Debt Maturity and Commitment to Firm Policies
Abstract: When firms can trade debt only at discrete dates, debt maturity becomes an effective tool to discipline investment and debt policies. In the absence of other frictions, single-period debt restores first-best investment. With market freezes, long-maturity debt amplifies underinvestment and the leverage ratchet effect, while short maturity mitigates these distortions. Calibrating the model to U.S. non-financial firms shows that choosing the optimal debt maturity can reduce the cost of commitment problems and market frictions by up to 4% of firm value. A decomposition of the equilibrium credit spread reveals that the agency component associated with time-inconsistent debt and investment policies is largest when leverage and default risk are low, and is substantially reduced by shorter debt maturities.
DOI: https://doi.org/10.24149/wp2302r2