The Cost of Debt

  • Author(s): JULES H. Van BINSBERGEN, JOHN R. GRAHAM, JIE YANG
  • Published: Nov 09, 2010
  • Pages: 2089-2136
  • DOI: 10.1111/j.1540-6261.2010.01611.x

ABSTRACT

We use exogenous variation in tax benefit functions to estimate firm‐specific cost of debt functions that are conditional on company characteristics such as collateral, size, and book‐to‐market. By integrating the area between the benefit and cost functions, we estimate that the equilibrium net benefit of debt is 3.5% of asset value, resulting from an estimated gross benefit (cost) of debt equal to 10.4% (6.9%) of asset value. We find that the cost of being overlevered is asymmetrically higher than the cost of being underlevered and that expected default costs constitute only half of the total ex ante costs of debt.

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