The presence of financial distress costs can explain why firms choose debt levels that are too low to exploit the interest tax shield.

Question

Quizplus · Accepted Answer

If a firm has to face financial distress costs due to high levels of debt, it may choose to keep its debt levels lower, even if it means losing out on the interest tax shield. The costs of financial distress, such as bankruptcy costs and agency costs, can outweigh the benefits of the tax shield. Thus, the presence of financial distress costs can explain why firms may choose to have lower debt levels.

The Presence of Financial Distress Costs Can Explain Why Firms