Uncertain Interest Rate and Debt Maturity Structure

Speaker: WEI Xu, Associate Professor, School of Finance, Central University of Finance and Economics

Tencent Meeting ID: 732-616-591 (This meeting is open to the public, please note your real name and faculty if you join the conference)

Abstract: This paper investigates the impact of term spread of risk-free interest rates on corporate debt maturity, both theoretically and empirically. We first establish a theoretical framework endogenizing firm's debt maturity with uncertain interest rates. We find that when the current short-term interest rate decreases compared with long-term rate (term spread increases), the expected future short-term rate increases. Hence, the relative cost of borrowing in short term increases at the current date but decreases at the rollover date. With these two opposite effects, the relationship between firm's optimal debt maturity and term spread can be hump-shaped. Then we use panel data of US firms from 1981-2018 to test our theoretical prediction. We regress firms’ debt maturity on term spread and term spread square. It is found that the coefficient of term spread (term spread square) is positive (negative) and significant, which implies a hump-shaped pattern consistent with our theoretical prediction. Robustness tests show that this empirical result is not driven by data pattern changes at different periods.