| This paper finds evidence supporting the existence of significant expected financial distress costs. Expected financial distress costs are estimated for a large sample of going-concern firms using a discounted cash flow valuation technique, with an emphasis on characterizing their sensitivity to leverage. I find that under CAPM the sum of direct and indirect expected financial distress costs for a typical mid-cap firm amounts to approximately 8% of operating value. Under the Fama-French three-factor model framework, it is approximately 5%. Very large firms exhibit minimal expected financial distress costs. Analysis may also have some implications for an industry-specific upper bound on optimal capital structure. |
