Refinancing of Long-Term Debt and Tendency to Overinvest

We examine how the forthcoming refinancing of long-term debt affects firms’ overinvestment tendency. We find that firms reduce overinvestment in the year before the refinancing year. Refinancing risk reduces the propensity to overinvest by 6–8%. Firms with relatively higher levels of refinancing risk tend to reduce overinvestment. Since firms with high leverage and low cash holdings are more likely to suffer from liquidity and credit constraints, our findings report that such firms experience a greater reduction in overinvestment. Long-term debt refinancing disciplines managers in reducing the tendency to overinvest. Firms with lower managerial ability have a greater tendency to reduce overinvestment in non-capital expenditures before refinancing. However, the likelihood of overinvestment in capital expenditures decreases irrespective of managerial ability. Reductions in overinvestment before refinancing also have a positive impact on firm performance.