A theory of debt maturity: The long and short of debt overhang, Working Paper 18160

Debt maturity influences debt overhang, the reduced incentive for highly levered borrowers to make real investments because some value accrues to debt. Reducing maturity can increase or decrease overhang even when shorter term debt’s value depends less on firm value. Future overhang is more volatile for shorter term debt, making future investment incentives volatile and influencing immediate investment incentives. With immediate investment, shorter term debt typically imposes lower overhang; longer term debt can impose less if asset volatility is higher in bad times. For future investments, reduced correlation between assets-in-place and investment opportunities increases the shorter term debt overhang. THIS PAPER STUDIES THE effects of debt maturity on the current and future real investment decisions of an equity owner (or a manager who is compensated by equity). Our analysis is based on debt overhang first analyzed by Myers (1977), who points out that outstanding debt may distort the firm’s investment incentives downward. Reduced incentives to undertake profitable investment