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The cost and timing of financial distress

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

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.

Suggested Citation

  • Elkamhi, Redouane & Ericsson, Jan & Parsons, Christopher A., 2012. "The cost and timing of financial distress," Journal of Financial Economics, Elsevier, vol. 105(1), pages 62-81.
  • Handle: RePEc:eee:jfinec:v:105:y:2012:i:1:p:62-81 DOI: 10.1016/j.jfineco.2012.02.005
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    1. repec:spr:busres:v:10:y:2017:i:1:d:10.1007_s40685-016-0041-8 is not listed on IDEAS
    2. Reindl, Johann & Stoughton, Neal & Zechner, Josef, 2013. "Market implied costs of bankruptcy," CFS Working Paper Series 2013/27, Center for Financial Studies (CFS).
    3. Adelino, Manuel & Dinc, I. Serdar, 2014. "Corporate distress and lobbying: Evidence from the Stimulus Act," Journal of Financial Economics, Elsevier, vol. 114(2), pages 256-272.
    4. Mousavi, Mohammad M. & Ouenniche, Jamal & Xu, Bing, 2015. "Performance evaluation of bankruptcy prediction models: An orientation-free super-efficiency DEA-based framework," International Review of Financial Analysis, Elsevier, vol. 42(C), pages 64-75.

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