Determinants of Stochastic Distance-to-Default

Efficient management of bankruptcy risk requires treating distant-to-default (DD) stochastically as long as historical stock prices move randomly and, thus, do not guarantee that history may repeat itself. Using long-term data that date back to 1952–2023, including the nonfinancial companies listed in the Dow Jones Industrial Average and National Association of Securities Dealers Automated Quotations indexes, this study estimates the historical and stochastic DDs via the geometric Brownian motion (GBM). The results show that (a) the association between the debt-to-equity ratio and the stochastic DD can be used as an indicator of excessive debt financing; (b) debt tax savings have a positive effect on stochastic DD; (c) bankruptcy costs have negative effects on stochastic DD; (d) in terms of the size of the company being proxied by sales revenue and the equity market value of the company, the DD is a reliable measure of bankruptcy costs; (e) in terms of macroeconomic influences, increases in the percentage change in manufacturing output are associated with lower observed and stochastic DD; and (f) in terms of the influences of industry, the stochastic DD is affected by the industry average retail inventory to sales. This paper contributes to related studies in terms of focusing on the indicators that a company’s management can focus on to address the stochastic patterns inherent in the estimation of the DD.