The risk-adjusted cost of financial distress

Heitor Almeida, Thomas Philippon

Research output: Contribution to journalArticle

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.

Original languageEnglish (US)
Pages (from-to)2557-2586
Number of pages30
JournalJournal of Finance
Volume62
Issue number6
DOIs
StatePublished - Dec 1 2007
Externally publishedYes

ASJC Scopus subject areas

  • Accounting
  • Finance
  • Economics and Econometrics

Fingerprint Dive into the research topics of 'The risk-adjusted cost of financial distress'. Together they form a unique fingerprint.

  • Prizes

    Brattle Prize

    Almeida, Heitor (Recipient), 2008

    Prize

  • Cite this