The Determinants of Debt Maturity in Australian Firms

The determinants of debt maturity in Australian rms
Jamie Alcock
a,b
, Frank Finn
c
, Kelvin Jui Keng Tan
c
a
Department of Land Economy, The University of Cambridge, Cambridge, CB3 9EP, UK
b
Department of Mathematics, The University of Queensland, Brisbane, St Lucia, 4072, Australia
c
UQ Business School, The University of Queensland, Brisbane, St Lucia, 4072, Australia
Abstract
We examine the determinants of debt maturity in the Australian capital market
with the Top 400 rms listed on the Australian Securities Exchange for the per-
iod 19892006. We nd that Australian rms not only exhibit a positive
leveragematurity relationship but also use short-term debt to signal their high
quality to the market. Our results are robust to dierent estimation methods that
control for endogeneity and error-dependence. We also nd that ignoring the
interaction between leverage and maturity can lead to erroneous conclusions
about the support for the matching principle, the agency costs hypothesis and
the transaction costs hypothesis.
Key words: Debt maturity; Capital structure; Leverage
JEL classication: G32, G01
doi: 10.1111/j.1467-629X.2010.00397.x
1. Introduction
Inappropriate debt maturity choice not only reduces rm value but can also
threaten a rms very existence. Debt maturity choice can aect a rms cost of
capital, its cash ow budgeting, its external monitoring and its renancing risk.
The authors would like to thank Necmi Avkiran, Trent Carmichael, Louis Ederington,
Robert Fa, John Clapp, Frederick Harris, Stephen Gray, Laurel Yanliang Yu, two
anonymous referees, and conference and seminar participants at the 2010 Midwest
Finance Conference, 2009 Australasian Finance and Banking Conference, and 2008
Financial Integrity Research Network (FIRN) Doctoral Tutorial for their helpful com-
ments and suggestions. We also thank the Australian Research Council and The Univer-
sity of Queensland (UQ) for their nancial support of this research (Discovery Grant
DP0663048 and UQ New Sta Research Start-Up Grant 2010001862).
Received 5 May 2010; accepted 18 December 2010 by Robert Fa (Editor).
2011 The Authors
Accounting and Finance 2011 AFAANZ
Accounting and Finance 52 (2012) 313341
The majority of debt maturity research focuses on the nancing behaviour of US
rms.
1
The literature examining debt maturity outside the United States is scant
but includes studies of rms in Europe, Latin America and Asia Pacic.
2
To
date, international debt maturity studies suggest that nancial market character-
istics play an important role in debt maturity choices. In this paper, we examine
the determinants of debt maturity choices of Australian rms.
Capital structure investigations of Australian rms are generally considered
important as there are a number of well-documented structural and regulatory
dierences between and among the Australian, United States and other interna-
tional capital markets. First, Australian investors can reduce their personal tax
liability via a franking credit attached to dividends under the Australian dividend
imputation tax system. The introduction of this tax system has resulted in Aus-
tralian rms reducing their debt borrowing signicantly (Twite, 2001). Second,
Australian rms are heavily reliant on bank debt funding (Cotter, 1999) rather
than public debt oerings. Bank debt is associated with higher monitoring of the
rms actions so agency costs of debt are expected to be lower in Australia (Ofek,
1993). As a result, short-term debt that is typically used to discipline a rms
value-destroying actions might play a less important role in mitigating agency
problems in Australia. Finally, Australia has a relatively smaller capital market
when compared to many developed countries such as the United States and so is
also a more concentrated and less liquid market across all maturities, especially
long-term debt
3
(Battellino and Chambers, 2006; Eichengreen and Luengnaru-
emitchai, 2006; Foster and Stewart, 1991). The reduced availability of debt
sources in the Australian market constrains management choices and likely
aects observed corporate maturity. Furthermore, any liquidity premium
observed in the Australian debt markets will aect optimal leverage. To the
extent that leverage inuences maturity decisions, a secondary eect may be
observed in the debt maturity of Australian rms.
The interaction between leverage and maturity is currently an under-investi-
gated area of research. While some maturity studies control for leverage and
known-leverage drivers, very few studies specically examine the role played by
leverage in the rms maturity decision. Merton (1974) alludes to a monotonic
relationship between optimal leverage and optimal debt maturity, although he
1
These US debt maturity studies include Barclay and Smith (1995), Guedes and Opler
(1996), Stohs and Mauer (1996), Datta et al. (2005), Billett et al. (2007) and Brockman
et al. (2010).
2
Debt maturity studies in Europe (Antoniou et al., 2006; Ozkan, 2002), in Latin America
(Terra, 2005), in Asia Pacic (Chen et al., 1999; Deesomsak et al., 2005) and international
comparisons (Demirguc-Kunt and Maksimovic, 1999; Fan et al., 2011).
3
Battellino and Chambers (2006) report that Australias domestic corporate bond matu-
rity prole is relatively short when compared to global standards, averaging around four
to six years.
314 J. Alcock et al./Accounting and Finance 52 (2012) 313341
2011 The Authors
stops short of specically identifying this relationship. Furthermore, Merton
does not identify any functional form of this relationship and therefore does not
distinguish whether leverage inuences the maturity decision or whether maturity
inuences the leverage decision or both. Flannery (1986) shows that rms with
more debt can minimize their renancing risk by borrowing longer term debt.
However, Leland and Toft (1996) show that debt maturity is a positive determi-
nant of leverage. In their model, rms with longer debt maturity optimally trade
o the tax advantages of debt against bankruptcy costs by choosing higher lever-
age ratios. Intuitively, a rm cannot determine the maturity of a debt issuance
until after it has decided that it will issue debt in the rst place. Accordingly, the
second objective of this study is to clarify the relationship between leverage and
maturity and to conrm the intuition that leverage is a determinant of debt
maturity.
We examine the determinants of debt maturity of Australian rms, including
the relationship between leverage and maturity, using 976 Australian rm-year
observations between 1989 and 2006. We nd support for the signalling hypothe-
sis that Australian rms issue short-term debt to signal their rm quality. We
also nd support for the hypothesized positive relationship between leverage and
maturity. The results are robust to several estimation designs that account for a
variety of endogeneity and error assumptions, dierent estimation methods,
alternative proxies and alternative specications. We also show that ignoring the
interaction between maturity and leverage can lead to erroneous conclusions
about the support for many traditional debt maturity theories, namely the
matching principle, the agency costs hypothesis and the transaction costs
hypothesis.
Structurally, the paper proceeds as follows. Section 2 reviews the traditional
determinants of debt maturity and develops hypotheses appropriate for testing
within the Australian capital market. Section 2 also claries the bi-directional
eect on leverage and maturity. These hypotheses are tested using the data and
model specied in Section 3. The results of the debt maturity study are presented
in Section 4. Section 5 presents a series of robustness tests. We summarize our
ndings in Section 6.
2. Theories of debt maturity
2.1. Base hypotheses
The traditional debt maturity literature can be categorized into seven groups:
the matching principle, agency costs models (contracting costs), signalling mod-
els (strict signalling, liquidity risk and seniority model), tax-based models, inter-
est rate hedging models, transaction costs models and debt valuation models
(Barclay and Smith, 1995; Morris, 1976; Titman and Wessels, 1988; Yi, 2005).
Here, we hypothesize how the conditions of the Australian market aect the debt
maturity decisions of Australian rms.
J. Alcock et al./Accounting and Finance 52 (2012) 313341 315
2011 The Authors
2.1.1. The matching principle
The most common prescription for debt maturity in the nance literature is
to match the maturity of liabilities to the maturity of assets (Myers, 1977).
Firms want debt to mature at the same time that new investment opportunities
appear so that managers will not pass up positive net present value projects.
The underinvestment problem is a direct result of an overhang of existing debt
raised for earlier projects while earning income for the current project. In addi-
tion, matching the maturity of liabilities to assets is thought to minimize trans-
action costs, especially renancing costs of short-term debt. Most, if not all,
international empirical debt maturity studies conrm the asset matching princi-
ple (Barclay and Smith, 1995; Guedes and Opler, 1996; Stohs and Mauer,
1996, for example).
However, Kolb (1987) suggests that strictly observing the matching principle
will be too risky for most rms as it implies a current ratio of one. Observing the
matching principle is further complicated by the illiquidity of long-term debt in
the Australian capital marketplace (Battellino and Chambers, 2006; Foster and
Stewart, 1991). The Australian market for public debt securities, especially long-
term debt securities, is much smaller than that of the United States. This may
imply that Australian rms with long-term assets face a reduced ability to match
their debt maturity to their asset maturity.
Rather than observing the matching principle to reduce the debt overhang
problem, rms can also choose to reduce their debt ratios. Twite (2001)
argues that under the Australian dividend imputation system equity is a rela-
tively less costly source of nancing and, as a result of employing this system,
rms have reduced their debt levels accordingly. Given that Australian rms
have relatively lower levels of debt, it is less important that these rms
observe the matching principle in mitigating the debt overhang problem.
Accordingly, we rst test whether Australian rms match their debt maturity
to the maturity of assets in place despite the nature of the Australian capital
market.
H1: Corporate debt maturity is matched to the maturity of assets in place.
2.1.2. Debt-equity agency costs
Myers (1977) suggests that short-term debt can be used to mitigate the under-
investment problem that arises from the conict between debtholders and equity-
holders. Short-term debtholders are better able to rewrite the debt agreement
before agency costs drive any material change to the value of the underlying
assets. High growth rms are more likely to face agency problems, such as
underinvestment, risk shifting and claim dilution (Barclay and Smith, 1995). If
Myers agency costs theory holds true, we expect corporate debt maturity to be
negatively related to the rms growth rate.
2011 The Authors
Myers (1977) also suggests two alternative ways of mitigating debt-equity
conicts: (i) to reduce the rms leverage or (ii) to attach restrictive debt cove-
nants to the debt issue. Consistent with these two arguments, high growth
Australian rms employ less debt (Brailsford et al., 2002) and Australian rms
attach debt covenants to most debt issues (Cotter, 1998). In Australia, debt-
equity conicts are further reduced because rms are heavily reliant on bank
debt funding that is associated with increased monitoring of the rms actions.
We test whether Australian rms reduce debt maturity to mitigate debt-equity
agency costs.
H2: Corporate debt maturity is negatively related to a rms growth rate.
2.1.3. Signalling
Under the signalling model, Flannery (1986) suggests rms should issue
short-term debt to minimize the eect of information asymmetries on nanc-
ing costs. Flannery (1986) argues that long-term debt is more likely to be
mispriced in the presence of information asymmetries. In the presence of
renance risk, only high-quality rms can signal their quality by issuing
short-term debt. This hypothesis is only moderately supported in the litera-
ture. Although Barclay and Smith (1995) and Stohs and Mauer (1996) pro-
vide evidence for the signalling model, their results are not economically
signicant.
Given that Australian rms heavily rely on bank debt, they are subject to close
external monitoring by banks (Cotter, 1999). This Australian nancial character-
istic may help to create a separating equilibrium. That is to say, only high-quality
Australian rms can issue bank and (non-bank) short-term debts to signal their
quality to the market because it is too costly in terms of external monitoring by
banks and in terms of renancing risk, for low quality rms to mimic them. If
Flannerys theory holds, we should nd high quality Australian rms use short-
term debt to signal their high quality to the market. However, reduced liquidity
in the longer term debt market may confound the eect of this hypothesis in
Australian rms.
H3: Corporate debt maturity is inversely related to a rms quality.
2.1.4. Tax and interest rate term structure
Brick and Ravid (1985) present a tax-induced framework to examine the debt
maturity problem. Brick and Ravid (1985) argue that if the term structure of
interest rates is upward sloping, issuing long-term debt increases rm value
through the acceleration of a receiving tax shield associated with the high long-
term interest rate. Australias dividend imputation system implies that the value
of the tax shields, and hence the relative value of issuing long-term debt, is
2011 The Authors
reduced. To investigate, we test whether Australian rms issue long-term debt
when facing an upward sloping yield curve.
H4: Corporate debt maturity is positively related to the slope of the term structure
of interest rates.
2.1.5. Interest rate risk
In the absence of a suitable hedging strategy, Morris (1976) suggests that a
prudent choice of debt maturity can be used to mitigate interest rate risk.
Morris (1976) proposes that short-term debt is used to hedge asset risk if
interest rates move in the same direction as revenues or asset values. The rea-
soning behind this theory is that revenues provide a natural hedge against
interest rate risk, which can then mitigate the need to further hedge interest
rate risk. Firms will benet from issuing short-term oating rate debt if a
positive correlation exists between the rm revenues and interest rates. Firms
with a negative correlation between assets and interest rates will prefer to
issue long-term debt.
This interest rate hedging strategy is not a preferred option for Australian
rms to employ as a means of managing interest rate risk. Benson and Oliver
(2004) nd that no respondents from their survey on Australian rms use non-
derivative means to hedge interest rate risk. We test whether Australian rms use
debt maturity to hedge interest rate risk.
H5: Corporate debt maturity is negatively related to the correlation between inter-
est rate risk and rm cash ows.
2.1.6. Transaction costs
Transaction costs may play an important role in determining whether to
issue short-term debt or long-term debt. Titman and Wessels (1988) suggest
that small rms are more likely to issue short-term debt because of the lower
xed costs associated with issuance. On the other hand, large rms are more
likely to issue long-term debt to take advantage of economies of scale. Empiri-
cally, Barclay and Smith (1995), Guedes and Opler (1996), Stohs and Mauer
(1996) and Ozkan (2002) all conrm this hypothesis with a variety of size
metrics.
H6: Corporate debt maturity is positively related to rm size.
2.2. Debt maturity as a function of leverage
The theories and predictions for directional eects between leverage and
maturity are mixed in the literature (Dennis et al., 2000; Diamond, 1991;
2011 The Authors
Leland and Toft, 1996). Diamond (1991) predicts that highly levered rms
would prefer long-term debt to avoid suboptimal liquidation, as this gives
rms more time to repay their debts. Flannery (1986) shows that rms with
more debt can minimize their renancing risk by borrowing longer term debt.
Leland and Toft (1996) show that debt maturity is a positive determinant of
leverage. In their model, rms with longer debt maturity optimally trade o
the tax advantages of debt against bankruptcy costs by choosing higher lever-
age ratios. The models from Diamond (1991) and Leland and Toft (1996)
agree on the positive relationship between leverage and maturity but disagree
on the bi-directional eects between them. However, when agency costs are
considered, Dennis et al. (2000) argue that leverage should negatively aect
debt maturity because the agency costs of the underinvestment problem can
be lowered by either of two nancing strategies: (i) reducing leverage and/or
(ii) shortening debt maturity. These two nancing strategies can be viewed as
substitutes for each other. In this section, we demonstrate a clear directional
relationship between leverage and debt maturity using Mertons (1974) frame-
work.
In Mertons model, the value of risky debt is given by the value of a riskless
bond less a European put option on the underlying value of the rm struck at
the face value of debt. Merton argues a monotonic relationship between volatil-
ity and optimal leverage and a similar monotonic relationship between volatility
and optimal debt maturity. We can use Mertons framework to identify a clear
functional relationship between leverage and optimal maturity of risky debt.
Firms can vary their leverage and maturity decisions to minimize their default-
risk premium and hence minimize the costs of risky debt. To calculate the
default-risk premium, k, for various levels of debt maturity and leverage, we use
Mertons (1974) model for valuing risky debt:
4
k r
f

1
T
lne
r
f
T
Nd
2

V
X
Nd
1
: 1
Panel A of Table 1 presents the risk premium of risky debt calculated for vari-
ous levels of debt maturity (T) and leverage (X/V). The risk premium for rms
with low leverage is monotonically related to term to maturity. At higher levels
of debt, the risk premium for risky debt is negatively related to term to maturity.
The nonlinear relationship between maturity, leverage and risk premium, in
Table 1, implies that the cheaper debt instrument is determined by the leverage
4
As per standard notation, d
1

ln
V
X
r
f
q
r
2
2
T
r
T
p
; d
2
d
1
r
T
p
, r
f
is the risk-free rate of
return, X is the strike price, q is the continuous dividend, T is the maturity of the bond
and r is the volatility of V the value of the rm. Details are available from the authors
upon request.
2011 The Authors
ratio.
5
To minimize the risk premium (risk-premium minimization argument)
under Mertons assumptions, the debt maturity strategy of rms should be posi-
tively related to leverage.
6
Table 1
Risk premium for various levels of leverage and debt maturity
Debt ratio
(debt/assets)
Panel A Panel B
Risk premium (%) Risk premium (%)
Without bankruptcy costs With bankruptcy costs
Term to maturity
1 2 5 10 1 2 5 10
0 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000
10 0.0000 0.0000 0.0002 0.0028 0.0000 0.0000 0.0004 0.0038
20 0.0000 0.0001 0.0083 0.0286 0.0000 0.0002 0.0130 0.0377
30 0.0001 0.0052 0.0531 0.0895 0.0003 0.0088 0.0758 0.1135
40 0.0045 0.0482 0.1640 0.1838 0.0103 0.0830 0.2261 0.2260
50 0.0562 0.2081 0.3547 0.3059 0.1200 0.3364 0.4736 0.3734
55 0.1430 0.3625 0.4805 0.3754 0.2811 0.5724 0.6309 0.4563
60 0.3114 0.5811 0.6258 0.4497 0.5847 0.8890 0.8156 0.5401
65 0.5998 0.8717 0.7894 0.5282 1.0792 1.3061 1.0160 0.6343
70 1.0468 1.2393 0.9700 0.6104 1.8210 1.8143 1.2406 0.7229
75 1.6865 1.6861 1.1663 0.6957 2.8328 2.4205 1.4776 0.8204
80 2.5446 2.2120 1.3770 0.7838 4.1048 3.1396 1.7333 0.9273
85 3.6362 2.8145 1.6006 0.8742 5.7023 3.9299 2.0007 1.0304
90 4.9662 3.4899 1.8359 0.9668 7.6377 4.7877 2.2728 1.1315
95 6.5294 4.2332 2.0817 1.0610 9.7736 5.7195 2.5553 1.2441
100 8.3131 5.0387 2.3367 1.1568 12.2017 6.7249 2.8657 1.3537
The default-risk premium (k) in the absence of bankruptcy costs and in the presence of 10% bank-
ruptcy costs (proportional to rm value) for various levels of leverage and maturity are calculated
using (1). Firm value is assumed to follow lognormal distribution with a standard deviation (r) of
30% per year and a risk-free rate (r
f
) of 10% per year. These results are qualitatively robust to
changes in level of bankruptcy costs.
5
Mertons model can be easily extended to incorporate bankruptcy costs that destroy
debt value when rm value is too low to pay the face value of debt in full. When bank-
ruptcy costs (regardless of any levels of bankruptcy costs) are included in the model, we
obtain qualitative similar results (see Panel B of Table 1) to those without bankruptcy
costs. Two main dierences between these models are worthy of note. First, higher bank-
ruptcy costs generate a higher risk premium. Second, the increase in the risk premium
because of bankruptcy costs is more noticeable for high leverage rms than for low lever-
age rms.
6
This relationship stands even if we consider the total costs of rolling debt over the same
borrowing horizon (for example, see Figure 1).
2011 The Authors
H7: Corporate debt maturity is positively related to corporate leverage.
3 Data and estimation methods
3.1. Data source and sample selection
We examine the debt maturity choices of the 400 largest Australian rms by
average market capitalization
7
during the period 19892006. We begin the
sample period in 1989, which is the year the FinAnalysis database has its rst
data. We stop the sample period in 2006, so that any results found here are not
contaminated by the eects of the Global Financial Crisis. Financial rms are
excluded because of their unique regulatory capital requirements. We then
exclude any rm whose total market value drops below $25 million during the
sample period, so that rms with restricted access to the capital markets do not
unduly inuence our results. We also exclude rms that have <5 years of
consecutive nancial reports to ensure that our proxies for volatility and interest-
rate correlation can be calculated. The nal sample, after exclusions, consists of
147 rms and 976 rm-year observations. The requirement for 5 years of data
suggests a potential for survivorship bias to aect our results. However, we lar-
gely mitigate any survivorship bias by utilizing an unbalanced panel design. All
measures in this study, except volatility and abnormal earnings, are measured at
the scal year-end prior to the year in which leverage and maturity are measured.
0 10 20 30 40 50 60 70 80 90 100
0.2
0.25
0.3
0.35
0.4
0.45
Debt to asset ratio
C
o
s
t
s

o
f

d
e
b
t
2 * 1 year debt
2 year debt
2 * 1 year debt
2 year debt
Without bankruptcy costs
0 10 20 30 40 50 60 70 80 90 100
0.2
0.25
0.3
0.35
0.4
0.45
0.5
Debt to asset ratio
C
o
s
t
s

o
f

d
e
b
t
With 10% bankruptcy costs
(a) (b)
Figure 1 (a) Compares the total costs of issuing two zero coupon bonds (ZCBs), each with a
dierent maturity, over a 2-year period. The solid line plots the total costs of issuing two successive
1 year ZCBs while the dotted line plots the total costs of issuing one single 2 year ZCB for various
levels of debt leverage. The total costs are calculated by ((1 + r
f
+ k)
2
) 1), where r
f
= 10%
and k is the risk premium in Table 1.We repeat this analysis for rms with simulated bankruptcy
costs of 10% in (b).
7
We adjust the market capitalization for ination using the Australian Consumer Price
Index to obtain an ination-invariant average.
2011 The Authors
3.2. Measurement of variables
8
3.2.1. Dependent variable proxy: debt maturity
The measurement of corporate debt maturity varies in the debt maturity litera-
ture. Long-term debt is typically dened as debt due after either 1 year (Scherr
and Hulburt, 2001), 3 years (Barclay et al., 2003; Barclay and Smith, 1995) or
5 years (Ozkan, 2002). Stohs and Mauer (1996) suggest adopting the weighted
average of debt maturity as a measurement for debt maturity dependent vari-
ables. Because of the availability of detailed debt maturity data in the Compustat
database, numerous US researchers employ a weighted average of debt maturity
measurement in their research such as Scherr and Hulburt (2001) based on the
work of Stohs and Mauer (1996). Unfortunately, in Australia it is not possible
to measure the weighted average of debt maturity as the maturity date of each
debt instrument is not provided in the annual report for Australian rms. Fortu-
nately, Scherr and Hulburt (2001) report that the use of dierent maturity mea-
surements has little impact on empirical results. We follow Barclay and Smith
(1995) and use the ratio of a rms long-term debt (debt due after 1 year) to total
debt as our proxy for debt maturity.
3.2.2. Independent variable proxies
Following the debt maturity literature,
9
we measure market leverage by total
debt (long-term debt plus debt in current liabilities) to market value of assets,
where market value of assets is estimated as book value of total assets less book
value of common equity plus market value of common equity.
It is worth noting that the measurements of maturity and leverage in this study
(and most other debt maturity studies) are inversely related to each other. Con-
sider the case of measurements of market leverage and debt maturity where the
increase in the total interest-bearing liabilities would make market leverage larger
and maturity smaller, thus naturally causing them to be negatively related to
each other.
The histogram of debt maturity in Figure 2a shows that most rms in our
sample have a high proportion of long-term debt. This nding also suggests that
our measurement of long-term debt is a conservative measurement to test the
existence of a positive maturity-leverage relationship. The histogram of market
8
For the selection of proxies for the dependent variables and independent variables, we
employ whenever possible, the same proxies used by each of the original authors (includ-
ing Barclay and Smith, 1995; Guedes and Opler, 1996; Stohs and Mauer, 1996; Johnson,
2003; Barclay et al., 2003) to ensure any deviation of our results from others is not simply
because of the use of dierent proxies.
9
For example, see Datta et al. (2005), Billett et al. (2007) and Stohs and Mauer (1996).
2011 The Authors
leverage in Figure 2b shows that most rms are not very highly levered. These
histograms are consistent with our argument that an increase in the numerator
(total debt) of market leverage also decreases the debt maturity through the
increase in the denominator (total debt). This general downward trend between
leverage and maturity proxies work against us nding the support for a positive
relationship between maturity and leverage (H7). Any support for the positive
component will be an underestimate of the strength and direction of the true
relationship.
We use a book value-weighted measure of asset maturity dened by Stohs and
Mauer (1996) to proxy asset maturity. The maturity of long-term assets is mea-
sured as gross property, plant and equipment (PP&E) divided by depreciation
expense while the maturity of current assets is measured as current assets divided
by total operating expenses. Total asset maturities is the weighted sum of these
measures where (gross PP&E/total assets) is the weight for long-term assets and
(current assets/total assets) is the weight for current assets.
Growth opportunities are generally measured by the market value of assets
divided by the book value of assets (market-to-book) in the capital structure lit-
erature (Johnson, 2003). To proxy for private positive information about rm
quality, Barclay and Smith (1995) and Barclay et al. (2003) suggest the use of
abnormal earnings. This proxy is motivated by the ndings from Kleidon (1986)
and Watts and Zimmerman (1986) that annual earnings are well described by a
random walk. Similarly, we measure abnormal earnings by the dierence
between earning per share (EPS) in year t + 1 and EPS in year t scaled by the
year t share price.
0
5
0
1
0
0
1
5
0
N
o
.

o
f

o
b
s
e
r
v
a
t
i
o
n
s
0 0.2 0.4 0.6 0.8 1
Debt maturity (Longterm debt/total debt)
Debt maturity histogram
0
2
0
4
0
6
0
N
o
.

o
f

o
b
s
e
r
v
a
t
i
o
n
s
0 0.2 0.4 0.6 0.8
Leverage (Total debt/firm value)
Leverage histogram
(a) (b)
Figure 2 Histograms of debt maturity and leverage are plotted using 976 rm-year observations
over 1989 and 2006 from FinAnalysis Database, in (a) and in (b), respectively. Histogram of debt
maturity (a) shows the distribution of debt maturity, measured by the proportion of long-term debt
(due more than one year) to total debt. Histogram of leverage (b) shows the distribution of leverage.
Leverage is measured by the ratio of total debt to market value of assets, where market value of
assets is estimated as book value of total assets less book value of common equity plus market value
of common equity.
2011 The Authors
The slope of the interest rate term structure is measured by the dierence
between the month-end yields on a 10-year government bond and a 2-year gov-
ernment bond matched to the month of a rms scal year end.
10
The correlation of rst dierences in prime rates and net prot before interest,
tax and depreciation (EBITDA) over 4 years preceding the sample year is used
as a proxy for the correlation between interest rates and cash ows (Hamson,
1992). Bond yields and prime rates are from Reserve Bank of Australia and
International Monetary Fund, respectively.
Following Billett et al. (2007), log of rm size is measured by the natural loga-
rithm of net sales. Dollar values are ination-adjusted (June 2000) using Austra-
lian Consumer Price Index (CPI). As alternative proxies, log of rm size is
also measured by log(total assets) or log(rm value) deated by the CPI or the
Producer Price Index.
11
3.3. Descriptive statistics
Panel A of Table 2 presents descriptive statistics for the dependent, indepen-
dent and control variables for the period of 19892006. The mean ($2178.58
million in constant June 2000 dollars) and median ($549.04 million) of rm size
show that our sample rms are slightly larger than those of Johnson (2003)
with a mean of $1506.91 million in constant 1995 dollars but smaller than
those of Billett et al. (2007) with a mean of $4504 million in constant Decem-
ber 2002 dollars.
12
The dispersion of rm size also suggests that we have a few
very large rms in our sample. To minimize some of the extreme values in our
ratio variables, we winsorize all ratio variables at the rst and 99th percentiles.
Australian rms have average asset maturity of 9.55 years, which is slightly
smaller than that of Billett et al. (2007) (12.06 years). The mean (1.63) and
median (1.09) of market-to-book suggest that most of our sample rms have
valuable growth opportunities. The mean of these growth opportunities in this
study is similar to those of Johnson (2003) (1.62) and Billett et al. (2007)
(1.66).
Panel B of Table 2 presents the Variance Ination Factors (VIF) and the Pear-
son correlation matrix among the measures of debt maturity and all independent
10
We obtain rms scal year-end date from Brailsford-OBrien Australian Financial
Database.
11
Log(market rm value) is used by Barclay and Smith (1995), Stohs and Mauer (1996),
Greenwood et al. (2010). Log(total assets) is employed by Antoniou et al. (2006). Log(net
sales) is employed by Billett et al. (2007), Guedes and Opler (1996). In unreported results,
we obtain qualitatively similar results when using any combinations of rm size measure-
ments.
12
We obtain qualitatively similar results if we index our rm size by 1995 or 2002 ina-
tion base years.
2011 The Authors
Table 2
Descriptive statistics of rm characteristics and correlations among the predictors of debt maturity
Characteristics Mean SD
Percentile
Min 25th Median 75th Max
Panel A: Descriptive statistics of rm characteristics
Debt maturity 0.74 0.30 0.00 0.64 0.85 0.96 1.00
Leverage 0.19 0.14 0.00 0.09 0.18 0.27 0.69
Firm size (net sales in $m) 2178.58 4520.67 2.65 193.42 549.04 2092.64 29,961.06
Asset maturity 9.55 9.12 0.21 3.28 6.82 12.71 49.95
Market-to-book 1.63 1.09 0.67 1.10 1.35 1.68 7.92
Abnormal earnings 0.02 0.08 )0.22 )0.01 0.01 0.03 0.50
Term structure (%) 0.61 0.36 )0.02 0.37 0.54 0.87 1.86
Interest-EBITDA correlation 0.19 0.68 )1.00 )0.42 0.33 0.85 1.00
Fixed assets ratio 0.38 0.21 0.01 0.22 0.37 0.53 0.90
Protability 0.13 0.09 )0.27 0.10 0.13 0.17 0.40
Volatility 0.04 0.05 <0.01 0.01 0.02 0.05 0.32
Variables VIF 1 2 3 4 5 6 7
Panel B: VIF and Pearson correlation matrix among measures of independent variables
(1) Debt Maturity 1.00
(2) Leverage 1.24 0.33*** 1.00
(3) Asset Maturity 1.06 0.10** 0.17*** 1.00
(4) Market-to-book 1.27 )0.25*** )0.40*** )0.14*** 1.00
(5) Abnormal earnings 1.02 )0.08* 0.07* 0.06* )0.05 1.00
(6) Term structure (%) 1.04 )0.01 )0.06 )0.11*** )0.08** )0.05 1.00
(7) Int-EBITDA correlation 1.01 )0.02 )0.04 )0.05 0.02 0.01 0.08* 1.00
(8) Log of rm size 1.09 0.14*** 0.18*** )0.04 )0.24*** )0.08* 0.01 0.01
Mean VIF 1.01
The table reports descriptive statistic (Panel A) and Pearson correlation (Panel B) for 976 rm-year observa-
tions between 1989 and 2006 from FinAnalysis Database. Variables are dened as: Debt Maturity is measured
by the proportion of debt maturity due in more than 1 year. Leverage is the ratio of total debt (long-term debt
plus debt in current liabilities) to market value of assets, where market value of assets is estimated as book
value of total assets less book value of common equity plus market value of common equity. Log of Firm Size
is measured by the natural logarithm of net sales (trading revenue) in millions of dollars. Dollar values are
ination-adjusted (June 2000) using Australian Consumer Price Index from International Monetary Fund
(IMF). Asset Maturity is a book value-weighted measured of asset maturity of long-term assets and current
assets, where the maturity of long-term assets is measured as gross property, plant and equipment (PP&E)
divided by depreciation expense, while the maturity of current assets is measured as current assets divided by
operating expenses. Market-to-book is measured by the market value of assets divided by the book value of
assets. Abnormal Earnings is the dierence between earning per share in year t + 1 and earnings per share in
year t scaled by the year t share price. Fixed Assets Ratio is the ratio of net property, plant, and equipment to
the book value of total assets. Protability is the ratio of earnings before interest, taxes, depreciation and amor-
tization (EBITDA) to the book value of total assets. Term Structure of interest rate is the dierence between
the month-end yields on a 10-year government bond and a 2-year government bond matched to the month of
a rms scal year end. Interest-EBITDA Correlation is measured by the correlation of rst dierences in
prime rates and EBITDA over 4 years preceding the sample year. Bond yields and prime rates are from
Reserve Bank of Australia and International Monetary Fund (IMF), respectively. Volatility is measured by
the standard deviation of rst dierences in EBITDA over the 4 years preceding the sample year, scaled by
average assets for that period. *,**,*** indicate signicance at the 5%, 1% and 0.1% levels, respectively. VIF,
Variance Ination Factors.
2011 The Authors
variables for the period 19892006. All VIF, including mean VIF, are well
below a commonly used rule of thumb of 10 so there appears to be little
threat of a multicollinearity problem among all debt maturity predictors. The
Pearson correlation matrix conrms this nding as most independent variables
demonstrate low levels of correlation. Column 1 of Table 2 shows the correla-
tion between each debt maturity predictor and debt maturity in the absence
of other debt maturity predictors. These univariate results are supportive of
our main hypothesis the monotonic relationship between leverage and
maturity. It is also supportive of the asset-maturity matching principle, debt-
equity agency costs hypothesis, signalling hypothesis and transaction costs
hypothesis.
3.4. Method
We test our hypotheses using several models to account for a broad range of
underlying assumptions regarding the eect of latent variables and error terms.
Substantial debt maturity literature utilizes ordinary least-squares (OLS) to esti-
mate the impact of all the debt maturity predictors on debt maturity in the
absence (Barclay and Smith, 1995) or presence (Stohs and Mauer, 1996) of lever-
age as a control variable. Single equation models assume that all debt maturity
predictors, especially leverage, are exogenous and that the error terms are inde-
pendent and identically distributed (i.i.d.) and unrelated to the regressors, i.e.,
E(l|X) = 0. For simple comparison with the earlier debt maturity studies, we
rst estimate the impact of all the debt maturity predictors on debt maturity
using a pooled OLS to facilitate comparison with previous literature. In pooled
OLS model results, we control for variables traditionally thought to explain
leverage.
13
If the error terms are not independent of the regressors, then the pooled-OLS
estimator is inconsistent. Johnson (2003) and Barclay et al. (2003) nd empirical
support for leverage and maturity being endogenous variables and being jointly
determined. In this study, we provide a theoretical proposition that maturity is a
function of leverage (H7). However, we do not rule out the possibility that lever-
age is also a function of maturity. We test for endogeneity of leverage using a
Dierence-in-Sargan-Hansen statistic.
14
We nd that exogeneity of leverage is
strongly rejected at the 5% level. To control for endogeneity, we also test
our hypotheses using an instrumental variables (IV) estimator as it provides a
13
When we do not control for traditional leverage determinants, we nd the results of the
pooled OLS regression are qualitatively similar.
14
This endogeneity test is robust to various violations of conditional homoscedasticity.
Under conditional homoscedasticity, this endogeneity test statistic is numerically equal to
a Hausman test statistic, see Hayashi (2000, pp. 2334).
2011 The Authors
consistent estimator under the assumptions of instrument relevance and instru-
ment validity.
15
If the instruments are not relevant, then the IV estimator becomes less ecient
and may result in a nite-sample bias.
16
We test the instruments for relevance (or
test for weak instruments) using the Cragg-Donald Wald F statistic and compare
the results with the weak ID test critical value reported by Stock and Yogo
(2005). The Cragg-Donald Wald F statistic for the instruments Z, described in
the following subsection, rejects the null hypothesis that the instruments are
weak at the 5% level of signicance.
17
To ensure that our instruments satisfy E(l|Z) = 0, we use a set of commonly
used control variables for leverage in the literature (discussed in the next subsec-
tion).
18
We also employ an overidentifying restrictions (OIR) test to test the
validity of our instruments. The OIR test does not reject the null hypothesis that
all instruments are valid. Following Greene (2002) and Kennedy (2003), we
employ IV-Generalized Method of Moments (GMM) estimators to allow for the
possibility of non-standard errors.
We test for the presence of heteroscedasticity using White/Koenkers hetero-
scedasticity test for pooled OLS and Pagan and Halls (1983) heteroscedasticity
test for IV-GMM regressions.
19
The results in pooled OLS regression signal
the existence of heteroscedasticity. Following Petersen (2009), we employ rm-
clustered standard errors for pooled OLS regression to ensure the robustness of
the standard errors. The Pagan-Hall statistic does not indicate the existence of
heteroscedasticity in IV-GMM.
15
Instrument relevance assumes that the instrumental variables, Z, are variables that are
correlated with the regressors, X, such as leverage while instrument validity assumes that
the instruments, Z, are not correlated with errors that satisfy E(l|Z) = 0 (Cameron and
Trivedi, 2009; Wooldridge, 2002).
16
Weak instruments make estimation less ecient because the IV estimator produces lar-
ger standard errors to those of the OLS estimator. Under weak instruments, standard
asymptotic theory may provide a poor approximation to the actual sampling distribution
of the IV estimator in typical nite-sample sizes (Cameron and Trivedi, 2009).
17
We repeat our analysis with limited information maximum likelihood (LIML) estima-
tion and continuously updated Generalized Method of Moments estimator (CUE) that
are more resistant to the weak instruments problems than IV methods (Hahn et al.,
2004). In unreported ndings, our results are qualitatively similar with those of LIML
and CUE.
18
For example, see Johnson (2003), Barclay et al. (2003), Datta et al. (2005) and Billett
et al. (2007).
19
Baum (2006) comments that the Pagan-Hall statistic is superior to the techniques more
commonly used (Breusch-Pagan and White tests for heteroscedasticity) in testing hetero-
scedasticity in the context of instrumental variables. That is because the Pagan-Hall statis-
tic is robust to the presence of heteroscedasticity elsewhere in a system of simultaneous
equations and to non-normally distributed disturbances.
2011 The Authors
We also test our hypotheses using an unbalanced panel Two-Stage Least
Square (2SLS) model. To test the use of xed vs. random eects in our study,
the standard Hausman test is not appropriate as we employ cluster-robust stan-
dard errors for the Two-Stage Least Square Random Eects (2SLS-RE) estima-
tor. We employ the Sargan-Hansen test to examine whether the extra
orthogonality conditions imposed by the Random Eects (RE) estimator are
valid. This test implies that a 2SLS-RE estimator is more appropriate than a
2SLS-FE (xed eects) estimator.
Furthermore, we employ a Three-Stage Least Squares (3SLS) regression model
to account for both dependent regressors and cross-equation correlation of the
errors. Under these assumptions, and if the errors are homoscedastic, 3SLS is a
more ecient estimator than 2SLS. Here, Pagan-Halls test of heteroscedasticity
in the IV-GMM indicates that the errors are not heteroscedastic so we include
the more ecient estimator (3SLS) in our results. Finally, we include year
dummy variables in all our regressions to control for the eects of latent macro-
economic event shock factors.
3.4.1. Proxies for the instrumental variable leverage
The control variables for leverage used in the system of simultaneous equa-
tion are size, growth, abnormal earnings, xed-assets ratio, protability and
volatility. Larger rms (size) are likely to face lower asymmetric information
problems; hence, they might use more equity than debt (Myers and Majluf,
1984). Firms with high growth opportunities should use lower leverage to
avoid underinvestment problems (Rajan and Zingales, 1995). The inclusion of
abnormal earnings is used to control for signalling eects in leverage choices
(Ross, 1977).
The xed-assets ratio is dened as net property, plant and equipment divided
by the book value of assets in the leverage equation. Firms with more tangible
assets are able to increase their optimal leverage as they face less risk shifting
problems and normally carry higher liquidation values (Harris and Raviv, 1990;
Williamson, 1988).
Protability is dened as the ratio of earnings before interest, taxes, depre-
ciation and amortization (EBITDA) to book value of assets. This is used to
control for changes in leverage ratio resulting from the dynamic pecking
order theory (Donaldson, 1961; Myers and Majluf, 1984). This theory implies
that protable rms will rst use their internal funds (the cheapest source of
nancing because of lowest asymmetric information) than external funds (debt
and equity) to nance their new projects. Hence, protable rms use less
debt.
Volatility is measured by the standard deviation of rst dierences in EBITDA
over the 4 years preceding the sample year scaled by average assets for that per-
iod (Johnson, 2003). Firms with high volatile earnings use less debt (Bradley
et al., 1984).
2011 The Authors
4. Results
The results of the relationships between debt maturity predictors and debt
maturity for pooled OLS regression, 2SLS Random Eects (2SLS-RE), Three-
stage Least Squares (3SLS) and Instrumental Variable-Generalized Method of
Moments (IV-GMM) are presented in Table 3. Our pooled OLS regression
provides support for the monotonic leveragematurity relationship (H7: the
risk-premium minimization argument) in Australia rms. Under a similar
methodology, where leverage is assumed to be exogenous, Stohs and Mauer
(1996) also nd support for the monotonic leveragematurity relationship (H7)
in US rms. The pooled regression support for the risk-premium minimization
argument is consistent with the empirical ndings of Stohs and Mauer (1996).
Based on our pooled regression results, we do not nd support for the match-
ing principle, agency costs hypothesis or transaction costs hypothesis. As such,
these ndings dier from those of Stohs and Mauer (1996). Given that Austra-
lian rms are heavily reliant on bank debt and that Australian long-term debt
markets are relatively illiquid in Australia, our results are likely to be reections
of the conditions of the Australian capital market. Another reason for this nd-
ing could be because Australian rms use less debt since the introduction of the
Australian imputation system, hence, there are fewer overhang problems. It is
worth noting when we reestimate pooled OLS regression without inclusion of
leverage and leverage controls, we nd support for the matching principle,
agency costs hypothesis and transaction costs hypothesis (more discussion in
Section 5.2.) that are consistent with those of Barclay and Smith (1995). This
nding is further conrmed by the endogeneity test for leverage. As a result, we
focus the rest of our discussion on the results of the system of equations esti-
mated by 2SLS-RE, 3SLS and IV-GMM, all of which control for endogeneity.
The results produced by all of these alternative approaches are qualitatively simi-
lar to each other in terms of both the coecients and signicance levels.
The monotonic relationship between leverage and maturity, suggested by the
risk-premium minimization argument in Section 2.2, is strongly supported across
all regressions by the empirical data. The empirical results are robust to dierent
estimation methodologies that allow for the possibility of the endogeneity of
leverage and maturity. Indeed, after controlling for the endogeneity issue, the
coecient on leverage in the model has substantially increased indicating that
maturity policy is more sensitive to leverage than previously thought.
The risk-premium minimization hypothesis motivating the monotonic
leveragematurity relationship relies upon simple Merton assumptions, and is
therefore not market specic. Accordingly, we expect this result to also be sup-
ported in other capital markets. Indeed, Stohs and Mauer (1996), Johnson
(2003) and Datta et al. (2005) all support the positive monotonic relationship
between leverage and maturity in the United States. Antoniou et al. (2006) also
support this hypothesis for rms in France, Germany and the UK. However,
because the Australian capital market does not provide liquid long-term debt,
2011 The Authors
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2011 The Authors
our ndings are likely to conservatively underestimate the true strength of the
leveragematurity relationship.
Leland and Toft (1996) argue that debt maturity determines the optimal lever-
age. Our 3SLS regression results not only show support for this reverse causality
but also show support for the risk-premium minimization argument (H7). It is
worth noting that the relationship between leverage and maturity is still a
positive monotonic function.
In this study, the risk-premium minimization hypothesis and the signalling
hypothesis are the only two debt maturity theories supported across all estima-
tion methods. There is no support for other traditional debt maturity theory in
Australia. These results imply that leverage and abnormal earnings are the major
determinants of maturity of Australian rms. Our results suggest that Australian
rms try to minimize the risk premium by issuing long (short) term debt when
they are highly (lowly) levered. High-quality Australian rms also try to signal
their quality to the market by issuing short-term debt when the costs of mimick-
ing this strategy are too high for low quality rms.
Interestingly, the most commonly cited debt maturity theory, maturity match-
ing, is not supported in any of the regressions. There is no evidence to suggest
that the xed assets of Australian rms are nanced by debt with longer term to
maturity and that current assets are nanced using short to medium debt after
controlling for other factors and endogeneity. This Australian matching principle
nding is a substantial point of dierence between Australian rms and the nd-
ings of the US studies of Johnson (2003), Barclay et al. (2003), Stohs and Mauer
(1996) and Guedes and Opler (1996).
20
Our results are likely to be reections of the conditions of the Australian market
in that Australian rms face substantial diculty in accessing long-term debt
instruments in the Australian capital market. Given that the average asset matu-
rity of our sample (9.55 years in Table 2) is smaller than the average Australian
Table 3 (continued)
The table shows the regression results from four dierent estimation methods: Ordinary Least Squares
(OLS), Two-stage Least Square Random Eect (2SLS-RE), Three-stage Least Squares (3SLS) and Instru-
mental Variable-Generalized Method of Moments (IV-GMM). All results are based on 976 rm-year obser-
vations between 1989 and 2006. Leverage is the ratio of total debt (long-term debt plus debt in current
liabilities) to market value of assets. All other variables are dened in Table 2. Standard errors adjusted for
clustering by rms are used when heteroscedasticity test indicates the presence of heteroscedasticity. Test of
endogeneity of leverage (Dierence-in-Sargan-Hansen Statistic) examines the null hypothesis that leverage
is an exogenous variable. Test of overidentifying restriction examines the null hypothesis that all instru-
ments are valid. Sargan-Hansen test (robust to clustered standard errors) examines the null hypothesis that
the extra orthogonality conditions imposed by the RE estimator are valid. Test of weak instruments exam-
ines the null hypothesis that the instruments are weak at 5% level of signicance. Standard errors are
reported in parentheses. *,**,*** indicate signicance at the 5%, 1% and 0.1% levels, respectively (two-
tailed). EBITDA, earnings before interest, taxes, depreciation and amortization.
20
Our results are unlikely to be driven by outliers, as our results are robust to dierent
degrees of trimming or winsorizing of two tails of the distribution from 1% to 5%.
2011 The Authors
corporate debt maturity of four to six years as reported by Battellino and Cham-
bers (2006), the mismatching between debt maturity and asset maturity in Austra-
lia is a reection of the conditions of the Australian capital market. Our ndings
are consistent with Kolbs (1987) suggestion that most rms might nd it too risky
to have a current ratio that is close to one, as implied by the matching principle.
One might argue the lack of support for the matching principle could be
caused by the eect of mismatching on our measurement of debt maturity and
asset maturity. Asset maturity is measured in number of years while debt matu-
rity is measured as a ratio which is bounded between zero and one. Although
our debt maturity measurement (proxied by proportion of debt that is due in
more than 1 year) is not able to distinguish the actual debt maturity pattern in
terms of years, it is able to tell if debt maturity has increased.
None of our regressions support the agency costs hypothesis once leverage is
controlled. These results are inconsistent with the ndings of US studies by John-
son (2003), Barclay et al. (2003) and Stohs and Mauer (1996). Two possible
explanations exist for these results: (i) debtholders do not use short-term debt to
mitigate debt-equity conicts in Australian rms, and/or (ii) Australian rms
face lower agency costs than US rms. Given most Australian rms heavily rely
on bank debt that is associated with increased monitoring of the rms actions,
we expect agency costs to be lower for Australian rms. Our results in the lever-
age equation of 3SLS are consistent with the results of Brailsford et al. (2002)
who nd that Australian rms use less debt to reduce debt-equity conicts.
Accordingly, we suggest that the lack of signicance for the agency costs hypoth-
esis is more likely to be the rst of these two explanations. Our results imply that
when choosing a method to mitigate underinvestment problems, Australian rms
utilize leverage in preference to debt maturity. Given that we have clearly estab-
lished a functional link between leverage and maturity, it is not surprising that
the agency costs hypothesis is not supported in the maturity equation.
Debt maturity is not the sole debt-related method available to rms to reduce
agency costs. Firms can also reduce agency costs (underinvestment problem) by
reducing leverage or by attaching restrictive debt covenants to the debt issue.
When leverage is high, restrictive debt covenants will help mitigate agency costs
as well as reduce the cost of debt. Given that almost all debt issued in Australia
is issued with debt covenants (Cotter, 1998), it is not surprising that the agency
costs hypothesis is not signicant once leverage is included in the model.
We nd strong support for the signalling hypothesis, proxied by abnormal earn-
ings. Previous empirical examinations of the signalling hypothesis are mixed and
country specic. The signalling hypothesis is supported in US studies by Stohs
and Mauer (1996) and Scherr and Hulburt (2001) but not supported in other inter-
national studies, including Ozkan (2000, 2002), and Antoniou et al. (2006). The
support for the signalling hypothesis is likely to be a reection of the conditions of
the Australian market. Given that Australian rms are subject to close and strong
monitoring by banks for their heavy use of bank debt, it is costly for low quality
rms to mimic the action of high-quality rms by issuing short-termdebt.
2011 The Authors
The lack of support for the term structure hypothesis is consistent with the
empirical results of Johnson (2003) and Stohs and Mauer (1996) who both con-
trol for leverage. When leverage is not included in the model, Barclay and Smith
(1995) nd a statistically signicant (but not economically signicant) positive
relationship between term structure and maturity while Guedes and Opler (1996)
nd a statistically negative relationship between term structure and maturity.
It is feasible that the interest rate risk hypothesis is not supported because the
increasing use of exchange traded interest-rate hedging instruments. Australian
rms may use these interest rate hedges in preference to the debt maturity hedge
to manage interest rate risk. Recently, Benson and Oliver (2004), in a survey of
the top 500 (by market capitalization) listed Australian companies, found that
no respondents use non-derivative means to hedge interest rate risk. This nding
further suggests that the relationship between debt maturity and the correlation
between interest rate risk and rm cash ows is no longer useful for Australian
rms.
Our examination provides little support for the transaction costs hypothesis in
all regressions. Given that Australian rms heavily rely on bank debt that is
reported by Blackwell and Kidwell (1988) to have lower transaction/oatation
costs than public debt, it is not surprising that Australian rms have less incen-
tive to minimize transaction costs associated with bank debt borrowing. Further-
more, the set-up costs across dierent maturities are often not signicantly
dierent from each other. The results are consistent with our expectation that
only rms that rely more on public debt oerings will have more incentive to
minimize the high transaction costs associated with public debt oerings. Hence,
the lack of support for the transaction costs hypothesis is a reection of the
conditions of the Australian market.
5. Robustness checks
5.1. Alternative measures of leverage
As we use book leverage (measured by total debt to total assets) to calculate
the default-risk premium in Section 2.2., we repeat all our analyses using book
leverage. Following Rajan and Zingales (1995), we also repeat our analysis with
alternate measures of leverage debt to capital, where capital is the sum of book
value of debt and (book/market) equity. We include these alternate results in
Table 4. The results show our ndings are robust there remains strong support
for the positive leveragematurity relationship and the signalling hypothesis.
5.2. Alternative specications
Table 5 shows that our baseline IV-GMM results from Table 3 in column (1)
are robust to alternative specications in columns (24). We vary the basic speci-
cation in column (1) by: (2) changing our term structure measurement from the
2011 The Authors
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2011 The Authors
dierence between 10-year and 2-year government bond yields to the dierence
between 10-year government bond yields and 3-month treasury bill yield); (3)
excluding year dummies; (4) controlling for industry eects. We also compare
our baseline IV-GMM results with debt maturity results that do not control for
endogeneity of leverage in columns 5 and 6. Column 5 excludes leverage mea-
surements from the pooled OLS regression. Column 6 further excludes leverage
controls from column 5.
5.2.1. Alternative measure of term structure of interest rate
Ideally, we would like to proxy short-term yields by the yield on 3-month
treasury bills rather than 2-year government bonds. Doing this will result in the
loss of 33% of our observations because the Reserve of Bank of Australia did
not issue treasury bills between June 2002 and February 2009. For robustness,
we repeat our analysis using the yield on 3-month treasury bills as the proxy
for short-term yields and obtain qualitatively similar results (column 2 of
Table 5).
5.2.2. Year eects
It is possible that the inclusion of time dummies might explain the lack of sup-
port for the term structure hypothesis. Time dummies are designed to capture
macroeconomic events, but they might have captured the shock from term struc-
ture of interest rate. When we exclude time dummies in the model (column 3 of
Table 5), the term structure hypothesis still does not seem to play an important
role in determining debt maturity choices. Again, our results are consistent with
the argument that Australian rms have less incentive to take advantage of inter-
est tax shields across dierent debt maturities.
Table 4 (continued)
The table shows our baseline results in column (1) with alternative leverage denitions in columns
(24) from the estimation method of Instrumental Variable-Generalized Method of Moments (IV-
GMM). In the book column, equity is measured at book value. In the market column, equity is
measured at market value. Market value of assets is estimated as book value of total assets less book
value of common equity plus market value of common equity. Capital is the sum of the book value
of debt and (book/market) equity. The other variables are dened in Table 2. We repeat our analysis
with alternative leverage denitions. Year dummies are included in all results. Standard errors
adjusted for clustering by rms are used when heteroscedasticity test indicates the presence of hetero-
scedasticity. Test of endogeneity of leverage (Dierence-in-Sargan-Hansen Statistic) examines the
null hypothesis that leverage is an exogenous variable. Test of overidentifying restriction examines
the null hypothesis that all instruments are valid. Test of weak instruments examines the null hypoth-
esis that the instruments are weak at 5% level of signicance. Standard errors are reported in paren-
theses. *,**,*** indicate signicance at the 5%, 1% and 0.1% levels, respectively (two-tailed).
EBITDA, earnings before interest, taxes, depreciation and amortization.
2011 The Authors
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2011 The Authors
5.2.3. Industry eects
To rule out the possibility that our results are driven by certain industries, we
include industry dummies in our model. Table 5 (column 4) shows that our
results are not aected by the inclusion of industry eects.
5.2.4. Alternative explanation endogeneity issue
Given that the debt overhang problem can be mitigated by reducing debt
ratios and/or observing the matching principle, the lack of support for the
matching principle might result from the endogeneity between leverage and
maturity. We further examine the possibility of the endogeneity issue by exclud-
ing leverage and leverage controls in the maturity equation, similar to the setting
of Barclay and Smith (1995). Table 5 (column 6) shows support for the matching
principle when endogeneity is not controlled for and leverage is not included in
the model. These results suggest that ignoring the theory that links maturity and
leverage can lead to an erroneous conclusion for the support of the matching
principle.
21
Some international studies such as Barclay and Smith (1995) and Guedes and
Opler (1996) do nd support for the agency costs hypothesis but only when
leverage is not included as a control variable. We only nd support for the
agency costs hypothesis when leverage is not included in the debt maturity equa-
Table 5 (continued)
The table shows our baseline results in column (1) with alternative specications in columns (26). We
vary the basic specication in column (1) by: (2) changing our term structure measurement from the dif-
ference between 10-year and 2-year government bond yields to the dierence between 10-year govern-
ment bond yields and 3-month treasury bill yields; (3) excluding year dummies; (4) controlling for
industry eects; (5) excluding leverage measurement from the pooled Ordinary Least Squares (OLS)
regression in Table 3; (6) excluding leverage measurement and leverage controls from the pooled OLS
regression. Leverage is the ratio of total debt (long-term debt plus debt in current liabilities) to market
value of assets. All other variables are dened in Table 2. Standard errors adjusted for clustering by
rms are used when heteroscedasticity test indicates the presence of heteroscedasticity. Test of endoge-
neity of leverage (Dierence-in-Sargan-Hansen Statistic) examines the null hypothesis that leverage is
an exogenous variable. Test of overidentifying restriction examines the null hypothesis that all instru-
ments are valid. Test of weak instruments examines the null hypothesis that the instruments are weak at
5% level of signicance. Standard errors are reported in parentheses. *,**,*** indicate signicance at
the 5%, 1% and 0.1% levels, respectively (two-tailed). EBITDA, earnings before interest, taxes, depre-
ciation and amortization; GMM, Generalized Method of Moments.
21
Using a single equation model, the studies of Stohs and Mauer (1996) and Guedes and
Opler (1996) nd support for the matching principle in the United States. After control-
ling for endogeneity issues with system of equations, some recent US debt maturity stud-
ies (Billett et al., 2007; Datta et al., 2005; Dennis et al., 2000), with the exception of
Johnson (2003) and Barclay et al. (2003), do not nd support for the matching principle.
2011 The Authors
tion (see columns 5 and 6 of Table 5). This erroneous conclusion supporting the
agency costs hypothesis is consistent with the omitted variable (leverage) criti-
cism from Stohs and Mauer (1996). These ndings suggest that Australian rms
may seek alternate means of mitigating debt-equity conicts such as using lower
leverage and/or restrictive debt covenants.
The lack of support for the transaction costs hypothesis might be attributed to
the endogeneity of leverage. If we do not control for leverage and the endogene-
ity problem, column 6 of Table 5 shows support for this transaction costs
hypothesis in the pooled OLS regression, and these results are consistent with
those of Barclay and Smith (1995) and Guedes and Opler (1996). Our ndings
suggest that ignoring the interaction between maturity and leverage can induce
misleading support for the transaction costs hypothesis.
6. Summary and conclusion
In this paper, we examine the determinants of debt maturity in the Austra-
lian capital market using a sample drawn from the Top 400 rms listed on the
Australian Securities Exchange for the period 19892006. We use Mertons
(1974) model to predict a monotonic relationship between leverage and matu-
rity. We nd support for this monotonic relationship between leverage and
maturity. Our results are robust to dierent estimation methods that control
for endogeneity and error-dependence. We also nd that ignoring the interac-
tion between maturity and leverage can lead to erroneous conclusions for the
support of the matching principle, agency costs hypothesis and transaction
costs hypothesis. After controlling for leverage, none (except signalling hypoth-
esis) of the traditional theories of debt maturity, including the matching princi-
ple, agency costs hypothesis, term structure hypothesis, interest rate risk
hypothesis and transaction costs hypothesis are supported by the empirical
data. This lack of support for the matching principle is perhaps the most
surprising result.
The lack of support in our empirical analysis for many traditional debt
maturity theories, except the positive leveragematurity relationship and the
signalling hypothesis, is likely a reection of the conditions of the Australian
capital market, namely (i) the Australian dividend imputation tax system, (ii)
the heavy reliance on bank debt for Australian rms and (iii) the relatively
smaller and illiquid Australian debt market. Since the introduction of the divi-
dend imputation tax system, Australian rms have reduced their leverage
(Twite, 2001), removing the cause of the debt overhang problem. It is then not
surprising that we do not nd support for Australian rms utilizing short-term
debt to mitigate the debt overhang problem. These ndings, together with those
of Twite (2001), suggest that the capital structure choice (both leverage and
maturity) of local rms are tailored to the specics of the Australian capital
marketplace.
2011 The Authors
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