Short-term debt and incentives for risk-taking

Marco Della Seta, Erwan Morellec and Francesca Zucchi

Journal of Financial Economics, 2020, vol. 137, issue 1, 179-203

Abstract: We challenge the view that short-term debt curbs moral hazard and demonstrate that, in a world with financing frictions and fair debt pricing, short-term debt generates incentives for risk-taking. To do so, we develop a model in which firms are financed with equity and short-term debt and cannot freely optimize their default decision because of financing frictions. We show that when firms are close to distress, the dynamic interaction of operating and rollover losses fuels default risk. In such instances, shareholders find it optimal to increase asset risk to improve interim debt repricing and prevent inefficient liquidation. These risk-taking incentives do not arise when debt maturity is sufficiently long.

Keywords: Short-term debt financing; Rollover risk; Risk-taking; Financing frictions (search for similar items in EconPapers)
JEL-codes: G32 G35 (search for similar items in EconPapers)
Date: 2020
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (19)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jfinec:v:137:y:2020:i:1:p:179-203

DOI: 10.1016/j.jfineco.2019.07.008

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