Working Paper: NBER ID: w17388
Authors: John R. Graham; Sonali Hazarika; Krishnamoorthy Narasimhan
Abstract: We use firm-level data to study corporate performance during the Great Depression era for all industrial firms on the NYSE. Our goal is to identify the factors that contribute to business insolvency and valuation changes during the period 1928 to 1938. We find that firms with more debt and lower bond ratings in 1928 became financially distressed more frequently during the Depression, consistent with the trade-off theory of leverage and the information production role of credit rating agencies. We also document for the first time that firms responded to tax incentives to use debt during the Depression era, but that the extra debt used in response to this tax-driven "debt bias" did not contribute significantly to the occurrence of distress. Finally, we conduct an out of sample test during the recent 2008-2009 Recession and find that higher leverage and lower bond ratings also increased the occurrence of financial distress during this period.
Keywords: Financial distress; Great Depression; Corporate performance; Leverage; Credit ratings
JEL Codes: G0
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Leverage (G32) | Financial Distress during the Great Depression (G33) |
| Credit Ratings (G24) | Financial Distress during the Great Depression (G33) |
| Leverage (G32) | Financial Distress during the 2008-2009 Recession (G33) |
| Credit Ratings (G24) | Financial Distress during the 2008-2009 Recession (G33) |
| Tax-driven Debt Usage (H69) | Financial Distress (G33) |