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I empirically test whether firms engage in risk-shifting. Contrary to what risk-shifting theory predicts, I find that firms reduce investment risk when they approach distress. To identify the effect of distress on risk-taking, I use a natural experiment with exogenous changes to leverage. Risk reduction is most prevalent among firms that have shorter maturity debt and bank debt. I also find that risk reduction occurs in firms with tighter bank loan financial covenants. These findings suggestdoi:10.1093/rfs/hhw059 fatcat:gzgapllsfrd2zlouojvd3c5q5e