| Abstract: | This paper examines the determinants of default-risk premiums and the ways in which they change over the business cycle. Seven default-risk factors are constructed from a large number of financial ratio/accounting variables. Factor scores summarizing these variables for a sample of industrial corporations are regressed with bond risk premiums for all years from 1971 to 1977—a complete business cycle. A second sample covering the years 1975 to 1977 is also examined. The main conclusion is that the cyclical movement of business conditions influences investors' assessments of default risk. Bonds issued in periods of economic normalcy have premiums that are significantly associated with earnings instability in addition to sales and size factors. By contrast, firms issuing bonds during recessionary climates must have relatively greater size and profitability to obtain funding at lower-interest costs. Firms with higher sales turnover ratios and, therefore, greater earnings instability with respect to economic downswings, are less likely to issue debt securities during depressed business conditions. |
