The Risk‐Adjusted Cost of Financial Distress

Heitor Almeida and Thomas Philippon ()

Journal of Finance, 2007, vol. 62, issue 6, 2557-2586

Abstract: Financial distress is more likely to happen in bad times. The present value of distress costs therefore depends on risk premia. We estimate this value using risk‐adjusted default probabilities derived from corporate bond spreads. For a BBB‐rated firm, our benchmark calculations show that the NPV of distress is 4.5% of predistress value. In contrast, a valuation that ignores risk premia generates an NPV of 1.4%. We show that marginal distress costs can be as large as the marginal tax benefits of debt derived by Graham (2000). Thus, distress risk premia can help explain why firms appear to use debt conservatively.

Date: 2007
References: Add references at CitEc
Citations: View citations in EconPapers (103)

Downloads: (external link)
https://doi.org/10.1111/j.1540-6261.2007.01286.x

Related works:
Working Paper: The Risk-Adjusted Cost of Financial Distress (2005)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:bla:jfinan:v:62:y:2007:i:6:p:2557-2586

Ordering information: This journal article can be ordered from
http://www.afajof.org/membership/join.asp

Access Statistics for this article

More articles in Journal of Finance from American Finance Association Contact information at EDIRC.
Bibliographic data for series maintained by Wiley Content Delivery ().