The Determinants of Long‐Term Corporate Debt Issuances

• Author: DOMINIQUE C. BADOER,CHRISTOPHER M. JAMES
• DOI: http://doi.org/10.1111/jofi.12264
• Published date: 01 February 2016
• Date: 01 February 2016

THE JOURNAL OF FINANCE •VOL. LXXI, NO. 1 •FEBRUARY 2016

The Determinants of Long-Term Corporate Debt

Issuances

DOMINIQUE C. BADOER and CHRISTOPHER M. JAMES∗

ABSTRACT

A significant proportion of the debt issued by investment-grade firms has maturities

greater than 20 years. In this paper we provide evidence that gap-filling behavior is

an important determinant of these very long-term issues. Using data on individual

corporate debt issues between 1987 and 2009, we find that gap-filling behavior is

more prominent in the very long end of the maturity spectrum where the required

risk capital makes arbitrage costly. In addition, changes in the supply of long-term

government bonds affect not just the choice of maturity but also the overall level of

corporate borrowing.

WHILE THE AVERAGE MATURITY of corporate borrowing is about five years, com-

panies sometimes issue very long-term bonds not tied to a particular tangible

asset. Perhaps the best known example is Walt Disney Company’s 100-year

(callable after 30 years) $300 million senior subordinated debenture issue in

1993 dubbed “Sleeping Beauty” bonds.1More recently, Apple issued $3 billion

in 30-year fixed rate bonds in 2013.2While 100-year bonds are rare, unse-

cured bond offerings with maturities of more than 20 years are common. For

example, between 1987 and 2009, 472 firms covered by Compustat made 1,620

unsecured bond offerings with maturities of more than 20 years and a total face

∗Dominique C. Badoer is at the University of Missouri and Christopher M. James is at the Uni-

versity of Florida. We thank two anonymous referees, Kenneth Singleton (Editor), David Brown,

Sarah Hamersma, Jonathan Hamilton, Joel Houston, Andy Naranjo, Michael Roberts, and seminar

participants at the Banking Conference at Universit`

a Bocconi, the IAES Conference (Montr´

eal),

and the University of Florida for helpful comments. The authors have read the Journal of Finance’s

disclosure policy and have no conflicts of interest to disclose.

1While the offering was well received, some analysts voiced concerns over the risk asso-

ciated with long-term issues. For example, William Gross of Piper Capital Management was

quoted as saying “It’s crazy, look at the path of Coney Island over the last fifty years and see

what happens to amusement parks” (Thomas T. Vogel, “Disney amazes investors with sale

of 100-year bonds” The Wall Street Journal, July 21, 1993, p.61). More recently, in mid-2010

several 100-year bonds were issued purportedly in response to very low long-term rates. See

http://www.bloomberg.com/news/2010–08–23/yield-hunt-driving-demand-for-longest-maturity-

debt-sales-credit-markets.html.

2The Wall Street Journal commented on Apple’soffering, stating “Thirty years ago, the internet

was in its infancy, the Macintosh didn’texist, and you might have purchased a handful of Porsche

944s for the cost of one gigabit worth of computer storage. Thirty years from today,it’s pretty much

impossible to project what the technology landscape will look like” (Rolfe Winkler, “Even Apple’s

crystal ball has clouds”, May 1, 2013, p. 46).

DOI: 10.1111/jofi.12264

457

458 The Journal of Finance R

value (in 2009 dollars) of $590 billion (the median maturity of these long-term

offerings was just over 30 years). Virtually all of these issuers were also active

in the short end of the maturity spectrum and regularly issued debt with ma-

turities of less than five years. As we outline below, very long-term unsecured

debt issues and significant year-to-year variation in the maturity of issues are

difficult to explain in the context of contracting cost theories of maturity choice

in which the average maturity of assets and the importance of growth options

drive debt maturity choice.3

In this paper we examine the determinants of long-term debt issues using

a data set of bond issues and bank borrowing by public firms during the 1987

through 2009 period. We address three related questions. First, to what extent

are very long-term corporate debt issues a response to changes in credit mar-

ket conditions, such as changes in the maturity composition of U.S. Treasury

debt or changes in the term structure of interest rates? Second, what types of

borrowers have the greatest supply elasticity with respect to changes in credit

market conditions? Third, to what extent do changes in the maturity compo-

sition of Treasury bonds and the term structure of interest rates affect the

propensity of firms to issue debt?

Our analysis is motivated by recent work by Greenwood, Hanson, and Stein

(2010, hereafter GHS) on “gap filling” and corporate debt maturity choice. GHS

develop a theory in which corporate issuers respond to shocks in the supply of

short- and long-term Treasury bonds. The basic idea is that important classes

of investors, such as pension funds and insurance companies, have a preference

for relatively safe long-term assets. Given a shock to the supply of long-term

government bonds, the cost and availability of risk capital limits the ability

of arbitrageurs to fill the gap. As a result, bond yields can stray from the

yields implied by the expectations hypothesis. Corporate issuers, particularly

those with investment-grade credit ratings, attempt to exploit differences in

the expected return on short- versus long-term bonds leading to supply shifts

in the long-term corporate market offsetting changes in the supply of long-term

government bonds.

We hypothesize that gap filling is likely to be a more important determinant

of very long-term corporate borrowing (20 years or more) than shorter-term

borrowing, for at least two reasons. First, the gap-filling hypothesis is based

on highly rated corporate issuers having a comparative cost advantage in ar-

bitraging rate differences arising from shifts in the maturity composition of

government debt. An important factor affecting the cost of arbitrage activity is

the amount of capital arbitrageurs must commit to a position and the amount

of capital available to them. Capital constraints include limits on leverage and

costs of raising external equity.4Given capital constraints, arbitrage costs are

likely to vary directly with the amount of risk capital needed. The amount of

3See, for example, Myers (1977), Barclay and Smith (1995), and Guedes and Opler (1996)for

discussions of agency cost explanations of maturity choice.

4See Gromb and Vayanos(2010) for a survey of the theoretical literature on financing constraints

and the limits of arbitrage.

Long-Term Corporate Debt Issuances 459

Tabl e I

Annual Implied Price Volatilities

This table presents the annual means of daily implied volatilities associated with the correspond-

ing futures on U.S. Treasury securities. Daily implied volatilities for the underlying securities are

calculated from a weighted average of the volatilities of the two closest call options. For all secu-

rities, the contract used is the closest pricing contract month that is expiring at least 20 business

days from the corresponding observation date. 20-year Treasury bond futures refer to U.S. Trea-

sury bonds that, if callable, are not callable for at least 15 years from the first day of the delivery

month or, if not callable, have a maturity of at least 15 years from the first day of the delivery

month. 10-year Treasury note futures refer to futures on notes maturing at least 6 1/2 years, but

not more than 10 years, from the first day of the delivery month. 5-year Treasury note futures refer

to U.S. T-notes that have an original maturity of not more than five years and three months and

a remaining maturity of not less than four years and two months as of the first day of the delivery

month. 2-year Treasury note futures refer to futures on U.S. Treasury notes that have an original

maturity of not more than five years and three months and a remaining maturity of not less than

one year and nine months from the first day of the delivery month but not more than two years

from the last day of the delivery month.

20-Year 10-Year 5-Year 2-Year

1994 10.42 7.45 4.95 1.94

1995 9.41 6.65 4.59 2.17

1996 9.98 6.75 4.72 2.03

1997 8.83 5.48 3.73 1.68

1998 8.66 5.71 4.09 2.06

1999 8.82 6.05 4.18 3.05

2000 9.32 6.52 4.13 1.60

2001 9.46 7.10 4.76 2.19

2002 10.98 7.93 5.47 2.15

2003 12.04 8.04 5.38 2.02

2004 10.01 6.92 4.70 1.87

2005 8.08 5.10 3.41 1.42

2006 6.79 4.25 2.86 1.26

2007 7.32 5.10 3.74 1.78

2008 13.5 9.22 6.68 3.00

2009 15.6 8.95 5.46 1.76

Total Average 9.97 6.71 4.56 1.97

N3,969

risk capital needed is likely to vary in turn with the price volatility associated

with a position. As shown in Table I, the average daily implied price volatility

of Treasury bonds increases with their maturity, with the implied price volatil-

ity associated with 20-year Treasury bonds averaging over five times the daily

price volatility of two-year bonds. Thus, for any value at risk (VAR) level the

amount of risk capital required for trades in very long-term Treasuries is orders

of magnitude larger than in the short end of the market.

The second reason we expect gap filling to be an important determinant of

long-term issues is that very long-term issues are difficult to explain in the

context of agency cost theories of maturity choice, which predict that issuers

will match the maturity of their liabilities to the maturity of their assets (see

Myers (1977)). In our sample, long-term issues (20+years) average 30 years