The search for the optimal, or value-maximizing, capital structure involves weighing the expected benefits of higher leverage against the expected "costs of financial distress." These costs include not only the direct costs of reorganization, but less quantifiable effects of financial trouble...

In this paper we argue that risk-adjustment matters for the valuation of financial distress costs, since financial distress is more likely to happen in bad times. Systematic distress risk implies that the risk-adjusted probability of financial distress is larger than the historical probability....

In this paper we argue that risk-adjustment matters for the valuation of financial distress costs, since financial distress is more likely to happen in bad times. Systematic distress risk implies that the risk-adjusted probability of financial distress is larger than the historical probability....

In this paper we argue that risk-adjustment matters for the valuation of financial distress costs, since financial distress is more likely to happen in bad times. Systematic distress risk implies that the risk-adjusted probability of financial distress is larger than the historical probability....

We argue that risk premia affect the valuation of financial distress costs because these costs are more likely to be incurred in bad times. We compute the NPV of distress costs using risk-adjusted default probabilities derived from corporate bond spreads. Because credit spreads are large, the...