May 2017 (Revised February 2019)

A Collateral Theory of Endogenous Debt Maturity

R. Matthew Darst and Ehraz Refayet


This paper studies optimal debt maturity when firms cannot issue state contingent claims and must back promises with collateral. We establish a trade-off between long-term borrowing costs and short-term rollover costs. Issuing both long- and short-term debt balances financing costs because different debt maturities allow firms to cater risky promises across time to investors most willing to hold risk. Contrary to existing theories predicated on information frictions or liquidity risk, we show that collateral is sufficient to explain the joint issuance of different types of debt: safe "money-like" debt, risky short- and long-term debt. The model predicts that borrowing costs are lowest, leading to more leverage and production, when firms issue multiple debt maturities. Lastly, we show that "hard" secured debt covenants are redundant when collateral is scarce because they act as perfect substitutes for short-term debt.

Revised Paper: Accessible materials (.zip)

Original Paper: PDFAccessible materials (.zip)

Keywords: collateral, debt maturity, investment, cost of capital, debt covenants


PDF: Full Paper

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Last Update: January 09, 2020