This study shows that the maturity structure of a firm's debt has a significant impact on its investment decisions. We show, after controlling for the effect of the overall level of leverage, that a higher percentage of long-term debt in total debt significantly reduces investment for firms with high growth opportunities. In contrast, the correlation between debt maturity and investment is not significant for firms with low growth opportunities. The results are strong at the firm level and at the business segment level. These results hold even after controlling for the endogeneity problem inherent in the relationship between total leverage, the maturity composition of leverage, and investment.
How a firm's level of debt and the maturity structure of the debt affect its investment decisions are fundamental issues in corporate finance. In a Miller-Modigliani world with complete markets, a firm's financial policy--including the maturity of its debt--has no bearing on its investment decisions. In a world with incomplete markets, however, agency problems inherent in interactions between shareholders, debtholders, and management, and associated with the level of leverage and its maturity composition, give rise to underinvestment or overinvestment incentives. A firm's financial policy may have a significant effect on its investment. Several empirical studies have investigated the relationship between firm leverage and investment. For example, Lang, Ofek, and Stulz (1996) and Aivazian, Ge, and Qiu (2005) directly test the effect of leverage on firm investment and find that leverage is significantly negatively related to investment. However, no empirical study has explored the effect of the maturity structure of corporate debt on corporate investment. Whether and to what extent debt maturity influences firm investment remains an unresolved empirical issue.
In this article, we directly test for the relationship between debt maturity and firm investment. We find that longer debt maturity is associated with less investment for firms with high growth opportunities. In contrast, debt maturity is not significantly related to investment for firms with low growth opportunities. These results support the prediction of Myers (1977) that debt maturing after the expiration of the growth option causes underinvestment problems. High-growth opportunity firms are more likely to face an underinvestment problem compared with low-growth opportunity firms and, thus, the negative effect of longer debt maturity on investment should be stronger for high-growth opportunity firms.
Note, however, that leverage and its maturity structure are not exogenous to investment. The negative linkage between investment and long-term debt may be due to the firm's adjustment of its level of debt, and the maturity structure of the debt, in view of anticipated future investment opportunities. Indeed, if future investment opportunities are anticipated and leverage adjustment costs are low, managers can reduce leverage and shorten debt maturity to mitigate the underinvestment problem; thus, it may be that debt maturity structure has no significant impact on investment once this endogeneity bias is taken into account. We employ two alternative approaches to correct for the endogeneity bias.
One approach follows that of Lang et al. (1996) who distinguish between the impact of leverage on growth in a firm's core business and that in its non-core business. They argue that a firm determines its leverage according to growth opportunities in its core business segment, and that its capital structure is weakly exogenous to investment in its non-core business segment. If capital structure has no impact on investment, one should not observe a strong relationship between leverage and investment in the firm's non-core segment. The other approach uses the instrumental variable method to address the endogeneity problem. Here, the maturity of the firm's assets and the tangibility of the assets are used as instrumental variables for debt maturity and leverage, respectively. Overall, our results indicate that the negative effect of longer debt maturity on investment remains strong for non-core business segments, and these results are robust using the instrumental variable approach. Thus, our results hold even after correcting the endogeneity bias, and support the hypothesis that debt maturity structure has a significant impact on firm investment.
The rest of the article proceeds as follows. Section I reviews the theoretical underpinnings of the linkage between debt maturity and investment. Section II presents the baseline results on the relationship between debt maturity and investment and addresses the endogeneity issue. Section III concludes the article.
I. The Debt Maturity-Investment Relationship
That debt maturity could affect corporate investment was pointed out in a seminal paper by Myers (1977), who analyzed possible externalities generated by debt on shareholders' (and management's) optimal investment strategy. If debt matures after the expiration of the firm's investment option, it reduces the incentives of the shareholder-management coalition in control of the firm to invest in positive net-present-value investment projects since the benefits accrue, at least partially, to the bondholders rather than accruing fully to the shareholders. Hence, compared to firms with shorter debt maturities, firms with long-term debt are less likely to exploit valuable growth opportunities.
