Are Firms Underleveraged? An Examination of the Effect of Leverage on Default Probabilities

Carlos Molina Manzano ()

Journal of Finance, 2005, vol. 60, issue 3, 1427-1459

Abstract: A commonly held view in corporate finance is that firms are less leveraged than they should be, given the potentially large tax benefits of debt. In this paper, I study the effect of firms' leverage on default probabilities as represented by the firms' ratings. Using an instrumental variable approach, I find that the leverage's effect on ratings is three times stronger than it is if the endogeneity of leverage is ignored. This stronger effect results in a higher impact of leverage on the ex ante costs of financial distress, which can offset the current estimates of the tax benefits of debt.

Date: 2005
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https://doi.org/10.1111/j.1540-6261.2005.00766.x

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Persistent link: https://EconPapers.repec.org/RePEc:bla:jfinan:v:60:y:2005:i:3:p:1427-1459

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