Taming the dark side of asset liquidity: The role of short-term debt

Using six alternative measures of asset liquidity, we examine the role short-term debt plays in taming the dark side of asset liquidity, which is the negative effect of high asset liquidity facing unsecured bondholders. The evidence from simultaneous equations models, which addresses the joint determination of leverage and debt maturity, indicates that short-term debt mitigates the negative effect. This moderating role of short-term debt is further shown to be more effective during a financial crisis and for firms with poor performance. This provides further evidence that short-term debt helps resolve the agency conflicts facing unsecured bondholders.