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

Author

Listed:
  • 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.

Suggested Citation

  • Armen Hovakimian & Ayla Kayhan & Sheridan Titman, 2012. "Are Corporate Default Probabilities Consistent with the Static Trade-off Theory?," The Review of Financial Studies, Society for Financial Studies, vol. 25(2), pages 315-340.
    • Handle: RePEc:oup:rfinst:v:25:y:2012:i:2:p:315-340
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    File URL: http://hdl.handle.net/10.1093/rfs/hhr101
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    Cited by:

    1. Yu, Ying & Wu, Haoyang & Tan, Yijiang, 2025. "Does digitalizing supply chains enhance corporate financial stability?," International Review of Financial Analysis, Elsevier, vol. 107(C).
    2. George Georgakopoulos & Kanellos Toudas & Evangelos I. Poutos & Theodoros Kounadeas & Stefanos Tsavalias, 2022. "Capital Structure, Corporate Governance, Equity Ownership and Their Impact on Firms’ Profitability and Effectiveness in the Energy Sector," Energies, MDPI, vol. 15(10), pages 1-10, May.
    3. Faulkender, Michael & Smith, Jason M., 2016. "Taxes and leverage at multinational corporations," Journal of Financial Economics, Elsevier, vol. 122(1), pages 1-20.
    4. Marianna Succurro, 2017. "Financial Bankruptcy across European Countries," International Journal of Economics and Finance, Canadian Center of Science and Education, vol. 9(7), pages 132-146, July.
    5. Wang, Chih-Wei & Chiu, Wan-Chien, 2019. "Effect of short-term debt on default risk: Evidence from Pacific Basin countries," Pacific-Basin Finance Journal, Elsevier, vol. 57(C).
    6. 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.
    7. Khatami, Seyed Hossein & Marchica, Maria-Teresa & Mura, Roberto, 2016. "Rating friends: The effect of personal connections on credit ratings," Journal of Corporate Finance, Elsevier, vol. 39(C), pages 222-241.
    8. Ni, Xiaoran & Xu, Hongmei, 2023. "Are short selling threats beneficial to creditors? Insights from corporate default risk," Pacific-Basin Finance Journal, Elsevier, vol. 81(C).
    9. 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.
    10. Lars Schweizer & Andreas Nienhaus, 2017. "Corporate distress and turnaround: integrating the literature and directing future research," Business Research, Springer;German Academic Association for Business Research, vol. 10(1), pages 3-47, June.
    11. Wang, Chih-Wei & Chiu, Wan-Chien & Peña, Juan Ignacio, 2017. "Effect of rollover risk on default risk: Evidence from bank financing," International Review of Financial Analysis, Elsevier, vol. 54(C), pages 130-143.
    12. Mauricio Jara‐Bertín & Cristian Pinto‐Gutiérrez & Carlos Pombo, 2021. "The effect of intra‐group loans on the cash flow sensitivity of cash: Evidence from Chile," International Review of Finance, International Review of Finance Ltd., vol. 21(2), pages 374-403, June.
    13. Giorgio Canarella & Mahmoud Nourayi & Michael J. Sullivan, 2014. "An alternative test of the trade-off theory of capital structure," Contemporary Economics, Vizja University, vol. 8(4), December.
    14. Larkin, Yelena, 2013. "Brand perception, cash flow stability, and financial policy," Journal of Financial Economics, Elsevier, vol. 110(1), pages 232-253.
    15. Joachim Jungherr & Matthias Meier & Timo Reinelt & Immo Schott, 2022. "Corporate Debt Maturity Matters For Monetary Policy," CRC TR 224 Discussion Paper Series crctr224_2022_360, University of Bonn and University of Mannheim, Germany.
    16. Joachim Jungherr & Immo Schott, 2021. "Optimal Debt Maturity and Firm Investment," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 42, pages 110-132, October.
    17. Maren Forier & Nadine Lybaert & Maarten Corten & Niels Appermont & Tensie Steijvers, 2023. "The flip side of the coin: how entrepreneurship-oriented insolvency laws can complicate access to debt financing for growth firms," European Journal of Law and Economics, Springer, vol. 56(3), pages 461-495, December.

    More about this item

    JEL classification:

    • G3 - Financial Economics - - Corporate Finance and Governance
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation

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