The Effect of APR Violations on the Seniority and Timing of Debt Issuance

We present a model that shows how interactions between creditor groups in bankruptcy can affect the debt issuance decisions of firms. In particular, we show that firms that issue debt with a specific seniority level may tend to keep issuing debt at the same level to avoid the costs of conflicts in bankruptcy. Our model also has predictions as to what types of firms may change seniority level in sequential issues. We also find that as bankruptcy costs increase, firms will tend to issue more junior debt. The empirical implications of our model are consistent with the somewhat surprising fact that most firms issue debt at one seniority level only, and quite a few of them cluster at the senior subordinated level. We also find that companies that issue subordinated debt are much smaller than those which issue senior debt, while those that issue at both levels are intermediate on most financial measures. These empirical regularities are broadly consistent with our theoretical analysis. Our model is also supported by the fact that companies that issue only senior debt pay lower spreads than companies that issue at both levels