This paper explores the relationship between aggregate economic distress and the maturity of debt. I argue that lenders would prefer shorter maturity of debt during periods of economic distress. I develop a model where a lender chooses the debt contract tenor that maximizes her expected profits. In doing so, she weighs the role of capital rotation with the expected margin on each transaction and the probability that the borrower defaults. The probability of a borrower defaulting depends on the aggregate economic conditions. The main prediction of the model is that a shock to the stability of the economy leads the lender to prefer shorter maturities on new debt contracts – moreover, this prediction is consistent with underlying relationships in option pricing. I empirically test this prediction using over twenty years of data on bank and public debt issuances and document a persistent negative relationship between aggregate economic distress and maturity of new debt contracts. I further extend the analysis to show that shortening contract maturities result in significant changes in the financial structure of nonfinancial corporations.
Santiago Barraza email@example.com
Financial Management Association Annual Conference. Las Vegas, U.S. 2016.