Firms That Age Well: Life Cycles and Default Risk

Abstract

The evolution of firms is not necessarily uniform. Exploring how this affects credit risk models, we find that firm life cycle provides additional explanatory power not captured by age. Firm age has an ambiguous effect on default risk and its impact during periods of high volatility is insignificant. Unobserved firm heterogeneity is an important determinant of credit default swap spreads and, when accounted for, riskier growth firms command a lower spread compared to mature firms that commonly benefit from the lowest spreads. Firms that age well by maintaining a growth profile are rewarded with lower cost of capital.

Keywords: Credit default swap, Credit risk, Firm life cycle

JEL Classification: G12, G32