The Cost of Debt





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    • van Binsbergen is from the Kellogg Graduate School of Management, Northwestern University, the Graduate School of Business, Stanford University, and NBER; Graham is from the Fuqua School of Business, Duke University, and NBER; and Yang is from the McDonough School of Business, Georgetown University. We thank Rick Green (the Acting Editor), an anonymous referee, Heitor Almeida, Ravi Bansal, Jonathan Berk, Michael Brandt, Alon Brav, Hui Chen, Dave Denis, Simon Gervais, Cam Harvey, Han Hong, Ralph Koijen, Mike Lemmon, Rich Mathews, Bertrand Melenberg, Francisco Pérez-González, Mitchell Petersen, Anamaría Pieschacón, Adriano Rampini, Michael Roberts, David Robinson, Ilya Strebulaev, George Tauchen, Larry Weiss, Toni Whited, participants at the WFA 2007 meeting, the NBER Summer Institute 2007, the EFA 2007 meeting, UNC Tax Symposium 2008, and the McKinsey Corporate Finance Conference, and seminar participants at Duke University, Georgetown University, Indiana University, New York University, Purdue University, Rice University, University of Chicago, University of Pittsburgh, and The Wharton School for helpful comments.


We use exogenous variation in tax benefit functions to estimate firm-specific cost of debt functions that are conditional on company characteristics such as collateral, size, and book-to-market. By integrating the area between the 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 (cost) of debt equal to 10.4% (6.9%) of asset value. We find that the cost of being overlevered is asymmetrically higher than the cost of being underlevered and that expected default costs constitute only half of the total ex ante costs of debt.