The Impact of the Structure of Debt on Target Gains

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.

Number of Pages in PDF File: 42

Keywords: Target returns, structure of debt, coinsurance

JEL Classification: G32, G34

working papers series