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Are Corporate Default Probabilities Consistent with the Static Tradeoff Theory?

  • Armen Hovakimian
  • Ayla Kayhan
  • Sheridan Titman

Default probability plays a central role in the static tradeoff 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.

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File URL: http://www.nber.org/papers/w17290.pdf
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 17290.

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Date of creation: Aug 2011
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Publication status: published as Armen Hovakimian & Ayla Kayhan & Sheridan Titman, 2012. "Are Corporate Default Probabilities Consistent with the Static Trade-off Theory?," Review of Financial Studies, Society for Financial Studies, vol. 25(2), pages 315-340.
Handle: RePEc:nbr:nberwo:17290
Note: CF
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