Juggler, JoachimSchott, Immo2017-01-132017-01-132016-11http://hdl.handle.net/10230/27888This paper introduces a maturity choice to the standard model of firm financing and investment. Longterm debt renders the optimal firm policy time-inconsistent. Lack of commitment gives rise to debt dilution. This problem becomes more severe during downturns. We show that cyclical debt dilution generates the observed counter-cyclical behavior of default, bond spreads, leverage, and debt maturity. It also generates the pro-cyclical term structure of corporate bond spreads. Debt dilution renders the equilibrium outcome constrained-inefficient: credit spreads are too high and investment is too low. In two policy experiments we find the following: (1) an outright ban of long-term debt improves welfare in our model economy, and (2.) debt dilution accounts for 84% of the credit spread and 25% of the welfare gap with respect to the first best allocation.application/pdfengThis is an Open Access article distributed under the terms of the Creative Commons Attribution License Creative Commons Attribution 4.0 International, which permits unrestricted use, distribution and reproduction in any medium provided that the original work is properlyattributed.info:eu-repo/semantics/workingPaperFirm financingInvestmentDebt maturityCredit spreadsDebt dilutioninfo:eu-repo/semantics/openAccess