The Cost of Debt

Jules H. van Binsbergen, John Graham, Jie Yang

NBER Working Paper No. 16023
Issued in May 2010
NBER Program(s):Corporate Finance

We estimate firm-specific marginal cost of debt functions for a large panel of companies between 1980 and 2007. The marginal cost curves are identified by exogenous variation in the marginal tax benefits of debt. The location of a given company's cost of debt function varies with characteristics such as asset collateral, size, book-to-market, asset tangibility, cash flows, and whether the firm pays dividends. By integrating the area between 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 of debt of 10.4% of asset value and an estimated cost of debt of 6.9%. We find that the cost of being overlevered is asymmetrically higher than the cost of being underlevered and that expected default costs constitute approximately half of the total ex ante cost of debt.

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Acknowledgments

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Document Object Identifier (DOI): 10.3386/w16023

van Binsbergen, Jules H., John R. Graham, and Jie Yang, “The Cost of Debt,” Journal of Finance, forthcoming December 2010. citation courtesy of

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