Abstract

http://ssrn.com/abstract=1337298
 
 

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The Cost of Financial Distress and the Timing of Default


Redouane Elkamhi


McGill University - Desautels Faculty of Management

Christopher A. Parsons


University of California, San Diego (UCSD) - Rady School of Management

Jan Ericsson


McGill University; Swedish Institute for Financial Research (SIFR)

May 12, 2009

EFA 2009 Bergen Meetings Paper

Abstract:     
At any point in time, most firms are not in financial distress. This implies that they must suffer value losses unrelated to their leverage--economic shocks--before becoming financially distressed. We show that if estimates of ex-ante financial distress costs are not filtered from the effects of future economic shocks, they are significantly biased upward, as far as an order of magnitude. Filtered from economic shocks, pure ex-ante distress costs average less than 1% of current firm value. We also estimate sensitivities of ex-ante distress costs to leverage that are generally far too small to offset the expected tax benefits. Extending our analysis to the cross section and time series, we confirm that ex-ante distress costs are highest: i) when the risk premium in debt markets is high, and ii) among firms with high systematic risk. Overall, our results suggest that most firms use debt too conservatively, but we characterize conditions under which they do not.

Number of Pages in PDF File: 50

Keywords: financial distress costs, default probabilities

JEL Classification: G32, G33

working papers series





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Date posted: February 4, 2009 ; Last revised: May 26, 2009

Suggested Citation

Elkamhi, Redouane and Parsons, Christopher A. and Ericsson, Jan, The Cost of Financial Distress and the Timing of Default (May 12, 2009). EFA 2009 Bergen Meetings Paper. Available at SSRN: http://ssrn.com/abstract=1337298 or http://dx.doi.org/10.2139/ssrn.1337298

Contact Information

Redouane Elkamhi
McGill University - Desautels Faculty of Management ( email )
1001 Sherbrooke St. West
Montreal, Quebec H3A1G5 H3A 2M1
Canada
Christopher A. Parsons (Contact Author)
University of California, San Diego (UCSD) - Rady School of Management ( email )
9500 Gilman Drive
Mail Code 0502
La Jolla, CA 92093-0112
United States
Jan Ericsson
McGill University ( email )
1001 Sherbrooke St. West
Montreal, Quebec H3A1G5 H3A 2M1
Canada
(514) 398-3186 (Phone)
(514) 398-3876 (Fax)
HOME PAGE: http://people.mcgill.ca/jan.ericsson/
Swedish Institute for Financial Research (SIFR)
Drottninggatan 89
SE-113 59 Stockholm, SE-113 60
Sweden
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