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

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  • Armen Hovakimian
  • Ayla Kayhan
  • Sheridan Titman

Abstract

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. The Author 2011. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: journals.permissions@oup.com., Oxford University Press.

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Bibliographic Info

Article provided by Society for Financial Studies in its journal Review of Financial Studies.

Volume (Year): 25 (2012)
Issue (Month): 2 ()
Pages: 315-340

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Handle: RePEc:oup:rfinst:v:25:y:2012:i:2:p:315-340

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Cited by:
  1. Larkin, Yelena, 2013. "Brand perception, cash flow stability, and financial policy," Journal of Financial Economics, Elsevier, vol. 110(1), pages 232-253.
  2. Chemmanur, Thomas J. & Cheng, Yingmei & Zhang, Tianming, 2013. "Human capital, capital structure, and employee pay: An empirical analysis," Journal of Financial Economics, Elsevier, vol. 110(2), pages 478-502.
  3. Alves, Paulo & Francisco, Paulo, 2013. "The Impact of Institutional Environment in Firms´ Capital Structure during the Recent Financial Crises," MPRA Paper 51300, University Library of Munich, Germany.

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