NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Are Corporate Default Probabilities Consistent with the Static Tradeoff Theory?

Armen Hovakimian, Ayla Kayhan, Sheridan Titman

NBER Working Paper No. 17290
Issued in August 2011
NBER Program(s):   CF

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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Document Object Identifier (DOI): 10.3386/w17290

Published: 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.

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