How large are Pre-Default Costs of Financial Distress? Estimates from a Dynamic Model

52 Pages Posted: 6 Apr 2020 Last revised: 19 Dec 2022

See all articles by Redouane Elkamhi

Redouane Elkamhi

University of Toronto - Rotman School of Management

Daniel Kim

University of Waterloo

Marco Salerno

Healthcare of Ontario Pension Plan Trust Fund

Date Written: December 11, 2022

Abstract

We estimate the costs of financial distress prior to default (pre-default costs) separately from the loss incurred at default (the loss given default) using a dynamic trade-off model of capital structure. We show that pre-default costs account for a large fraction of total distress costs, approximately 64.1\%. We demonstrate that the expected pre-default costs of financial distress vary significantly across industries with a range between 3.2% and 8.3%, and are higher for small firms relative to larger ones.

Keywords: Dynamic Capital Structure, Financial Distress, Structural Estimation

JEL Classification: G30, G32, G33

Suggested Citation

Elkamhi, Redouane and Kim, Daniel and Salerno, Marco, How large are Pre-Default Costs of Financial Distress? Estimates from a Dynamic Model (December 11, 2022). Available at SSRN: https://ssrn.com/abstract=3553063 or http://dx.doi.org/10.2139/ssrn.3553063

Redouane Elkamhi

University of Toronto - Rotman School of Management ( email )

105 St. George Street
Toronto, Ontario M5S 3E6 M5S1S4
Canada

Daniel Kim

University of Waterloo ( email )

Waterloo, Ontario N2L 3G1
Canada

Marco Salerno (Contact Author)

Healthcare of Ontario Pension Plan Trust Fund ( email )

1 York
Toronto, Ontario M5S 3G8
Canada

Do you have negative results from your research you’d like to share?

Paper statistics

Downloads
206
Abstract Views
1,226
Rank
262,387
PlumX Metrics