Can Managers Successfully Time the Maturity Structure of Their Debt Issues?

Abstract

This paper provides a rational explanation for the apparent ability of managers to successfully time the maturity of their debt issues. We show that a structural break in excess bond returns during the early 1980s generates a spurious correlation between the fraction of long-term debt in total debt issues and future excess bond returns. Contrary to Baker, Taliaferro, and Wurgler (2006) , we show that the presence of structural breaks can lead to nonsense regressions, whether or not there is any small sample bias. Tests using firm-level data further confirm that managers are unable to time the debt market successfully. Copyright 2006 by The American Finance Association.

Interest rate changes and the timing of debt issues

“…1 provides an overview of interest rates and quantities of debt issued on a monthly basis during our sample period. Interest rates peaked in the early 1980s at the same time that inflation in the US was very high, as discussed by Butler et al (2006a). The graphical results indicate a general tendency for debt issuances to follow rate declines.…”

“…For the sample of public debt, for which we have continuous data since 1970, the percent of callable issues peaks at 88.6% in 1981, the year with the highest average yield on 10-year government bonds of 13.9% and the highest average yield to maturity on new issues of 15.8%. This corresponds with the timing of a structural change identified by Butler et al (2006a). Table 1 provides an overview of the average issue characteristics of our sample.…”

“…Baker et al (2003) examine annual data and conclude that corporations time the bond market by the choice of short-term debt versus long-term debt, and they state that ''[t]he maturity of new debt issues predicts excess bond returns." 1 Butler et al (2006a) present evidence that the apparent timing found by Baker, Greenwood, and Wurgler is a form of ''pseudo market timing" (see Schultz, 2003) because it is no longer found in the annual data once they adjust for structural changes in the interest rate environment. 2 We provide new evidence regarding debt market timing by examining a large detailed sample of new corporate public debt issues, private placements, Rule 144A issues and bank loans over the 1970 to 2006 period.…”

“…The Baker et al (2003) and Butler et al (2006a) studies both use aggregate annual data from the Federal Flow of Funds databases to compare short-term and long-term corporate debt. Baker et al (2003) recognize that their data have a number of limitations.…”

“…To reflect the structural break in the interest rate environment identified by Butler et al (2006a), we include a dummy variable set equal to one for months after December 1981, zero otherwise. We also control for the term spread, credit spread, and return experienced by the market.…”