Are Corporate Default Probabilities Consistent with the Static Trade-off Theory?

Armen Hovakimian; Ayla Kayhan; Sheridan Titman

doi:10.1093/rfs/hhr101

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Are Corporate Default Probabilities Consistent with the Static Trade-off Theory?

Armen Hovakimian¹; Ayla Kayhan²; Sheridan Titman³

¹ Baruch College · ² United States Securities and Exchange Commission · ³ The University of Texas at Austin

Review of Financial Studies 2012

Default probability plays a central role in the static trade-off 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.

DOI: 10.1093/rfs/hhr101
Volume: 25 (2)
Pages: 315-340
Language: en
Export: BibTeX
Sources: openalex crossref