A company’s debt maturity schedule can shape whether it makes an acquisition, how much it spends, and whether it pays with cash. In the latest Insights@Questrom blog post, Dirk Hackbarth, Professor of Finance at Boston University Questrom School of Business examines why the real issue isn’t simply when debt comes due—it’s how costly that debt will be to refinance.
Why refinancing risk—not simply debt maturity—can determine whether companies pursue acquisitions, how much they spend, and whether they pay with cash.
Suppose your company has identified an attractive acquisition. The strategic fit is good, the price looks reasonable, and financing is available.
But there is another question the CFO should ask before signing the deal: What happens when our existing debt comes due?
My co-authors and I set out to answer that question: refinancing risk can materially affect whether firms undertake acquisitions in the first place, how large those acquisitions are, and how they pay for them. The surprising part is that simply knowing when debt matures is not enough.
Why should an acquisition depend on when a company’s debt comes due?
An acquisition uses financial resources today. But a company may also know that it will need to return to the bond market tomorrow.
If refinancing that existing debt is likely to be expensive, spending cash or taking on additional financing for an acquisition becomes more costly than it first appears. Management may therefore preserve financial flexibility rather than pursue an otherwise attractive transaction.
We call this maturity overhang: costly future refinancing can discourage investment today.
Isn’t this simply a question of whether a firm has short-term debt?
Not quite—and this is the key distinction.
Imagine two companies whose bonds will both mature next year.
One company’s bonds trade above face value. Refinancing may actually allow the company to replace relatively expensive existing debt with cheaper financing. The other company’s bonds trade well below face value. Refinancing forces that company to replace debt under substantially worse market conditions.
Same maturity. Very different economic consequences.
A maturity measure sees the two companies as essentially identical. Our measure of rollover risk does not. It combines two pieces of information:
Rollover risk = potential refinancing loss × refinancing frequency.
A firm faces particularly high rollover risk when it must refinance frequently, and doing so is costly.
Does that distinction actually matter for corporate decisions?
Quite a bit.
In our sample, a one-standard-deviation increase in rollover risk reduces the probability that a company makes an acquisition by about 2.5 percentage points, compared with an average acquisition probability of roughly 21 percent.
And when high-rollover-risk firms do make acquisitions, the deals are substantially smaller—by roughly 20 percent of the average deal size.
This is why focusing only on debt maturity can be misleading: traditional maturity measures show little ability to explain acquisition activity, but once refinancing conditions are incorporated, however, a strong relationship emerges.
Does rollover risk also affect how companies pay for deals?
Yes, and the logic is intuitive.
A company expecting costly refinancing has a reason to conserve cash. Cash used to acquire another company today cannot be used to meet refinancing needs tomorrow.
Consistent with that idea, a one-standard-deviation increase in rollover risk reduces the likelihood of an all-cash acquisition by about 4.3 percent. Firms facing greater refinancing pressure rely more heavily on equity and preserve their cash buffers.
That suggests the method of payment isn’t simply about whether cash or stock is cheaper – it also reflects how much management values keeping financial flexibility.
But aren’t cash acquisitions normally good news for shareholders?
That is the conventional view. An all-cash offer is often interpreted as a signal of managerial confidence: executives are willing to commit cash rather than issue potentially undervalued shares.
Our results add an important qualification.
When an acquirer has low rollover risk, investors react favorably to an all-cash acquisition. The acquirer earns an excess stock return of about 1.5 percent over the three days surrounding the announcement.
When rollover risk is high, however, that positive reaction disappears.
Why? Cash itself has become more valuable. Spending it on an acquisition means giving up financial flexibility precisely when the company may soon need that flexibility to refinance debt.
So, investors appear to ask not simply, “Is management confident enough to pay cash?” but also, “Can this company afford to give up the cash?”
How do we know refinancing risk is causing these decisions rather than simply reflecting them?
That is an important concern because firms choose both their acquisition strategies and their debt structures.
To help separate cause from correlation, we examine the Federal Reserve’s 2011 Maturity Extension Program, which changed long-term borrowing conditions for reasons unrelated to individual firms’ acquisition plans. The program encouraged firms to lengthen their debt maturities; average bond maturity in our setting increased from roughly six years to eight years.
Using this externally driven change in refinancing conditions, we continue to find that greater rollover risk reduces acquisition activity. That makes it less likely that our results simply reflect managers arranging debt maturities in anticipation of acquisitions.
What should managers and boards take away from this?
The basic lesson is simple:
Do not examine a company’s debt maturity schedule in isolation.
A bond coming due next year is not necessarily a problem. The real question is what refinancing that bond is likely to cost when the time comes.
For CFOs, that means acquisition planning and liability management should be considered jointly. Extending maturities when financing conditions are favorable may preserve the flexibility to pursue investment opportunities later.
For boards and investors, it means interpreting a proposed acquisition—and especially an all-cash acquisition—in light of the company’s refinancing position.
And for students of corporate finance, the broader lesson is that financing and investment decisions cannot be neatly separated. A financing decision made years ago can eventually determine whether a company is willing or able to undertake a valuable investment today.
Before asking only whether an acquisition creates value, managers should also ask one more question:
What debt do we have coming due—and what will it cost us when it does?
This article is based on research by Dirk Hackbarth, Jarrad Harford, Zhiyao Chen, and Yuxin Luo on rollover risk and corporate acquisitions.
