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In the Path of the Storm: Does Distress Risk Cause Industrial Firms to Risk-Shift?

Author

Listed:
  • Kevin Aretz
  • Shantanu Banerjee
  • Oksana Pryshchepa

Abstract

We study whether industrial firms risk-shift in response to distress risk increases induced through hurricane strikes. Using new proxies capturing deliberate managerial decisions about the risk of a firm’s operating segment portfolio, differences tests suggest that hurricane strikes prompt moderately, but not highly, distressed firms to skew their asset mixes toward riskier segments by shutting down low-risk, high-average-Q segments. In turn, the moderately distressed firms observe abnormally high failure rates after a hurricane strike. Employing covenant violation data, we offer further evidence that creditor control prevents highly distressed firms from raising their risk. Our conclusions extend those of other studies by suggesting that moderate distress risk levels can lead the managers of industrial firms to not only engage in risk-taking, but, in fact, in risk-shifting.

Suggested Citation

  • Kevin Aretz & Shantanu Banerjee & Oksana Pryshchepa, 2019. "In the Path of the Storm: Does Distress Risk Cause Industrial Firms to Risk-Shift?," Review of Finance, European Finance Association, vol. 23(6), pages 1115-1154.
    • Handle: RePEc:oup:revfin:v:23:y:2019:i:6:p:1115-1154.
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    File URL: http://hdl.handle.net/10.1093/rof/rfy028
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    Citations

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    Cited by:

    1. Peydró, José-Luis & Polo, Andrea & Sette, Enrico, 2020. "Risk Mitigating versus Risk Shifting: Evidence from Banks Security Trading in Crises," CEPR Discussion Papers 15473, C.E.P.R. Discussion Papers.
    2. Zhiyao Chen & Ran Duchin, 2024. "Do Nonfinancial Firms Use Financial Assets to Take Risk?," The Review of Corporate Finance Studies, Society for Financial Studies, vol. 13(1), pages 1-37.
    3. (DJ) Fairhurst, Douglas & Liu, Yanguang & Ni, Xiaoran, 2020. "Employment protection and tax aggressiveness: Evidence from wrongful discharge laws," Journal of Banking & Finance, Elsevier, vol. 119(C).
    4. Feng, Zhi-Yuan & Wang, Chou-Wen & Lu, Yu-Hong, 2022. "The impact of climatic disaster on corporate investment policy," Journal of Multinational Financial Management, Elsevier, vol. 66(C).

    More about this item

    Keywords

    Agency conflicts; Risk-shifting; Distress risk; Segment data; Hurricane strikes;
    All these keywords.

    JEL classification:

    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation

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