Capital Structure in Financial Distress: A Comprehensive Study across Industries and Borders

Abstract

This paper examines the effects of financial distress on the relationships between capital structure and its determinants – continuing on the famous research by Rajan and Zingales from 1995. The sample contains balance sheet information for 3743 non-financial firms over a period of 14 years, classified into NAICS sectors and distributed across the G7 countries. Results reveal that financial stress (i) puts downwards pressure on the positive relationship between capital structure and tangible assets, (ii) causes a substantial shift in the negative link between capital structure and profitability, so much so that it be-comes strongly positive, (iii) has an ambiguous effect on the relationship between capital structure and investment opportunities, putting upwards pressure when measured at book leverage and downwards pressure when measured at market leverage, (iv) has weak impact on the relationship between capital structure and tangible assets in countries and sectors with high tangibility, (v) has strong impact on the relationship between capital structure and company size in countries and sectors with large firms, and (vi) has weak impact on the relationship between capital structure and profitability in countries and sectors with high profit margin.