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Comments on

Empirical Evidence of Risk Shifting Behavior in Large and Small

Distressed Firms

Yehning Chen

National Taiwan University

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Main Contributions

An extension of Eisdorfer (2008)

- Eisdorfer (2008): For distressed firms,

• Volatility↑ → Gains from risk-taking↑→ Investment↑

• This effect is more significant when volatility is higher

- Contribution 1: the above effects are significant only for

small firms because their agency problems are more serious

- Contributions 2: for measuring asset return and volatility,

use Duan (1994, 2000) rather than Merton (1974)

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Comments

Very interesting idea: size (market capitalization) matters!

Empirical results support the idea.

Dependent:investment

Dependent:ΔVolatility

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Comments

Why does size matter? A puzzle!

- Is the risk-shifting problem more serious for small firms?

Not necessarily. (complexity, bargaining power, …)

Size is rarely used as a proxy for agency problems

(Smaller → Adverse selection↑→ Risk shifting↑? )

- Wild guess: size may be related to financial distress

Given the same z-score: Larger firms → less likely to fail

→ less distressed → less likely to suffer risk-shifting

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Comments

Using Duan (1994, 2000) to calculate asset return and

volatility

- Plus: More rigorous conceptually

- Minus: Results less comparable to Eisdorfer (2008)

- How significant are the improvements?

If claim the improvements are important

→ Need to show what differences it makes

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Comments

Some minor points

- Style: too similar to Eisdorfer (2008) in format

(tables, variables used, hypotheses, paragraphs…)

- Results in Table 7 (Cost of risk-shifting) are not significant

• Impact of investment on debt value is insignificant

• For small distressed firms, the overinvestment problem

reduces value of debt only by 0.97%

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Comments

Some minor points

- Results against the intuitions

(1) z-score↑→ risk-shifting↓→ marginal return of investment↑

Table 3 finds the opposite results (for large firms)

(2) Secured debt↑, convertible debt↑, or regulated industry

→ Risk-shifting problem should be less serious.

Table 5 finds the opposite results