Cyclical Demand and the Choice of Debt Maturity

Abstract

This study provides a model in which a supplier’s use of short‐ and long‐term debt depends on the demand for its product. The model predicts that suppliers use short‐term debt to match their assets' and liabilities' maturities and that their incentive to do so is stronger, the larger the term premium. The model also predicts that the use of short‐term debt increases the amplitudes of the supplier’s investment, production, and sales cycles. These changes occur because the use of short‐term debt permits suppliers to match production and sales more closely to the pattern of demand for the final good.