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Financial Distress in the Great Depression


  • We thank two anonymous referees, Michael Bradley, Alon Brav, Murillo Campello, Bill Christie (Editor), Harry DeAngelo, Laura Field, David Hsieh, Pete Kyle, Mike Lemmon, Antionette Schoar, Dennis Sheehan, Sheri Tice, Mike Weisbach, and seminar participants at Duke, Indiana, Penn State, Tulane, and UCLA for valuable feedback. We acknowledge financial support from the Hartman Center at the Fuqua School of Business. Graham acknowledges financial support from an Alfred P. Sloan Foundation fellowship. Hazarika acknowledges financial support from PSC-CUNY and the Baruch College Fund. Any errors are ours alone.


We use firm-level data to study corporate performance during the Great Depression era for all industrial firms on the NYSE. Our goal is to identify the factors that contribute to business insolvency and valuation changes during the period 1928-1938. We find that firms with more debt and lower bond ratings in 1928 became financially distressed more frequently during the Depression, consistent with the trade-off theory of leverage and the information production role of credit rating agencies. We also document for the first time that firms responded to tax incentives to use debt during the Depression era but that the extra debt used in response to this tax-driven “debt bias” did not contribute significantly to the occurrence of distress. Finally, we conduct an out-of-sample test during the recent 2008-2009 Recession and find that higher leverage and lower bond ratings also increased the occurrence of financial distress during this period.