Working Paper: NBER ID: w17290
Authors: Armen Hovakimian; Ayla Kayhan; Sheridan Titman
Abstract: 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.
Keywords: corporate default probabilities; static tradeoff theory; capital structure
JEL Codes: G3; G33
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| firm size (L25) | probability of default (G33) |
| asset tangibility (H82) | probability of default (G33) |
| marginal tax rates (H29) | probability of default (G33) |
| bankruptcy costs (K35) | capital structure risk (G32) |
| sensitivity to negative shocks (E44) | probability of default (G33) |
| limited access to capital markets (G19) | bankruptcy risk (G33) |