The Reliability of Corporate Zero-Default Debt

Abstract

Although corporate bankruptcy has been examined in terms of measurement and modeling, a question remains standing still: Is it worthy enough to predict the bankruptcy or will it be better to develop a tool to prevent it from the beginning? Corporate bankruptcy techniques, models and theories focus on predicting the bankruptcy only rather than preventing bankruptcy which helps corporate managers take the right borrowing decision. The researcher believes that Corporate Debt Safe Buffer is a valid model in this respect. This thesis tests a bankruptcy prevention model (Eldomiaty, et al., 2014) on the non-financial firms listed in DJIA30 and NASDAQ100 over the period 1999-2016. The results provide a validation for this model with Trade off, Pecking Order and Free Cash Flow theories of capital structure as the results are quite significant and can be used for determining a debt ratio safe buffer. The researcher uses the following statistical methods to test the new model Lagrange Multiplier Test, Cointegration Using Unit Root Test, Linearity versus Nonlinearity Test, Hausman Test. The results prove that: (a) firms tend to adapt a positive debt ratio safe buffer, (b) there is no significant difference between debt ratio safe buffer and the observed debt ratio. The overall results show that the predication of bankruptcy is a helpful tool for credit rating agencies when evaluating corporate creditworthiness, although the model help avoiding bankruptcy.