choice between short- and long-term debts from arm’s length lenders, and Diamond (1993) links the choice of maturity with the choice of seniority of debt contracts under asymmetric information. Using a hidden-action model, Rey and Stiglitz (1993) have further demonstrated the disciplinary role of short-term lending to resolve moral hazard problems. They show that short-term lenders have desirable incentives to exert control and invest in monitoring, and the possibility of not rolling over loans is an effective threat over firms. Furthermore, Von Thadden (1995) argues that monitoring by lenders helps overcome the short-term bias of corporate investment under asymmetric information.<sup>2</sup> In this paper, the choice of debt maturity is analyzed from the perspective of the lender and not from that of the borrower as common in the literature (see, e.g., Flannery, 1986). This is especially applicable to developing countries where the bargaining power in deciding maturity choice is more likely to be on the side of the banks than the firms which are credit constrained. As a complement to the hidden action model by Rey and Stiglitz (1993), the hidden-information framework proposed in this paper emphasizes the benefits of short-term contracts as a screening device in high-risk credit markets. Building on Von Thadden (1995), we do not assume that monitoring is perfect and the lender learns the firm’s credit quality with certainty. Our paper models information acquisition as a screening process, through repeated short-term lending relationships, which may be more or less effective depending on the level of uncertainty in the micro-, macroeconomic as well as institutional environment.

A number of empirical studies have focused on the impact of information asymmetries on the choice of debt maturity by firms within individual countries,<sup>3</sup> or across countries.<sup>4</sup> Using loan-level data for the US, Berger, Espinosa-Vega, Frame and Miller (2005) investigate the importance of information asymmetries and credit risk ratings for loan maturity choices. They find that information asymmetries reduce loan maturities and, consistent with Diamond (1991), the relationship between debt maturity and risk ratings is found to be stronger when

> 2 While earlier models have been primarily concerned with financing choices in closed economies, recent financial turmoil in emerging markets has stimulated research into the linkages between debt maturity, the term structure of interest rates and the possibility of self-fulfilling currency and banking crises (see, e.g., Kaminsky and Reinhart, 1999, Demirguc-Kunt and Detrgiache, 1998). Short-term debt has often been criticized as a source of financial instability. On the one hand, a number of theoretical studies show that the accumulation of shortterm external debt is important in the generation of self-fulfilling financial crises (see Chang and Velasco, 2001, Rodrik and Velasco, 1999). On the other hand, Diamond and Rajan (2000) argue that the build-up of short-term debt in emerging markets is the consequence of the illiquidity and poor quality of investments in countries lacking adequate regulation and institutions. Detragiache and Spilimbergo (2002) find empirical evidence supporting this theory.

> 3 See, Berger, Espinosa-Vega, Frame and Miller (2006) and Ortiz-Molina and Penas (2006), Barclay and Smith (1995), Guedes and Opler (1996) and Stoh and Mauer (1996) for the US studies.

> 4 See, Dermirguc-Kunt and Maksimovic (1999), Giannetti (2003), Fan, Titman and Twite (2006), and Schmukler and Vesperoni (2006).

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