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Empirical Evidence of Risk Shifting in Financially Distressed Firms
Author(s) -
EISDORFER ASSAF
Publication year - 2008
Publication title -
the journal of finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 18.151
H-Index - 299
eISSN - 1540-6261
pISSN - 0022-1082
DOI - 10.1111/j.1540-6261.2008.01326.x
Subject(s) - volatility (finance) , empirical evidence , shareholder , incentive , investment (military) , empirical research , economics , monetary economics , business , enterprise value , financial economics , finance , microeconomics , corporate governance , philosophy , epistemology , politics , political science , law
This paper provides evidence of risk‐shifting behavior in the investment decisions of financially distressed firms. Using a real options framework, I show that shareholders' risk‐shifting incentives can reverse the expected negative relation between volatility and investment. I test two hypotheses that are consistent with risk‐shifting behavior: (i) volatility has a positive effect on distressed firms' investment; (ii) investments of distressed firms generate less value during times of high uncertainty. Empirical evidence using 40 years of data supports both hypotheses. I further evaluate the effect of various firm characteristics on risk shifting, and estimate the costs of the investment distortion.