Debt Specialization

Abstract

This paper examines debt structure using a new and comprehensive database on types of debt employed by public U.S. firms. We find that 85% of the sample firms borrow predominantly with one type of debt, and the degree of debt specialization varies widely across different subsamples-large rated firms tend to diversify across multiple debt types, while small unrated firms specialize in fewer types. We suggest several explanations for why debt specialization takes place, and show that firms employing few types of debt have higher bankruptcy costs, are more opaque, and lack access to some segments of the debt markets.

Capital Structure and Debt Priority

“…In addition, firms presenting a large probability of default due to very high leverage specialize their debt structure. However, in contrast to Colla, Ippolito, and Li () and Rauh and Sufi (), who find that high credit quality firms largely favor senior bonds, our results indicate that as credit quality (measured by total debt and/or asset volatility) improves, the firm relies more on subordinated debt. One plausible explanation for this discrepancy is that in both empirical studies, firms use other forms of debt, including bank loans, inducing a strategic debt service that is ignored in this paper.…”

“…Our results are partially consistent with the empirical findings of Colla, Ippolito, and Li () and Rauh and Sufi (). This evidence suggests, as our model predicts, that firms with low and medium credit quality (large junior coupon, high asset volatility, intermediate leverage) spread their debt priority.…”

“…Beyond some leverage level, only senior debt is optimally issued. This result is supported empirically by Colla, Ippolito, and Li (), who find that firms have a high degree of debt specialization when the volatility of their operational cash flows is high.…”

“…Rauh and Sufi () observe that rated firms simultaneously issue debt with different types and priorities and that the number of debt classes depends markedly upon these firms’ credit standing. Additionally, in a large data set of rated and unrated publicly listed firms, Colla, Ippolito, and Li () report that the sample mean ratios for senior and subordinated bonds over total debt are approximately 40% and 10%, respectively. Moreover, a growing body of theoretical research acknowledges and attempts to explain debt heterogeneity and priority structure.…”

Does the source of debt financing affect default risk?

“… To build the Capital IQ‐based sample, we apply the following rules: (1) We merge the main analysis sample with the Capital IQ database and remove firm–years for which the difference between total debt reported in Compustat and the sum of debt types reported in Capital IQ exceeds 10% of total debt (see Colla, Ippolito, & Li, ); (2) when the bank debt‐to‐total debt ratio or public debt‐to‐total debt ratio is larger 100%, it is replaced with 100%; (3) we remove observations in which the sum of bank and public debts is greater than total debt; (4) when bank and public debt data are both missing, we replace them with zeros; and (5) if the bank debt‐to‐total debt ratio is missing but the public debt‐to‐ total debt is not missing, or vice versa, we replace the missing value with the difference between 100% and the non‐missing value. …”