This study examines the relationship between debt maturity, leverage and firm value. This examination extends models of risky debt such as those suggested by Merton (1974) and Black and Cox (1976) to incorporate Debt Covenants and Bankruptcy Costs. The theoretical analysis demonstrates that debt maturity is a quadratic function of leverage. Consequently, the capital structure puzzle is a multidimensional, rather than a univariate, problem.
This study tests these theoretical analyses via an empirical examination of the determinants of firm capital structure in the current market and regulatory framework of Australia. The inter-relationship between debt maturity, leverage and firm value is examined using data from 177 mature Australian firms, listed on the Australian Stock Exchange over the period 1996 to 2005. The empirical analysis provides strong support for the predicted quadratic relationship between debt maturity and debt leverage. This finding holds after controlling for tax, financial distress, investment and profitability, which are suggested by Classical Trade-off Theory and Pecking Order Theory, and for several different measures of leverage and debt maturity.
We also take advantage of recent corporate tax reductions to examine the marginal effect of taxation on these findings. Two corporate tax reductions were introduced, in 2001 and in 2002; hence the 10 year sample period is divided into 1996 to 2000 and 2001 to 2005. We find that these tax effects have an impact on the variables of our study. Most significantly, we find that the liabilities-based measure of leverage, (L/V)2, is no longer a good predictor of debt maturity in the new tax regime. This result suggests that debt covenants are the driver for the quadratic relationship between debt maturity and debt leverage (as opposed to liability-based leverage).