Financial Distress in the Great Depression

Abstract:     
We use firm-level data to study corporate performance during the Great Depression era for all industrial firms on the NYSE. Our goal is to identify the factors that contribute to business insolvency and valuation changes during the period 1928 to 1938. We find that firms with more debt and lower bond ratings in 1928 had a greater probability of becoming financially distressed during the Great Depression. We also document for the first time that firms responded to tax incentives to use debt during the Depression era, but that the extra debt used in response to this tax-driven “debt bias” did not contribute significantly to the occurrence of distress. Finally, we conduct an out of sample test during the recent Great Recession and find that higher leverage and lower bond ratings also increased the probability of becoming financially distressed during this period.

Number of Pages in PDF File: 40

Accepted Paper Series