TAILIEUCHUNG - THE IMPACT OF FIRM'S CHARACTERISTICS ON JUNK-BOND DEFAULT

Recently, much academic and regulatory interest has been concentrated on the problem of high-yield, junk bond default. Arguably, corporate bonds have defaulted for many reasons, including factors specific to the individual issuing firm, variables corresponding to the industry in which it operates, and macroeconomic forces affecting the business cycle. Individual factors include the firm's leverage, industry type, agency problem, riskiness of the investment decisions, managerial integrity, efficiency and investment savvy together with institutional operating costs. Industry and aggregate factors affect the firm's performance and therefore affect default as well. This paper tests the significance of the firm's characteristics on the likelihood of default and assesses their. | Journal Of Financial And Strategic Decisions Volume 8 Number 2 Summer 1995 THE IMPACT OF FIRM S CHARACTERISTICS ON JUNK-BOND DEFAULT Sam Ramsey Hakim and David Shimko Abstract This study examines firm-specific value and risk factors as early predictors of junk bond default. Reduction in equity value increased variation in long-term debt levels and reductions in cash flow are found to be statistically significant indicators of higher default probabilities in a logit model. Variations in investment levels have insignificant explanatory power. The model provides individual investors with the ability to assess the default risk of high-yield securities based on the levels of observable financial variables. INTRODUCTION Recently much academic and regulatory interest has been concentrated on the problem of high-yield junk bond default. Arguably corporate bonds have defaulted for many reasons including factors specific to the individual issuing firm variables corresponding to the industry in which it operates and macroeconomic forces affecting the business cycle. Individual factors include the firm s leverage industry type agency problem riskiness of the investment decisions managerial integrity efficiency and investment savvy together with institutional operating costs. Industry and aggregate factors affect the firm s performance and therefore affect default as well. This paper tests the significance of the firm s characteristics on the likelihood of default and assesses their relative impact on future default rates. Bonds are considered high yield or junk based on the credit ratings they receive from the two major US rating agencies Moody s and Standard Poor s. Any bond rated below Baa3 by Moody s or BBB- by S P is included in the high yield universe. High yield bonds are classified in two ways as fallen angels which are former investment grade bonds that have declined in ratings and as new issue high yield bonds which are issued generally by young growing companies in .

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