Do Firms Engage in Risk-Shifting? Empirical Evidence

Erik P. Gilje
2016 The Review of financial studies  
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 suggest
more » ... findings suggest that debt composition and financial covenants serve as important mechanisms to mitigate debt-equity agency conflicts, such as risk-shifting, that are not explicitly contracted on. * I would also like to thank Rüdiger Fahlenbrach,
doi:10.1093/rfs/hhw059 fatcat:gzgapllsfrd2zlouojvd3c5q5e