The differential impact of leverage on the default risk of small and large firms

By L. Cathcart, Alfonso Dufour, Ludovico Rossi, S. Varotto. Journal of Corporate Finance, 2020

137 citations recorded by the source corpus.

Abstract 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.

View Paper: https://www.semanticscholar.org/paper/d242f0a5e53a64905d288e0c14923f093c6686cd