This paper studies how a borrower issues long- and short-term debt in response to shocks to the fundamental value. Short-term debt protects creditors from future dilution and incentivizes the borrower to reduce leverage after small negative shocks. Long-term debt postpones default and allows the borrower time to recover after large negative shocks. When borrowers are in distress, they rely on short-term debt; however, they issue both types of debt during more normal periods. Our model generates novel implications for the dynamic adjustment of debt maturities.

We investigate equilibrium debt dynamics for a firm that cannot commit to a future debt policy and is subject to a fixed restructuring cost. We formally characterize equilibria when the firm is not required to repurchase outstanding debt prior to issuing additional debt. For realistic values of issuance costs and debt maturity, the no-commitment policy generates tax benefits that are similar to those obtained by a benchmark policy with commitment. For positive but arbitrarily small issuance costs, there are maturities for which shareholders extract essentially the entire claim to cash-flows.