Corporate debt maturity and stock price crash risk

• DOI: http://doi.org/10.1111/eufm.12134
• Published date: 01 June 2018
• Author: Cheng Zeng,Yangke Liu,Edward Lee,Viet Anh Dang
• Date: 01 June 2018

DOI: 10.1111/eufm.12134

ORIGINAL ARTICLE

Corporate debt maturity and stock price crash risk

Viet Anh Dang

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Edward Lee

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Yangke Liu

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Cheng Zeng

Alliance Manchester Business School,

University of Manchester, M13 9SS, UK

Emails: Vietanh.Dang@manchester.ac.uk;

Edward.Lee@manchester.ac.uk;

Yangke.Liu@postgrad.mbs.ac.uk;

Cheng.Zeng@manchester.ac.uk

Abstract

We find that firms with a larger proportion of short-term

debt have lower future stock price crash risk, consistent with

short-term debt lenders playing an effective monitoring role

in constraining managers’bad-news-hoarding behaviour.

The inverse relationship between short-maturity debt and

future crash risk is more pronounced for firms that are

harder to monitor due to weaker corporate governance,

higher information asymmetry, and greater risk-taking.

These findings suggest that short-term debt substitutes for

other monitoring mechanisms in curbing managerial

opportunism and reducing future crash risk. Our study

implies that short-maturity debt not only preserves

creditors’interests, but also protects shareholders’wealth.

KEYWORDS

debt maturity, corporate governance, information asymmetry, stock

price crash risk

JEL CLASSIFICATION

G3, G12, G14

The authors gratefully acknowledge the constructive comments of John Doukas (the Editor) and two anonymous referees

on the earlier version of the paper. The authors are also grateful for helpful comments from Michael Brennan, Marie

Dutordoir, Susanne Espenlaub, Ning Gao, Maria Marchica, Roberto Mura, Konstantinos Stathopoulos, Norman Strong,

Karin Thorburn, and discussants and participants at the European Financial Management Association 2016 Annual

Conference, the 2016 Financial Management Annual Meeting, the 2016 Vietnam International Conference in Finance, the

2017 World Finance Conference, as well as participants of the faculty research seminar at Fudan University, Shanghai. All

remaining errors are those of the authors.

Eur Financ Manag. 2018;24:451–484. wileyonlinelibrary.com/journal/eufm © 2017 John Wiley & Sons, Ltd.

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INTRODUCTION

Debt is one of the primary means of capital acquisition for firms in the US and around the world (e.g.,

Graham, Leary, & Roberts, 2015; Öztekin, 2015). In the context of debt contracting, the structure of

debt maturity significantly influences the decision-making of both firms and investors. The existing

academic literature on debt maturity comprises two pathways. One stream of literature has extensively

documented the determinants of firms’debt maturity choices (e.g., Antoniou, Guney, & Paudyal, 2006;

Barclay & Smith, 1995; Brockman, Martin, & Unlu, 2010; Custódio, Ferreira, & Laureano, 2013;

Datta, Iskandar-Datta, & Raman, 2005; Guedes & Opler, 1996; Ozkan, 2000; Stohs & Mauer, 1996).

The other strand of literature investigates the interaction between debt maturity and other corporate

policies, including financial leverage (Barclay, Marx, & Smith, 2003; Johnson, 2003), debt covenants

(Billett, King, & Mauer, 2007), cash holdings (Harford, Klasa, & Maxwell, 2014), and real investment

(Aivazian, Ge, & Qiu, 2005; Almeida, Campello, Laranjeira, & Weisbenner, 2011; Duchin, Ozbas, &

Sensoy, 2010). Despite the growing awareness of the role of debt maturity in shaping corporate finance

and investment policies, relatively limited research is available on whether and how the monitoring of

short-term debt lenders affects shareholder wealth through its impact on stock prices. Our study fills

this gap in the literature by examining the effect of short-term debt on future stock price crash risk.

Stock price crash refers to an extreme collapse in equity value that causes a severe decline in

shareholders’wealth. This downside risk is of serious concern to investors and firms alike because it

affects their risk management and investment decision making. Prior literature suggests that the

primary cause of stock price crash is managers’tendency to hoard and withhold unfavourable

information from outsiders in the presence of potential agency problems (e.g., Callen & Fang, 2015b;

Hutton, Marcus, & Tehranian, 2009; Jin & Myers, 2006; Kothari, Shu, & Wysocki, 2009). Incentivized

by empire building, as well as career and compensation concerns, managers may attempt to conceal bad

news over an extended time, and upon subsequent revelation of such accumulated information the

market value of their firms corrects sharply downward, leading to stock price crashes.

We hypothesize that short-term debt can reduce a firm's stock price crash risk for the following reasons.

Since the repayment of debt financing is fixed, lenders face an asymmetric payoff, that is, they are exposed

to downside credit risk with a capped upside payoff. Under such circumstances, the timely disclosure of

bad news is of particular importance to debtholders. Compared to long-term debt, debt with short

maturities involves more frequent renewal or refinancing (Diamond, 1991a; Myers, 1977), thus serving as

an effective tool for lenders to monitor managerial behaviour and enhance information transparency (Datta

et al., 2005; Graham, Li, & Qiu, 2008; Rajan & Winton, 1995; Stulz, 2001). This is because incomplete

debt contracts only allocate lenders’control rights ex ante, hence giving lenders strong incentives to use the

credible threat of not renewing debt contracts to deter managers’opportunistic behaviour ex post

(Giannetti, 2003). Lenders of short-term debt, in particular, can protect their rights by requiring managers

to provide timely and reliable information about firms’financial condition and future investments when

negotiating the renewal of debt contracts. This distinct feature of short-term debt enhances managerial

information revelation, curbs the likelihood of bad news hoarding, and hence reduces future stock price

crash risk. While it is possible that long-term debt holders can also play a monitoring role, especially

through the use of debt covenants, the monitoring function of long-term debt tends to be less effective than

that of short-term debt, because long-term debt holders can act only when a covenant violation occurs

(Rajan & Winton, 1995). As a result of this limitation, the ability of long-term debtholders to curb

managerial hoarding of adverse information may be relatively weaker than that of short-term debtholders.

Overall, our arguments predict that short-maturity debt is negatively related to future stock price crash risk.

To test this prediction, we regress future stock price crash risk on short-term debt, while controlling

for several important firm-specific determinants of crash risk. Consistent with prior studies

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(e.g., Chen, Hong, & Stein, 2001; Hutton et al., 2009; Kim, Li, & Zhang, 2011a,b; Kim & Zhang,

2016), we use two main measures of stock price crash risk, namely (i) the negative conditional

skewness of firm-specific weekly returns, and (ii) the ‘down-to-up volatility’of firm-specific weekly

returns. Following the debt maturity literature, we measure short-maturity debt as the fraction of debt

due within three years, which is a well-established cutoff point for computing the short-term debt ratio

(e.g., Barclay & Smith, 1995; Brockman et al., 2010; Harford et al., 2014; Johnson, 2003).

We document empirical evidence in support of our main hypothesis. Using a sample of 7,712

unique firms and 53,052 firm-year observations from 1989 through 2014, we find that firms using more

short-term debt exhibit lower future stock price crash risk. This finding is in line with managers being

less likely to conceal and hoard bad news in the presence of external monitoring by short-term debt

lenders. Our results are robust to a battery of tests addressing endogeneity concerns and those using

alternative measures of key variables, including crash risk and short-maturity debt. Importantly, using

a sample of new debt issues, we find that the maturities of those debt issues are positively related to

future stock price crash risk, which further strengthens our main inference of a causal relationship

between short-term debt and future crash risk.

We next investigate whether short-term debt effectively substitutes for other monitoring

mechanisms in curbing managerial bad-news-hoarding behaviour. These additional empirical analyses

are motivated by the extant studies on the agency perspective of debt maturity (e.g., Datta et al., 2005;

Rajan & Winton, 1995). If short-term debt indeed reduces stock price crash risk due to creditors’

monitoring, then we would expect such an effect to make a bigger difference among firms that are more

susceptible to agency problems and information asymmetry. Consistent with this conjecture, we show

that the mitigating effect of short-term debt on crash risk is more pronounced when firms have weaker

governance, such as less (long-term) institutional ownership and lower shareholder rights. Meanwhile,

we find that the negative relationship between short-term debt and future crash risk is stronger among

firms with a higher degree of information asymmetry, measured by analyst forecast errors, a dispersion

in analyst earnings forecasts, and research and development (R&D) intensity. Finally, we show that

the inverse relationship between short-term debt and future crash risk is more salient for firms that

engage in greater risk-taking, including those with higher leverage or without bond rating. Taken

together, these findings shed light on how short-term debt lenders can substitute other corporate

monitoring mechanisms in mitigating managerial discretion and future stock price crash risk.

Our paper contributes to at least two strands of literature. First, to the best of our knowledge, this is

the first study to investigate the equity market consequences of corporate debt maturity, with a focus on

the impact of short-term debt on high moments of stock return distribution (i.e., extreme negative

returns). Prior research suggests that short-maturity debt plays a significant role in reducing agency

costs (Childs, Mauer, & Ott, 2005; Datta et al., 2005; Myers, 1977), risk-taking incentives (Barnea,

Haugen, & Senbet, 1980; Brockman et al., 2010; Leland & Toft, 1996), and audit risk (Gul & Goodwin,

2010) through the frequent and stringent monitoring of external creditors (Rajan & Winton, 1995;

Stulz, 2001). However, there has been little, if any, research testing the impact of short-term debt on

corporate disclosure behaviour and, ultimately, shareholder wealth. Our empirical evidence therefore

extends this literature by showing that short-term debt can reduce stock price crash risk through curbing

managers’bad-news-hoarding activities.

Second, our study enriches a growing stream of research on stock price crash risk. As a special

feature of stock return distribution, the issue of stock price crash risk is attracting increased attention

among academics and practitioners. Recent studies show that various internal and external factors

influence firms’stock price crash risk, consistent with the bad-news-hoarding argument (see Habib,

Jiang, & Hasan, 2016 for a literature review). Among the internal mechanisms affecting managerial

incentives to withhold adverse information are executive compensation (Kim et al., 2011a), tax

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