Empirical Evidence of Risk Shifting in Financially Distressed Firms

Assaf Eisdorfer

Journal of Finance, 2008, vol. 63, issue 2, 609-637

Abstract: This paper provides evidence of risk‐shifting behavior in the investment decisions of financially distressed firms. Using a real options framework, I show that shareholders' risk‐shifting incentives can reverse the expected negative relation between volatility and investment. I test two hypotheses that are consistent with risk‐shifting behavior: (i) volatility has a positive effect on distressed firms' investment; (ii) investments of distressed firms generate less value during times of high uncertainty. Empirical evidence using 40 years of data supports both hypotheses. I further evaluate the effect of various firm characteristics on risk shifting, and estimate the costs of the investment distortion.

Date: 2008
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https://doi.org/10.1111/j.1540-6261.2008.01326.x

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Persistent link: https://EconPapers.repec.org/RePEc:bla:jfinan:v:63:y:2008:i:2:p:609-637

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