Tài liệu THE IMPACT OF FIRM''''S CHARACTERISTICS ON JUNK-BOND DEFAULT pptx

Journal Of Financial And Strategic Decisions

Volume 8 Number 2 Summer 1995

47

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 recapitalizations. The growth of the market has been exceptional.

According to estimates by Drexel Burnham Lambert (1989), the size of the market grew from $15 billion in 1976

to almost $200 billion in 1989. At the end of 1988, high yield bonds represented an estimated 25% of the entire

corporate bond market.

The remainder of the paper is organized as follows. In section II and III respectively, we discuss the

significance of default in bond valuation and provide a brief review of related research. In Section IV, we introduce

the warning signals of default, present the proposed methodology and describe the data for the study. The

methodology is applied in section V and a statistic is derived in section VI to test the model goodness of fit. In

section VII we discuss the result and provide two examples to show how the model can be put to use by individual

investors. Section VIII concludes the paper.

*University of Nebraska, Omaha.

**University of Southern California.

We would like to thank Joseph Bencivenga of Salomon Brothers and Melvin Vukcevich of Kemper Securities Group for helpful comments.