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The Hazards of Debt: Rollover Freezes, Incentives, and Bailouts

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  • Ing-Haw Cheng
  • Konstantin Milbradt

Abstract

We investigate the trade-off between incentive provision and inefficient rollover freezes for a firm financed with short-term debt. First, debt maturity that is too short-term is inefficient, even with incentive provision. The optimal maturity is an interior solution that avoids excessive rollover risk while providing sufficient incentives for the manager to avoid risk-shifting when the firm is in good health. Second, allowing the manager to risk-shift during a freeze actually increases creditor confidence. Debt policy should not prevent the manager from holding what may appear to be otherwise low-mean strategies that have option value during a freeze. Third, a limited but not perfectly reliable form of emergency financing during a freeze--a "bailout"--may improve the terms of the trade-off and increase total ex ante value by instilling confidence in the creditor markets. Our conclusions highlight the endogenous interaction between risk from the asset and liability sides of the balance sheet. The Author 2011. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: journals.permissions@oup.com., Oxford University Press.

Suggested Citation

  • Ing-Haw Cheng & Konstantin Milbradt, 2012. "The Hazards of Debt: Rollover Freezes, Incentives, and Bailouts," Review of Financial Studies, Society for Financial Studies, vol. 25(4), pages 1070-1110.
  • Handle: RePEc:oup:rfinst:v:25:y:2012:i:4:p:1070-1110
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    File URL: http://hdl.handle.net/10.1093/rfs/hhr142
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    Cited by:

    1. Duchin, Ran & Sosyura, Denis, 2014. "Safer ratios, riskier portfolios: Banks׳ response to government aid," Journal of Financial Economics, Elsevier, vol. 113(1), pages 1-28.
    2. Gur Huberman & Rafael Repullo, 2013. "Moral Hazard and Debt Maturity," Working Papers wp2013_1311, CEMFI.
    3. Andrey Krishenik & Andreea Minca & Johannes Wissel, 2015. "When do creditors with heterogeneous beliefs agree to run?," Finance and Stochastics, Springer, vol. 19(2), pages 233-259, April.
    4. Hugonnier, Julien & Malamud, Semyon & Morellec, Erwan, 2015. "Credit market frictions and capital structure dynamics," Journal of Economic Theory, Elsevier, vol. 157(C), pages 1130-1158.
    5. Zhiguo He & Konstantin Milbradt, 2016. "Dynamic Debt Maturity," NBER Working Papers 21919, National Bureau of Economic Research, Inc.
    6. Bruche, Max & Segura, Anatoli, 2017. "Debt maturity and the liquidity of secondary debt markets," Journal of Financial Economics, Elsevier, vol. 124(3), pages 599-613.
    7. Segura, Anatoli & Suarez, Javier, 2016. "How Excessive Is Banks' Maturity Transformation?," CEPR Discussion Papers 11111, C.E.P.R. Discussion Papers.
    8. Milbradt, Konstantin & Oehmke, Martin, 2015. "Maturity rationing and collective short-termism," LSE Research Online Documents on Economics 84513, London School of Economics and Political Science, LSE Library.
    9. Qian, Xingwang & Steiner, Andreas, 2017. "International reserves and the maturity of external debt," Journal of International Money and Finance, Elsevier, vol. 73(PB), pages 399-418.
    10. Martin Oehmke & Hongda Zhong & Chong Huang, 2017. "A Theory of Multi-Period Debt Structure," 2017 Meeting Papers 1645, Society for Economic Dynamics.
    11. Konstantin Milbradt & Martin Oehmke, 2014. "Maturity Rationing and Collective Short-Termism," NBER Working Papers 19946, National Bureau of Economic Research, Inc.
    12. repec:ipg:wpaper:2014-331 is not listed on IDEAS
    13. Xingwang Qian & Andreas Steiner, 2016. "International Reserves, External Debt Maturity, and the Reinforcement Effect for Financial Stability," ifo Working Paper Series 211, ifo Institute - Leibniz Institute for Economic Research at the University of Munich.
    14. Gechun Liang & Eva Lutkebohmert & Wei Wei, 2012. "Funding Liquidity, Debt Tenor Structure, and Creditor's Belief: An Exogenous Dynamic Debt Run Model," Papers 1209.3513, arXiv.org, revised Mar 2015.
    15. Norden, Lars & Roosenboom, Peter & Wang, Teng, 2016. "The effects of corporate bond granularity," Journal of Banking & Finance, Elsevier, vol. 63(C), pages 25-34.
    16. Zhiguo He & Konstantin Milbradt, 2012. "Endogenous Liquidity and Defaultable Bonds," NBER Working Papers 18408, National Bureau of Economic Research, Inc.
    17. Philipp König & David Pothier, 2014. "Asymmetric Information and Roll-over Risk," Discussion Papers of DIW Berlin 1364, DIW Berlin, German Institute for Economic Research.
    18. Nosal, Jaromir B. & Ordoñez, Guillermo, 2016. "Uncertainty as commitment," Journal of Monetary Economics, Elsevier, vol. 80(C), pages 124-140.
    19. Meg Adachi-Sato & Chaiporn Vithessonthi, 2016. "Corporate Debt Maturity and Future Firm Performance Volatility," PIER Discussion Papers 29., Puey Ungphakorn Institute for Economic Research, revised May 2016.
    20. Eisenbach, Thomas M., 2013. "Rollover risk as market discipline: a two-sided inefficiency," Staff Reports 597, Federal Reserve Bank of New York, revised 01 Oct 2016.
    21. Dangl, Thomas & Zechner, Josef, 2016. "Debt maturity and the dynamics of leverage," CFS Working Paper Series 547, Center for Financial Studies (CFS).
    22. Anat R. Admati & Peter M. DeMarzo & Martin F. Hellwig & Paul Pfleiderer, 2010. "Fallacies, Irrelevant Facts, and Myths in the Discussion of Capital Regulation: Why Bank Equity is Not Expensive," Discussion Paper Series of the Max Planck Institute for Research on Collective Goods 2010_42, Max Planck Institute for Research on Collective Goods.
    23. N. Letifi & J.-L. Prigent, 2014. "On the debt capacity of growth and decay options," Working Papers 2014-391, Department of Research, Ipag Business School.
    24. Posch, Peter N. & Löffler, Gunter & Kranz, Sebastian, 2015. "Predatory Short Sales and Bailouts," Annual Conference 2015 (Muenster): Economic Development - Theory and Policy 114734, Verein für Socialpolitik / German Economic Association.

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