Corporate debt maturity and stock price crash risk

Published date01 June 2018
AuthorCheng Zeng,Yangke Liu,Edward Lee,Viet Anh Dang
Date01 June 2018
DOI: 10.1111/eufm.12134
Corporate debt maturity and stock price crash risk
Viet Anh Dang
Edward Lee
Yangke Liu
Cheng Zeng
Alliance Manchester Business School,
University of Manchester, M13 9SS, UK
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 managersbad-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
creditorsinterests, but also protects shareholderswealth.
debt maturity, corporate governance, information asymmetry, stock
price crash risk
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;24:451484. © 2017 John Wiley & Sons, Ltd.
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 firmsdebt 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
shareholderswealth. 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 managerstendency 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 lenderscontrol rights ex ante, hence giving lenders strong incentives to use the
credible threat of not renewing debt contracts to deter managersopportunistic 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 firmsfinancial 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
(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 volatilityof 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
managersbad-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 firmsstock 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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