Corporate Debt Maturity

Corporate capital structure choices have at least two dimensions that need to be determined: the amount of debt (leverage) and the term of the debt contract (debt maturity). However, little is known about the theoretical interdependence between leverage and debt maturity. Furthermore, leverage and debt maturity are treated independently in most empirical examinations of capital structure. The main purpose of this thesis is to theoretically and empirically examine the relationship between leverage and debt maturity in both the Australia and the US capital markets. Our theoretical model, which builds upon Merton’s (1974) standard option pricing framework, shows that firms that follow a linear leverage-maturity relationship can minimize the risk premium of debt, thus reducing the costs of debt. Three empirical studies are conducted to examine this linear leverage-maturity relationship in various markets and industries. The first empirical study starts by examining the linear leverage-maturity relationship and the role played both by traditional debt maturity theories and in Australian firms. This focus was chosen because empirical examinations of debt maturity and the role played by market imperfections are limited compared to those of corporate leverage, especially in the Australian context. We find support for a positive linear leverage-maturity relationship. The rest of the debt maturity findings suggest that the capital structure choices of local Australian firms are tailored to the specifics of the Australian capital marketplace. The second empirical study reexamines the linear leverage-maturity relationship and the traditional debt maturity theories in the US capital market to facilitate a direct comparison to the majority of debt maturity literature, which focuses on US firms. The US empirical data also show support for the linear leverage-maturity relationship. Taken together with evidence from Australia and other international studies, we find that support for the positive linear leverage-maturity relationship is not country specific. Our findings also suggest that ignoring the interaction between leverage and maturity can lead to erroneous conclusions about the support for other traditional debt maturity studies. The third empirical study examines the capital structure choices of US Real Estate Investment Trusts (REITs) and real estate companies (non-REITs). REITs and non-REITs are typically ignored in mainstream capital structure research due to their distinct forms of corporate organization. For example, REITs are able to significantly reduce corporate tax liabilities, often to the point of eliminating them altogether. We find substantial differences in the nature of the relationship between leverage and maturity for these two firm types. Leverage is a determinant of maturity for non-REITs, whereas maturity is a determinant of leverage for REITs. We also find that the drivers of capital structure choices in REITs and non-REITs clearly reflect the effects of the regulation of REITs. Given that most debt is issued with debt covenants in the US and Australia, we extend our theoretical model by incorporating debt covenants. One common reason for incorporating restrictive covenants in debt issues is to reduce debt-equity agency costs. We show that utilizing covenants in this way introduces owner-manager agency costs that result in shorter-term debt than would otherwise be optimal. That is, in the presence of debt covenants, agency costs drive a concave functional relationship between maturity and leverage. Finally, our fourth empirical study confirms this concave functional relationship between leverage and maturity with a large sample of US industrial firms. With detailed debt covenant data, we confirm that this concave relationship is driven by asset-based covenants. We also show that the alignment of managers’ and owners’ interests, as proxied by future levels of managerial ownership and executive stock options, significantly reduces the effect of these owner-manager agency costs on maturity decisions. These insights provide a sound explanation for a variety of competing empirical observations in the capital structure and corporate governance literature. Key words: capital structure, debt maturity, leverage, agency costs, debt covenants. ANZSRC: 150201-Finance (75%), 150202-Financial Econometrics (15%), 010205-Financial Mathematics (10%).