Capital Structure Choices and Survival in a Deregulated Environment

We examine the impact of capital structure choices for survival in a deregulated industry. Financial leverage in particular has been identified by numerous prior studies as a major determinant of the probability of survival in most industries. In the course of a deregulation, the debt overhang effect stemming from high leverage negatively affects the ability of existing firms to survive when a regulatory shock occurs (Zingales, 1998). Following such a regulatory shock, and consistent with the tradeoff and debt overhang theories of capital structure, firms are more likely to reduce their level of leverage (Ovtchinnikov, 2010). This causes the expected costs of financial distress to rise higher and we can expect a negative association between leverage and survival in a deregulated industry. However, in a highly competitive setting, firms may signal their level of quality by contracting for more debt instead of equity (Ross, 1977). This signaling perspective can therefore induce the existence of a positive association between leverage and survival in a deregulated context. Using a sample of private trucking firms, we test this hypothesis and find a negative association between leverage and survival. In a refined analysis aimed at distinguishing high “quality” versus low “quality” firms, we adopt the “excess capacity” approach of De Vany and Saving (1977). Consistent with our initial findings, we find that the negative association between leverage and survival increases with the level of excess capacity.