| Summary: | This thesis investigates the effect of capital structure on probability of default using a
sample data of 496 firms from 17 developing countries for the period 2010-2017. The
study applies the two-step system generalized method of moments that mitigate
endogeneity problem. The study also examines the moderating effect of corporate
social responsibility (CSR) on the relationship between capital structure and long-term
debt to the probability of default.
The study finds a strong positive relationship between capital structure and probability
of default. Furthermore, CSR activities negatively moderate the relationship between
capital structure and probability of default. Moreover, CSR activities also negatively
moderate the relationship between long-term debt and probability of default. The
findings of this study have implications for managers and investors. Managers should
be wary of debt financing because it is one of the major causes of default probability.
Managers should also embrace CSR activities as their top agenda because high CSR
activities help to establish good relationships with various stakeholders which helps
to facilitate firms’ access to alternative sources of finance and decrease firms’ usage
of debts, hence reducing the probability of default. Investors should consider high CSR
firms when making investment decisions because high CSR decreases default risk
which serves as potential protection to investments.
This study makes three major contributions to finance literature. First, this study
investigates capital structure as determinant of probability of default using a large
sample of firms in developing countries. Second, this study adds a new determinant
(i.e. CSR) of probability of default by specifically establishing evidence that CSR
moderates the relationship between capital structure and probability of default on one hand, and long-term debt and probability of default on the other hand. Third, this study
finds that firms’ active CSR participation helps to decrease their need for debt
(especially debts with longer maturity), thus lowering their default probability.
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