The expected cost of default

Brent Glover

Journal of Financial Economics, 2016, vol. 119, issue 2, 284-299

Abstract: The sample of observed defaults significantly understates the average firm׳s true expected cost of default due to a sample selection bias. I use a dynamic capital structure model to estimate firm-specific expected default costs and quantify the selection bias. The average firm expects to lose 45% of firm value in default, a cost higher than existing estimates. However, the average cost among defaulted firms in the estimated model is only 25%, a value consistent with existing empirical estimates from observed defaults. This substantial selection bias helps to reconcile the levels of leverage and default costs observed in the data.

Keywords: Default costs; Structural estimation; Costs of financial distress; Dynamic capital structure (search for similar items in EconPapers)
JEL-codes: G30 G32 G33 (search for similar items in EconPapers)
Date: 2016
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Citations: View citations in EconPapers (60)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jfinec:v:119:y:2016:i:2:p:284-299

DOI: 10.1016/j.jfineco.2015.09.007

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