Strategic Liability Management: Lessons from Past Inflation

I study firm liability decisions through the learning-from-experience channel, where a manager who experienced high inflation in her lifetime strategically decreases the real value of firm liabilities. During periods of high inflation, the real value of fixed-rate liabilities is lower than that of floating-rate liabilities. A manager that learned from past inflation, acknowledging this fact, converts floating-rate to fixed-rate debts using interest rate swaps. This liability management mitigates unexpected inflation shocks and demands high returns sorted by inflation beta. Consistent with findings from survey data, a manager draws lessons from inflation experience, stretching her experience back to the distant past.