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Do Firms Engage in Risk-Shifting? Empirical Evidence

44 Pages Posted: 11 Sep 2016  

Erik Gilje

University of Pennsylvania - The Wharton School

Date Written: September 9, 2016

Abstract

I empirically test whether firms engage in risk-shifting. Contrary to what risk-shifting theory predicts, I find that firms reduce investment risk when they approach financial distress. To identify the effect of distress on risk-taking, I use a natural experiment with exogenous changes to leverage. Risk reduction is most prevalent among firms that have shorter maturity debt, bank debt, and tighter bank loan financial covenants. These findings suggest that debt composition and financial covenants serve as important mechanisms to mitigate debt-equity agency conflicts, such as risk-shifting, that are not explicitly contracted on.

JEL Classification: G31, G32, G33

Suggested Citation

Gilje, Erik, Do Firms Engage in Risk-Shifting? Empirical Evidence (September 9, 2016). Available at SSRN: https://ssrn.com/abstract=2837013 or http://dx.doi.org/10.2139/ssrn.2837013

Erik Gilje (Contact Author)

University of Pennsylvania - The Wharton School ( email )

3641 Locust Walk
Philadelphia, PA 19104-6365
United States

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