The Impact of Capital Structure Change on Firm Value: Some Estimates

Abstract

This study develops a model based on current corporate finance theories which explains stock returns associated with the announcement of issuer exchange offers. The major independent variables are changes in leverage multiplied by senior security claims outstanding and changes in debt tax shields. Parameter estimates are statistically significant and consistent in sign and relative magnitude with model predictions. Overall, 55 percent of the variance in stock announcement period returns is explained. The evidence is consistent with taxbased theories of optimal capital structure, a positive debt level information effect, and leverage-induced wealth transfers across security classes. THERE IS AN EXTENSIVE theoretical literature concerning optimal capital structure.' However, there is little empirical evidence of a relation between changes in capital structure and firm value. In the best known test of an optimal capital structure model, Miller-Modigliani [15] reported evidence of a positive relationship between firm value and leverage which they attributed to a debt tax shield effect. Their results are suspect, however, because of statistical problems they encountered when attempting to adjust for differences in the firms' asset structures. Since only regulated firms were examined, there is also some concern that their empirical findings were caused by the regulatory environment in which these firms operate. No strong evidence of a relation between a firm's value and the size of its debt tax shield has been uncovered since the Miller-Modigliani study.This study estimates the impact of a change in debt level on firm values. Two forms of capital structure change are examined: issuer exchange offers, and recapitalizations. The results indicate that both stock prices and firm values are positively related to changes in debt level and leverage; senior security prices are negatively related to these capital structure change variables. This evidence is consistent with models of optimal capital structure and with the hypothesis that debt level changes release information about changes in firm value. especially Robert Hamada, for their considerable help and encouragement. This is based on a chapter of my dissertation written at the University of Chicago. I have also benefited from the suggestions of the participants in the many finance workshops where this paper was presented. I also wish to thank the many U.S. corporations which voluntarily co-operated in this study. An earlier version of this paper was presented at the Western Finance Association meetings in Jackson Hole in June 1981. I take sole responsibility for any remaining errors. 'See, for example, Modigliani-Miller [16, 17], Kraus-Litzenberger [10], Scott [19], Miller [14], and DeAngelo-Masulis [5].

Impact of Capital Structure on Stock Prices: Evidence from Oman

“…Even after that study, no strong research work had been carried out to identify evidence of a relation between a firm's value and the size of its debt tax shield, evidence of a relation between a firm's value and the size of its debt tax shield. Further, Masulis (1983) found that both stock prices and firm values are positively related to changes in debt level and leverage; security prices are negatively related to these capital structure change variables. This evidence is consistent with models of optimal capital structure and with the hypothesis that debt level changes release information about changes in firm value.…”

“…None of these studies of capital structure changes, however, resolves the issue of what factors determine the negative average stock price response. Nor do they completely explain the motivation for these capital structure changes As stated by Masulis (1983) presented an extensive theoretical literature available with respect to the optimal capital structure. However, evidence of a relation between changes in capital structure and firm value are seldom reported.…”

How to Evaluate the Performance of the Taiwan Biotech and Biopharmaceutical Corporations?

“…Take the stock price and relationship of financial operation as the research topic, the stock price of corporation rose with the level of financial leverage discovered by Masulis (1983). Simultaneously, the value of corporation is related to the debt level positively.…”

Debt Maturity and Stock Returns: An Inter-Sectoral Comparison of Malaysian Firms

“…Despite various capital structure theories that have tried to rationalise the impact of leverage, past literature often provides mixed empirical evidence on the role of leverage in return predictability. Among some well-known studies, Hamada (1972), Masulis (1983), and Bhandari (1988) in early years found that stock returns are positively associated with leverage. Fama and French (1992), as well as Strong and Xu (1997), later discover the negative relationship between book leverage and returns, but the relationship becomes insignificant when book-to-market is considered.…”