Debt Maturity Structure and Credit Quality

SSRN Electronic Journal, 2006

This paper provides new evidence on the empirical success of structural models in explaining corporate credit risk changes. A parsimonious set of common factors and firm-level fundamentals, inspired by structural models, explains more than 54% (67%) of the variation in credit spread changes for medium (low) grade bonds. No dominant latent factor is present in the unexplained variation. While our set of variables has lower explanatory power among high-grade bonds, it does capture most of the systematic variation of credit-spread changes in that category as well. It also subsumes the explanatory power of the Fama and French (1993) factors among all grade classes. Not necessarily. Studying a large and diverse cross-section of 2,375 domestic corporate bonds over the 1990-2003 period, which covers the full spectrum of credit ratings (from AAA to D), we demonstrate that structural models are impressively successful in explaining credit spread changes in the middle and low-grade bond segments. Specifically, they explain more than 54% and even 67% of individual bond credit spread changes in these categories, respectively. In the highest-grade tercile the explanatory power is about 35%. Explanatory power differs across bond classes partly due to the different role played by firm-level fundamentals such as volatility, leverage, and growth opportunities. These variables are particularly important in the low-grade segment, but they play little role in the high-grade segment. Moreover, our common factors capture twice as much variation in the low-grade tercile relative to the highest-grade tercile. Principal component analysis reveals no latent factor in the residual variation of low-and medium-grade bond portfolios and a strong latent factor in high-grade portfolios. However, analysis of individual bond regression residuals reveals virtually no common variation across any of the credit risk groups, providing solid evidence that structural models capture essentially all the systematic variation in individual bond credit spread changes for all credit risk classes. We provide additional evidence that idiosyncratic volatility and the price-tobook ratio have a strong basis in empirical corporate bond pricing. Campbell and Taksler (2003) document a synchronous upward trend in aggregate idiosyncratic volatility and aggregate credit spread levels. Pastor and Veronesi (2003) show that the priceto-book ratio and idiosyncratic volatility are both driven by uncertainty about the firm's future profitability. Since future profitability affects default probability in a structural model framework, Pastor and Veronesi (2003) establish a theoretical link between credit spread levels (and potentially changes), idiosyncratic volatility, and the price-to-book ratio. We provide fresh empirical evidence on this link by showing that changes in idiosyncratic volatility and the price-to-book ratio, both at the aggregate and firm level, are economically and statistically significant in explaining both crosssectional differences, as well as the time-series variation, in corporate credit spread changes. Our findings indicate that these variables should be considered along with more traditional ones in studies of credit risk changes at the individual bond level.

Journal of Risk and Financial Management

The purpose of this study is to examine the relationship between credit rating scales and debt maturity choices. A liquidity hypothesis is used to formulate the testable proposition and conceptual framework. Generalized linear model (GLM) and pooled ordinary least square (OLS) are utilized by SAS programming to test the proposed hypothesis. Other different estimation techniques are also used for robust evidence. Results suggest that companies with high and low ratings have a shorter debt maturity. Companies with medium ratings have longer debt maturity structure. Liquidity shows a negative association with longer debt maturity structure. It is evident that at high rating scale with high liquidity, and at lower rating scales with lower liquidity firms have a shorter debt maturity. Mid rated firms with a low probability of refinancing risk show longer debt maturity structure. Considering refinancing risk by Asian companies make the nonlinear relationship between credit ratings and debt maturity choices. Results suggest the importance of credit ratings for the optimization of debt maturity structure of Asian firms, which was totally overlooked by the past studies. The findings of this study are consistent with the liquidity hypothesis. The findings also motivating financial managers and investors to consider credit ratings as a measure of financial constraints.

Social Science Research Network, 2000

We provide an empirical examination of the determinants of corporate debt maturity. Our evidence offers strong support for the contracting-cost hypothesis. Firms that have few growth options, are large, or are regulated have more long-term debt in their capital structure. We find little evidence that firms use the maturity structure of their debt to signal information to the market. The evidence is consistent, however, with the hypothesis that firms with larger information asymmetries issue more short-term debt. We find no evidence that taxes affect debt maturity. FINANCIAL ECONOMICS HAS MADE significant progress in explaining the incentives that lead large public corporations to choose particular financing policies. Increasingly, the profession is moving beyond an examination of the basic leverage choice to more detailed aspects of the financing decision. In this article, we extend this literature by employing data from a large sample of firms to examine hypotheses about the determinants of the maturity structure of the firm's debt. We group the hypotheses that have been offered to explain corporate debt maturity into three categories: contracting-cost hypotheses, signaling hypotheses, and tax hypotheses. Our evidence supports the contracting-cost hypotheses. Consistent with Myers (1977), firms with more growth options in their investment opportunity sets have less long-term debt in their capital structure. Large firms and regulated firms have more long-term debt. The evidence on signaling hypotheses is mixed. We find limited evidence that firms use debt maturity to signal information to the market. However, our evidence is consistent with a pooling equilibrium in which firms with larger potential information asymmetries (measured by the amount of growth options in their investment opportunity sets) issue more short-term debt. Our evidence also suggests a nonmonotonic relation between credit standing and debt maturity as predicted by Diamond (1993). We find no evidence that taxes affect debt maturity. We develop the hypotheses in Section I and describe our data in Section II. In Section III, we test hypotheses about variation in debt maturity structure, and in Section IV, we examine the robustness of our results. We present our conclusions in Section V.

Journal of Banking & Finance

We study the extent to which a firm's debt maturity structure affects its borrowing costs from banks. By examining the syndicated loans from 1990 to 2014 in the U.S. market, we find that a firm's short-maturity debt structure is a major determinant of loan spreads after accounting for firm-and loan-specific variables, and firm and year fixed effects. A one-standard-deviation increase in the ratio of short-term debts to total assets increases the mean loan spread by 11.44bps, representing an additional $0.643 million in total interest expense. The result supports the rollover risk hypothesis that short-term debts intensify shareholder and bondholder conflicts and lead to greater credit risk. In addition, we demonstrate that high-growth firms experience a significantly smaller increase in loan spread than low-growth firms as the short-term debt ratio increases. This finding is consistent with the asset substitution theory that short-term debts mitigate the overinvestment problem and therefore reducing firm risk.

Policy Research Working Papers, 1999

Firms tend to match assets with liabilities, and more of Debt proFitable firms have more long-term debt. Long-term