Download this Paper Open PDF in Browser

Are Corporate Default Probabilities Consistent with the Static Tradeoff Theory?

38 Pages Posted: 22 Jul 2011  

Armen Hovakimian

Baruch College - Zicklin School of Business

Ayla Kayhan

Louisiana State University; Commodity Futures Trading Commission (CFTC)

Sheridan Titman

University of Texas at Austin - Department of Finance; National Bureau of Economic Research (NBER)

Multiple version iconThere are 3 versions of this paper

Date Written: June 1, 2011

Abstract

Probability of default plays a central role in the static tradeoff theory of capital structure. We provide a direct test of this theory by regressing the probability of default, measured by S&P credit ratings and Moody’s KMV Expected Default FrequencyTM (EDFTM), on firm characteristics that proxy for the costs of bankruptcy and the tax benefits of debt. Contrary to predictions of the theory, firms with high bankruptcy costs, that is smaller firms and firms with lower asset tangibility, choose capital structures with higher bankruptcy risk. Further analysis suggests that the capital structures of smaller firms with lower asset tangibility, which tend to have less access to capital markets, are more sensitive to negative profitability and equity value shocks, making them more sensitive to bankruptcy risk.

Keywords: capital structure, tradeoff theory, default probability

JEL Classification: G32

Suggested Citation

Hovakimian, Armen and Kayhan, Ayla and Titman, Sheridan, Are Corporate Default Probabilities Consistent with the Static Tradeoff Theory? (June 1, 2011). Available at SSRN: https://ssrn.com/abstract=1892480 or http://dx.doi.org/10.2139/ssrn.1892480

Armen Hovakimian (Contact Author)

Baruch College - Zicklin School of Business ( email )

One Bernard Baruch Way
Box B10-225
New York, NY 10010
United States
646-312-3490 (Phone)
646-312-3451 (Fax)

HOME PAGE: http://faculty.baruch.cuny.edu/ahovakimian/

Ayla Kayhan

Louisiana State University ( email )

E. J. Ourso School of Business
Department of Finance
Baton Rouge, LA 70803
United States

HOME PAGE: http://faculty.bus.lsu.edu/akayhan/index.htm

Commodity Futures Trading Commission (CFTC) ( email )

1155 21st Street NW
Washington, DC 20581
United States

Sheridan Titman

University of Texas at Austin - Department of Finance ( email )

Red McCombs School of Business
Austin, TX 78712
United States
512-232-2787 (Phone)
512-471-5073 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Paper statistics

Downloads
240
Rank
94,502
Abstract Views
1,201