Working Paper: NBER ID: w12362
Authors: John Y. Campbell; Jens Hilscher; Jan Szilagyi
Abstract: This paper explores the determinants of corporate failure and the pricing of financially distressed stocks using US data over the period 1963 to 2003. Firms with higher leverage, lower profitability, lower market capitalization, lower past stock returns, more volatile past stock returns, lower cash holdings, higher market-book ratios, and lower prices per share are more likely to file for bankruptcy, be delisted, or receive a D rating. When predicting failure at longer horizons, the most persistent \nfirm characteristics, market capitalization, the market-book ratio, and equity volatility become relatively more significant. Our model captures much of the time variation in the aggregate failure rate. Since 1981, financially distressed stocks have delivered anomalously low returns. They have lower returns but much higher standard deviations, market betas, and loadings on value and small-cap risk factors than stocks with a low risk of failure. These patterns hold in all size quintiles but are particularly strong in smaller stocks. They are inconsistent with the conjecture that the value and size effects are compensation for the risk of financial distress.
Keywords: financial distress; bankruptcy; asset pricing
JEL Codes: G1
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| higher leverage (G32) | higher likelihood of bankruptcy (G33) |
| lower profitability (L21) | higher likelihood of bankruptcy (G33) |
| lower market capitalization (G10) | higher likelihood of bankruptcy (G33) |
| lower past stock returns (G17) | higher likelihood of bankruptcy (G33) |
| more volatile past stock returns (G17) | higher likelihood of bankruptcy (G33) |
| lower cash holdings (G39) | higher likelihood of bankruptcy (G33) |
| higher market-to-book ratios (G32) | higher likelihood of bankruptcy (G33) |
| lower prices per share (G19) | higher likelihood of bankruptcy (G33) |
| market capitalization (G10) | significance in predicting failure (G33) |
| market-to-book ratio (G32) | significance in predicting failure (G33) |
| equity volatility (C58) | significance in predicting failure (G33) |
| financially distressed stocks (G33) | lower average returns (G19) |
| financially distressed stocks (G33) | higher standard deviations (C46) |
| financially distressed stocks (G33) | higher market betas (G19) |
| low returns on distressed stocks (G33) | correlated with increases in institutional ownership (G34) |
| increases in market-wide risk (E44) | low returns on distressed stocks (G33) |