Dynamic Risk Shifting, Debt Maturity and Negotiation Tactics

London Business School Accounting Subject Area Working Paper

44 Pages Posted: 20 May 1997

See all articles by Eli Talmor

Eli Talmor

London Business School

Charles J. Cuny

affiliation not provided to SSRN

Date Written: May 1997

Abstract

We examine the risk shifting problem of capital investments in a dynamic context. We find that when a firm has a long- lived project and may issue debt in the future, the risk- shifting problem is partially ameliorated early in the project life. In fact, if the potential future cash flows associated with the firm are sufficiently large relative to current cash flows, then the firm may actually underinvest in the risky asset early in the project life. We also consider the case when the firm issues both short- and long-term debt upfront, and find implications for the optimal strategy of debt negotiation. Four debt issuance strategies are considered and the optimal debt maturity mix is derived for each. These strategies are rank-ordered. Rolled-over debt is most efficient, simultaneous debt issuance is next preferred, followed by the two policies of sequentially issuing short and long-term debt. The policy of issuing long-term debt before short-term debt is typically the least preferred.

JEL Classification: G31, G32

Suggested Citation

Talmor, Eli and Cuny, Charles John, Dynamic Risk Shifting, Debt Maturity and Negotiation Tactics (May 1997). London Business School Accounting Subject Area Working Paper, Available at SSRN: https://ssrn.com/abstract=48 or http://dx.doi.org/10.2139/ssrn.48

Eli Talmor (Contact Author)

London Business School ( email )

Regent's Park
London, NW1 4SA
United Kingdom
+44 20 7000 7000 (Phone)

Charles John Cuny

affiliation not provided to SSRN

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