Do Firms Engage in Risk-Shifting? Empirical Evidence

Erik P. Gilje

The Review of Financial Studies, 2016, vol. 29, issue 11, 2925-2954

Abstract: I empirically test whether firms engage in risk-shifting. Contrary to what risk-shifting theory predicts, I find that firms reduce investment risk when they approach financial distress. To identify the effect of distress on risk-taking, I use a natural experiment with exogenous changes to leverage. Risk reduction is most prevalent among firms that have shorter maturity debt, bank debt, and tighter bank loan financial covenants. These findings suggest that debt composition and financial covenants serve as important mechanisms to mitigate debt-equity agency conflicts, such as risk-shifting, that are not explicitly contracted on.Received January 8, 2015; accepted May 27, 2016 by Editor David Denis.

JEL-codes: G31 G32 G33 (search for similar items in EconPapers)
Date: 2016
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Citations: View citations in EconPapers (40)

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