The Effect of Corporate Debt on Default Risk

The purpose of this study is to examine if there is any systematic relationship between the default risk and financial performance. From analytical results, this study develops the hypothesis by comparing the financial performance between pre-change and post-change period, using a sample of 173 Korean firms that experienced changes in their capital structures through the issue of debt during 2001-2010 period. The empirical results indicate that the financial performance has decreased for the issue of new debt from pre-change to post-change period, but the issue of debt is positively related to the cost of capital. These results hold up even after controlling for the differences in the financial leverage and size between pre-change and post-change period. Overall, the findings provide directly support to the hypothesis that the issue of debt is a negative function of the firm's financial performance as measured by the firm’s profitability( ROA) and WACC.