The Impact of the Structure of Debt on Target Gains

Dice Center Working Paper No. 2005-5

42 Pages Posted: 10 Mar 2005

See all articles by Tomas Jandik

Tomas Jandik

University of Arkansas - Sam M. Walton College of Business

Anil K. Makhija

Ohio State University (OSU) - Department of Finance

Date Written: October 4, 2005

Abstract

Consistent with prior literature, we find that increases in target leverage have a positive impact on returns to target shareholders irrespective of the source of debt. Even so, financing with bank debt has a remarkably different impact. If a target firm's debt is primarily sourced from banks, as opposed to when debt is dominated by public or private non-bank debt, we find that an increase in target leverage from the 25th to the 75th percentile (1) raises the probability of a bid leading to a successful takeover by 14%, but (2) lowers returns to target shareholders by 5.2% in the event a takeover occurs. (3) Supporting the coinsurance effect as an explanation, we find that an increase in leverage from the 25th to the 75th percentile lowers returns to target shareholders by 8.7% if target debt is relatively risky and bank-dominated. Finally, the transaction time to complete a takeover is also relatively smaller when debt is bank-dominated, since banks can more efficiently shift their debt to the typically more secure bidders.

Keywords: Target returns, structure of debt, coinsurance

JEL Classification: G32, G34

Suggested Citation

Jandik, Tomas and Makhija, Anil K., The Impact of the Structure of Debt on Target Gains (October 4, 2005). Dice Center Working Paper No. 2005-5, Available at SSRN: https://ssrn.com/abstract=679026 or http://dx.doi.org/10.2139/ssrn.679026

Tomas Jandik

University of Arkansas - Sam M. Walton College of Business ( email )

WCOB 302
Fayetteville, AR 72701
United States
479-575-6147 (Phone)

Anil K. Makhija (Contact Author)

Ohio State University (OSU) - Department of Finance ( email )

2100 Neil Avenue
Columbus, OH 43210-1144
United States
614-292-1899 (Phone)

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