Essays in Corporate Finance

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Prior research has been divided regarding how firms respond to bankruptcy

risk, largely revolving around two competing forces. On the one hand, asset substitution

encourages firms to increase the riskiness of assets to extract value from

creditors. On the other, firms want to minimize bankruptcy risk, either by reducing

cash flow risk or through increasing the size of the firm.

I test these two theories using a natural experiment of chemicals used in production

processes being newly identified as carcinogenic to explore how firms may

respond to potential negative cash flow resulting from litigation risk. I use plantlevel

chemical data to study firm exposure to risk. I examine how responses between

firms of differing levels of chemical exposure may vary within the industry, how firm

financial distress affects firm response and whether public and private firms respond

differently. In general, my research provides support for the asset substitution theory.

My first paper studies how investment response varies based on level of carcinogenic

exposure. I find that firms with moderate levels of exposure make efforts

to mitigate their cash flow risk and reduce their exposure. At the same time, firms

with high levels of exposure increase their exposure and riskiness of future cash

flows. These findings are consistent with asset substitution theory.

My second paper analyzes the interaction of financial distress and risk exposure.

I find that firms in a stronger financial position are more likely to limit their

exposure by reducing the number of exposed facilities. On the other hand, not only

do firms in weaker financial position not decrease their exposure, I find that, in some

instances, they increase their exposure to carcinogens. This work again supports

the theory of asset substitution.

Finally, in my third paper, I explore if public firms respond differently to a

potential negative cash flow shock than do private firms. I test whether existing

public firms are more likely to attempt to minimize their cash flow risk and thus

reduce their carcinogen exposure than are private firms. I do not find evidence that

public firms respond differently to this shock than do private firms.