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

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  • D'Mello, Ranjan
  • Gruskin, Mark
  • Kulchania, Manoj

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.

Suggested Citation

  • D'Mello, Ranjan & Gruskin, Mark & Kulchania, Manoj, 2018. "Shareholders valuation of long-term debt and decline in firms' leverage ratio," Journal of Corporate Finance, Elsevier, vol. 48(C), pages 352-374.
    • Handle: RePEc:eee:corfin:v:48:y:2018:i:c:p:352-374
    DOI: 10.1016/j.jcorpfin.2017.11.006
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    More about this item

    Keywords

    Capital structure; Marginal cost of debt; Leverage;
    All these keywords.

    JEL classification:

    • G30 - Financial Economics - - Corporate Finance and Governance - - - General
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G34 - Financial Economics - - Corporate Finance and Governance - - - Mergers; Acquisitions; Restructuring; Corporate Governance

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