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The cost and timing of financial distress

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  • Elkamhi, Redouane
  • Ericsson, Jan
  • Parsons, Christopher A.
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    Abstract

    Assessments of the trade-off theory have typically compared the present value of tax benefits to the present value of bankruptcy costs. We verify that this comparison overwhelmingly favors tax benefits, suggesting that firms are under-leveraged. However, when we allow firms to experience even modest (e.g., 1–2% annualized) financial distress costs prior to bankruptcy, the cumulative present value of such costs can easily offset the tax benefits.

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    File URL: http://www.sciencedirect.com/science/article/pii/S0304405X12000232
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    Bibliographic Info

    Article provided by Elsevier in its journal Journal of Financial Economics.

    Volume (Year): 105 (2012)
    Issue (Month): 1 ()
    Pages: 62-81

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    Handle: RePEc:eee:jfinec:v:105:y:2012:i:1:p:62-81

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    Web page: http://www.elsevier.com/locate/inca/505576

    Related research

    Keywords: Trade off theory; Financial distress; Debt-equity holder conflicts; Tax benefits; Financial leverage;

    References

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    Cited by:
    1. Reindl, Johann & Stoughton, Neal & Zechner, Josef, 2013. "Market implied costs of bankruptcy," CFS Working Paper Series 2013/27, Center for Financial Studies (CFS).

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