Differential impact of leverage on the default risk of small and large firms

Cathcart, L., Dufour, A. ORCID: https://orcid.org/0000-0003-0519-648X, Rossi, L. and Varotto, S. ORCID: https://orcid.org/0000-0001-5328-5327 (2020) Differential impact of leverage on the default risk of small and large firms. Journal of Corporate Finance, 60. 101541. ISSN 0929-1199 doi: 10.1016/j.jcorpfin.2019.101541

Abstract/Summary

We analyse a sample of 6 million firm-year observations of large corporations and small and medium sized enterprises (SMEs) spanning 6 European countries from 2005 to 2015, to determine the impact of leverage and different sources of funding on default risk. We find that financial leverage has a greater impact on the probability of default of SMEs than of large corporations. The difference in default probability between the top and bottom leverage quartiles is 1.24% for large firms and 2.87% for SMEs. This difference may be explained by the greater exposure of SMEs to short-term debt and their consequently higher refinancing risk. Indeed, we find that SMEs that recover from the state of insolvency may have similar leverage to defaulted SMEs; however their liability structure is significantly altered towards long-term debt and away from short-term debt. Our findings have important implications not only for bank regulators and policy-makers but also for credit risk modelling.

Item Type	Article
URI	https://reading-pure-test.eprints-hosting.org/id/eprint/87142
Identification Number/DOI	10.1016/j.jcorpfin.2019.101541
Refereed	Yes
Divisions	Henley Business School > Finance and Accounting Central Services
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