Are Corporate Default Probabilities Consistent with the Static Tradeoff Theory?
Baruch College - Zicklin School of Business
Louisiana State University
University of Texas at Austin - Department of Finance; National Bureau of Economic Research (NBER)
NBER Working Paper No. w17290
Default probability plays a central role in the static tradeoff theory of capital structure. We directly test this theory by regressing the probability of default on proxies for costs and benefits of debt. Contrary to predictions of the theory, firms with higher bankruptcy costs, i.e., 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 susceptible to bankruptcy risk.
Number of Pages in PDF File: 42
Date posted: August 12, 2011