Does the threat of takeover affect default risk?

We examine the impact of the threat of takeovers on default risk. Using a sample of 50,189 firm‐year observations for US firms over the period 1990–2015, we find that the threat of takeovers has a negative relation with default risk. We use difference‐in‐difference analysis to address potential endogeneity concerns and propensity score matching to control for self‐selection bias. The results are robust to alternative measures of default risk and exclusion of the dot com and financial crisis periods. Our results also hold after controlling for Governance Index and Entrenchment Index. We identify improvement in performance and earnings quality in response to the threat of takeovers as channels underlying our main result. The effect of the threat of takeovers on default risk is more pronounced for firms with opaque information environment and low institutional ownership. Our findings provide important insights for the market for corporate control as a disciplining mechanism in reducing default risk.