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Financial Distress in the Great Depression
Author(s) -
Graham John R.,
Hazarika Sonali,
Narasimhan Krishnamoorthy
Publication year - 2011
Publication title -
financial management
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.647
H-Index - 68
eISSN - 1755-053X
pISSN - 0046-3892
DOI - 10.1111/j.1755-053x.2011.01163.x
Subject(s) - leverage (statistics) , financial distress , insolvency , debt , recession , business , monetary economics , bond , bond credit rating , distress , bond market , incentive , depression (economics) , financial system , economics , finance , psychology , credit reference , credit risk , keynesian economics , machine learning , computer science , microeconomics , psychotherapist , macroeconomics
We use firm‐level data to study corporate performance during the Great Depression era for all industrial firms on the NYSE. Our goal is to identify the factors that contribute to business insolvency and valuation changes during the period 1928‐1938. We find that firms with more debt and lower bond ratings in 1928 became financially distressed more frequently during the Depression, consistent with the trade‐off theory of leverage and the information production role of credit rating agencies. We also document for the first time that firms responded to tax incentives to use debt during the Depression era but that the extra debt used in response to this tax‐driven “debt bias” did not contribute significantly to the occurrence of distress. Finally, we conduct an out‐of‐sample test during the recent 2008‐2009 Recession and find that higher leverage and lower bond ratings also increased the occurrence of financial distress during this period.