The Causes and Consequences of Initial Public Straight Debt Offers

Using a sample of young, high-growth, firms, this study documents that information, monitoring, contracting and agency costs, as captured by firm size, the investment opportunity set, profitability and the current need for funds, influence the likelihood that a firm transitions from no long-term debt, to private long-term, to public long-term debt. This study also provides new evidence on the ex post operating consequences of firms following the debt IPO that is consistent with the negative stock price reaction at offer announcement. Consistent with the signaling models of debt maturity choice, asset efficiency, profitability, and capital expenditures decline significantly following the debt IPO. However, sales growth is unaffected by the change in financial policy. Consistent with Myers (1977), growth opportunities, as measured by the market-to-book ratio, decline significantly following the debt IPO, suggesting that straight debt offers are made when the agency costs of debt are expected to decline. Together, the findings are consistent with the negative stock price reaction at offer announcement and provide strong support for predictions of debt maturity structure theories. These results are robust to whether or not the firm has a banking relationship prior to the debt offer, or whether the firm issues investment grade or high-yield debt.