Shareholders valuation of long-term debt and decline in firms' leverage ratio

Ranjan D'Mello, Mark Richard Gruskin, Manoj Kulchania

Research output: Contribution to journalArticle

1 Citation (Scopus)

Abstract

The median U.S. non-regulated firm reports a 47% decline in leverage ratio between 1980 and 2010. We investigate whether the cost-benefit tradeoff to shareholders, captured by the valuation impact of an additional dollar of debt on owners' equity, is an explanation for the observed change in leverage. Using Faulkender and Wang (2006) methodology, we find that shareholders view increasing debt to have a negative impact on their wealth, that is, shareholders perceive firms to be over-levered. Further, the net cost of issuing additional debt has increased steadily for three decades beginning in 1980 before declining marginally after 2010. This trend holds for different groups of firms classified on factors known to affect capital structure decisions. Managers respond to the changing cost to shareholders by reducing (increasing) leverage when the cost of debt increases (decreases). The time-series pattern in the marginal cost of debt persists after controlling for firm-specific characteristics. We find that macroeconomic factors, such as federal debt, play a role in explaining the marginal value of debt.

Original languageEnglish (US)
Pages (from-to)352-374
Number of pages23
JournalJournal of Corporate Finance
Volume48
DOIs
StatePublished - Feb 1 2018

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Debt
Long-term debt
Shareholders
Leverage ratio
Cost of debt
Leverage
Costs
Median
Trade-offs
Capital structure
Equity
Macroeconomic factors
Firm-specific characteristics
Marginal value
Factors
Owners
Wealth
Methodology
Cost-benefit
Marginal cost

All Science Journal Classification (ASJC) codes

  • Business and International Management
  • Finance
  • Economics and Econometrics
  • Strategy and Management

Cite this

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title = "Shareholders valuation of long-term debt and decline in firms' leverage ratio",
abstract = "The median U.S. non-regulated firm reports a 47{\%} decline in leverage ratio between 1980 and 2010. We investigate whether the cost-benefit tradeoff to shareholders, captured by the valuation impact of an additional dollar of debt on owners' equity, is an explanation for the observed change in leverage. Using Faulkender and Wang (2006) methodology, we find that shareholders view increasing debt to have a negative impact on their wealth, that is, shareholders perceive firms to be over-levered. Further, the net cost of issuing additional debt has increased steadily for three decades beginning in 1980 before declining marginally after 2010. This trend holds for different groups of firms classified on factors known to affect capital structure decisions. Managers respond to the changing cost to shareholders by reducing (increasing) leverage when the cost of debt increases (decreases). The time-series pattern in the marginal cost of debt persists after controlling for firm-specific characteristics. We find that macroeconomic factors, such as federal debt, play a role in explaining the marginal value of debt.",
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Shareholders valuation of long-term debt and decline in firms' leverage ratio. / D'Mello, Ranjan; Gruskin, Mark Richard; Kulchania, Manoj.

In: Journal of Corporate Finance, Vol. 48, 01.02.2018, p. 352-374.

Research output: Contribution to journalArticle

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