Dynamic Debt Maturity
A firm chooses its debt maturity structure and default timing dynamically, both without commitment. Via the fraction of newly issued short-term bonds, equity holders control the maturity structure, which affects their endogenous default decision. A shortening equilibrium with accelerated default emerges when cash-flows deteriorate over time so that debt recovery is higher if default occurs earlier. Self-enforcing shortening and lengthening equilibria may co-exist, with the latter possibly Pareto-dominating the former. The inability to commit to issuance policies can worsen the Leland-problem of the inability to commit to a default policy—a self-fulfilling shortening spiral and adverse default policy may arise.
We thank Guido Lorenzoni, Mike Fishman, Kerry Back, Vojislav Maksimovic, Martin Oehmke, and seminar audiences at the Kellogg Lunch workshop, EPFL Lausanne, SITE Stanford, LSE, INSEAD, Toulouse, University of Illinois Urbana- Champaign, Ohio State Corporate Finance Conference 2015, WFA Seattle 2015, and the Texas Finance Festival 2015 for helpful comments. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.