Keywords: External finance premium, bankruptcy costs, financial accelerator
Abstract: We quantify the cross-sectional and time-series behavior of the wedge between
the cost of external and internal finance by estimating the structural
parameters of a canonical debt-contracting model with informational frictions.
For this purpose, we construct a new dataset that includes balance sheet information,
measures of expected default risk, and credit spreads on publicly traded
debt for about 900 U.S. firms over the period 1997Q1 to 2003Q3. Using nonlinear
least squares, we obtain precise time-specific estimates of the bankruptcy
cost parameter and consistently reject the null hypothesis of frictionless financial
markets. For most of the firms in our sample, the estimated premium on
external finance was very low during the expansionary period 1997-99, but rose
sharply in 2000--especially for firms with higher ratios of debt to equity--and
remained elevated until early 2003.
Full paper (387 KB PDF)
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Last update: January 3, 2005