optimal debt maturity when firms cannot issue state contingent claims and must back promises with collateral. We establish a tradeoff between long-term borrowing costs and short-term rollover costs. Issuing both long-and short-term debt balances financing costs because different debt maturities allow firms to cater risky promises across time to investors most willing to hold risk. Contrary to existing theories predicated on information frictions or liquidity risk, we show that collateral is sufficient to explain the joint issuance of different types of debt: safe "money-like" debt, risky short-and longterm debt. The model predicts that borrowing costs are lowest, leading to more leverage and production, when firms issue multiple debt maturities. Lastly, we show that "hard" secured debt covenants are redundant when collateral is scarce because they act as perfect substitutes for short-term debt.

Parameterizing Debt Maturity

“…Debt maturity is also an important issue in corporate finance, and requires models of this choice typically entail a simple parameterization of outstanding obligations (see, for example,Manuelli and Sánchez (2018) andDarst and Refayet (2019)). However, the sheer volume and complexity of public debt offerings far dwarf that of most firms and so parameterization is much more dramatically stylized in the public sector case.4©International Monetary Fund.…”