Short-Term Debt Overhang
65 Pages Posted: 5 Dec 2022 Last revised: 13 Oct 2023
Date Written: October 3, 2023
Abstract
We consider a dynamic asymmetric information model where firms face multiple investment opportunities and their capital structure is endogenous at all times.We identify a new economic force, short-term debt overhang, which leads firms to issue short-term debt and subsequently underinvest in growth options. This force, which arises at the optimal mechanism and is time- consistent, generates several new testable predictions. Strikingly, we find that greater retained earnings, or cash, can reduce the investment in positive net present value projects by firms with intermediate credit ratings, and that these firms are the most likely to issue short-term debt.
Keywords: debt overhang, adverse selection, capital structure, debt maturity, underinvestment
JEL Classification: G32
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