The Cost of Debt
WFA 2007 Big Sky, MT Meetings Paper
65 Pages Posted: 8 Mar 2007 Last revised: 15 Sep 2013
Date Written: May 11, 2010
We estimate firm-specific marginal cost of debt functions for a large panel of companies between 1980 and 2007. The marginal cost curves are identified by exogenous variation in the marginal tax benefits of debt. The location of a given company’s cost of debt function varies with characteristics such as asset collateral, size, book-to-market, asset tangibility, cash flows, and whether the firm pays dividends. By integrating the area between benefit and cost functions we estimate that the equilibrium net benefit of debt is 3.5% of asset value, resulting from an estimated gross benefit of debt of 10.4% of asset value and an estimated cost of debt of 6.9%. We find that the cost of being overlevered is asymmetrically higher than the cost of being underlevered and that expected default costs constitute approximately half of the total ex ante cost of debt.
Keywords: capital structure, cost of debt
JEL Classification: G30, G32
Suggested Citation: Suggested Citation