On the impact of financial distress on capital structure: The role of leverage dynamics

Research output: Working paper


This paper uses a research design that addresses the endogenous effect of financial distress on debt ratios. Using a probability of financial distress derived from a hazard model as a measure of financial distress, we find that leverage dynamics are crucial in unraveling the true effect of financial distress on leverage. Our findings offer an explanation for the prior conflicting evidence on the association between leverage and financial distress and shed new light on the role of leverage dynamics in understanding capital structure decisions. We then show that firms balance the tax benefit of debt and financial distress costs when making financing decisions in a dynamic process.

Bibliographical metadata

Original languageEnglish
Publication statusPublished - 2008