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Trade-off Model of Debt Maturity Structure
Authors:Jun  Sang-Gyung  Jen  Frank C
Institution:(1) School of Business, Hanyang University, Seoul, Korea, 133-791;(2) School of Management, State University of New York, 355 Jacobs Center, Buffalo, NY, 14260
Abstract:In this paper, we suggest the trade-off model to explain the choice of debt maturity. This model is based on balancing between risk and reward of using shorter-term loans. Shorter-term loans have cost advantage over, but incur higher refinancing and interest rate risk than longer-term loans. Using the Compustat data, we show that the principal components of financial attributes are financial flexibility and financial strength. Therefore, only firms with greater financial flexibility and financial strength can use proportionately more short-term loans. We also document that financially strong firms take advantage of lower interest rates of short-term debt. They use proportionately more short-term loans when the term premium is high. The results of our study also provide evidence supporting the agency cost hypothesis, which is strongly supported by current literature.
Keywords:debt maturity  agency cost  financial flexibility  financial strength  financing decision
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