Hostname: page-component-586b7cd67f-rcrh6 Total loading time: 0 Render date: 2024-11-28T16:25:48.810Z Has data issue: false hasContentIssue false
  • English
  • Français

Interest Rate Uncertainty and the Optimal Debt Maturity Structure

Published online by Cambridge University Press:  06 April 2009

Ivan E. Brick  and
S. Abraham Ravid
Get access Rights & Permissions [Opens in a new window]

Abstract

As demonstrated by Boyce and Kalotay (1979) and Brick and Ravid (1985), the use of long-term debt may be preferred because of tax-related advantages. Brick and Ravid show that if there exists a tax advantage to debt and nonstochastic interest rates, long-term debt will increase the present value of the tax benefits of debt if the term structure of interest rates, adjusted for risk of default, is increasing. A decreasing term structure, on the other hand, calls for short-term debt. The present paper extends the tax-induced argument of Brick and Ravid to allow for the presence of stochastic interest rates. Once interest rates are uncertain, pricing even under risk neutrality becomes a complex issue. We analyze the debt maturity decision under two competing pricing equations: the return to maturity expectations hypothesis and the local expectations hypothesis. (This terminology is used in Cox, Ingersoll, and Ross (1981) and Campbell (1986).) Under uncertainty, a debt capacity factor will create an additional incentive to issue long-term debt. Our other results may be interpreted to indicate that if the term premium, the difference between the implied forward interest rate and the future expected spot rate, is positive (sufficiently negative) then long-term (short-term) debt maturity strategy is optimal.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 26 , Issue 1 , March 1991 , pp. 63 - 81
Copyright
Copyright © School of Business Administration, University of Washington 1991

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

References

Barnea, A; Haugen, R.; and Senbet, L.. “A Rationale for Debt Maturity and Call Provisions in The Agency Theoretical Framework.” Journal of Finance, 35 (12 1980), 1223–1243.CrossRefGoogle Scholar
Barnea, A; Haugen, R.; and Senbet, L.. “An Equilibrium Analysis of Debt Financing under Costly Tax Arbitrage and Agency Problems.” Journal of Finance, 36 (06 1981), 1223–1234.CrossRefGoogle Scholar
Bogue, M. C, and Roll, R. R.. “Capital Budgeting of Risky Projects with ‘Imperfect’ Markets for Physical Capital.” Journal of Finance, 29 (05 1974), 601–613.Google Scholar
Boyce, W. M, and Kalotay, A. J.. “Tax Differentials and Callable Bonds.” Journal of Finance, 34 (09 1979), 825–838.CrossRefGoogle Scholar
Braswell, R; Marks, B.; Reinhart, W.; and Sumners, D.. “The Effect of Term Structure and Taxes on the Issuance of Discount Bonds.” Financial Management, 17 (Winter 1988), 92–103.CrossRefGoogle Scholar
Braswell, R; Sumners, D.; and Reinhart, W.. “The Effect of the Tax Act of 1982 on the Appropriate Coupon Strategy for Issuing Corporate Bonds.” National Tax Journal, 36 (06 1983), 255–256.CrossRefGoogle Scholar
Brennan, M. J, and Schwartz, E. S.. “Corporate Income Taxes, Valuation, and the Problem of Optimal Capital Structure.” Journal of Business, 51 (01 1978), 103–114.CrossRefGoogle Scholar
Brick, I. E, and Ravid, S. A.. “On the Relevance of the Debt Maturity Structure.” Journal of Finance, 40 (12 1985), 1423–1437.CrossRefGoogle Scholar
Brick, I. E, and Fisher, L.. “Effects of Classifying Equity or Debt on the Value of the Firm under Tax Asymmetry.” Journal of Financial and Quantitative Analysis, 22 (12 1987), 383–399.CrossRefGoogle Scholar
Campbell, J. Y. “A Defense of Traditional Hypotheses about the Term Structure of Interest Rates.” Journal of Finance, 41 (03 1986), 183–193.CrossRefGoogle Scholar
Cox, J. C; Ingersoll, J. E.; and Ross, S. A.. “A Re-examination of Traditional Hypotheses about the Term Structure of Interest Rates.” Journal of Finance, 36 (09 1981), 769–799.Google Scholar
De Angelo, H., and Masulis, R.. “Optimal Capital Structure under Corporate and Personal Taxation.“ Journal of Financial Economics, 8 (03 1980), 3–30.Google Scholar
Fama, E. F. “Risk-Adjusted Discount Rates and Capital Budgeting under Uncertainty.” Journal of Financial Economics, 5 (08 1977), 3–24.CrossRefGoogle Scholar
Fisher, L; Brick, I. E.; and Ng, F.. “Tax Incentives and Financial Innovation: The Case of Zero Coupon and Other Deep-Discount Corporate Bonds.” Financial Review, 18 (11 1983), 292–305.CrossRefGoogle Scholar
Flannery, M. “Asymmetric Information and Risky Debt Maturity Choice.” Journal of Finance, 41 (03 1986), 19–37.CrossRefGoogle Scholar
Kane, A.; Marcus, A.; and McDonald, R.. “Debt Policy and the Rate of Return Premium to Leverage.” Journal of Financial and Quantitative Analysis, 20 (12 1985), 479–499.CrossRefGoogle Scholar
Kim, H. “A Mean-Variance Theory of Optimal Capital Structure and Corporate Debt Capacity.” Journal of Finance, 33 (03 1978), 45–64.Google Scholar
Kraus, A., and Litzenberger, R.. “A State Preference Model of Optimal Financial Leverage.” Journal of Finance, 28 (09 1973), 911–922.Google Scholar
Lee, W. L.; Thakor, A. V., and Vora, G.. “Screening Market Signalling and Capital Structure Theory.” Journal of Finance, 38 (12 1983), 1507–1518.CrossRefGoogle Scholar
Lewis, C. M. “A Multiperiod Theory of Corporate Financial Policy under Taxation.” Journal of Financial and Quantitative Analysis, 25 (03 1990), 25–43.CrossRefGoogle Scholar
Modigliani, F., and Miller, M. H.. “Corporate Income Taxes and the Cost of Capital: A Correction.” American Economic Review, 53 (06 1963), 433–443.Google Scholar
Morris, J. R. “On Corporate Debt Maturity Policies.” Journal of Finance, 31 (03 1976), 29–37.CrossRefGoogle Scholar
Myers, S. “Determinants of Corporate Borrowing.” Journal of Financial Economics, 5 (11 1977), 147–176.CrossRefGoogle Scholar
Scott, J. “A Theory of Optimal Capital Structure.” Bell Journal of Economics, 7 (Spring 1976), 33–54.CrossRefGoogle Scholar
Stiglitz, J. “On the Irrelevance of Corporate Financial Policy.” American Economic Review, 64 (12 1974), 851–866.Google Scholar
Teicherow, D.An Introduction to Management Science. NY: John Wiley & Sons (1964).Google Scholar