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Unformatted text preview: d can maintain a stronger bargaining position
when renewing the loan contracts (Rajan (1992)). By having the power to withdraw continued 13 ﬁnancing, banks can inﬂuence the ﬁrm’s management decisions over investment policy. Also,
shorter maturities limit the period over which an opportunistic ﬁrm can exploit its creditors
without defaulting. In the worse case, with short term debt, banks can pull their capital out at
any indication of trouble (Diamond and Rajan (2000)).
Following the literature, we include ﬁve variables to control for ﬁrm speciﬁc characteristics.
First, we include the natural logarithm of assets (Log (assets) ) as a measure of ﬁrm size. According to the ﬁnancial structure decision literature, size might be positively associated with
reputation as well as the level of the ﬁrm speciﬁc information that is disclosed to public (Diamond (1991b)). Also, larger ﬁrms are likely to be more diversiﬁed and hence have less chance
of going into ﬁnancial distress than smaller ﬁrms. Further, larger ﬁrms tend to have easier
access to other ﬁnancial markets and institutions (Demirg¨¸-Kunt and Maksimovic (1999)).
Accordingly, ﬁrm size is likely to be positively correlated with the level of long term debt.
Second, we include the ratio of the market to the book value of total assets (M-B ratio ) as
a proxy for future investment opportunities. The debt maturity structure literature suggests
that ﬁrms with high growth prospects are susceptible to under-investment and over investment
problems. This under-investment problem arises in ﬁrms with debt outstanding (Myers (1977)).
Managers tend to pass up their investment opportunities because risky debt captures part of
any proﬁtable future investment returns. On the other hand, the over-investment problem arises
because of limited liabilities (Jensen and Meckling (1976)). Firms have incentives to invest in
risky projects with low or even negative expected payoﬀ because if the projects pay oﬀ, they
capture most of it, whereas if the projects do not pay oﬀ, their losses are bounded by limited
liabilities. Short term debt might mitigate this problem since the debt contract comes up for
negotiation before completion of the projects. Hence the creditors can monitor the operation
and investment decisions of the ﬁrms. Thus we predict a negative relation between growth
opportunities and long term debt.
Third, we also include the ratio of net ﬁxed assets to total assets (Fixed asset ratio ) in the
model to capture the eﬀect of collateral on the use of long term loans. Investment in ﬁxed
assets is also relatively less diﬃcult to observe and verify by outside investors compared to
investment in intangible assets. Hence the information asymmetries are relatively low in ﬁrms
with a high ratio of ﬁxed assets. Accordingly, a high ﬁxed ratio is expected to be positively
related to long term borrowing capacity. The ﬁxed asset ratio can also be used to control for the
maturity matching eﬀect on ﬁnancing structure . Stohs and M...
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- Fall '13