The Market for Corporate Control and the Cost of Debt

51 Pages Posted: 19 Jan 2009

See all articles by Jiaping Qiu

Jiaping Qiu

McMaster University - Michael G. DeGroote School of Business

Fan Yu

Claremont McKenna College - Robert Day School of Economics and Finance

Date Written: September 26, 2008

Abstract

How do bondholders view the existence of an open market for corporate control? Between 1985 and 1991, 30 states in the U.S. enacted business combination (BC) laws, raising the cost of corporate takeovers. Relying on these exogenous events, we estimate the influence of the market for corporate control on the cost of debt. We identify different channels through which an open market for corporate control can benefit or harm bondholders: a reduction in managerial slack or the "quiet life," resulting in higher profitability and firm value; a coinsurance effect, in which firms become less risky after being acquired; and an increasing leverage effect, in which bondholder wealth is expropriated through leverage-increasing takeovers. Consistent with the first two mechanisms, we find that the cost of debt rose after the passage of the BC laws; moreover, it rose sharply for firms in non-competitive industries, and for firms rated speculative-grade. In contrast, there is virtually no effect for firms in competitive industries, or firms rated investment-grade.

Suggested Citation

Qiu, Jiaping and Yu, Fan, The Market for Corporate Control and the Cost of Debt (September 26, 2008). Journal of Financial Economics, Forthcoming; Robert Day School of Economics and Finance Research Paper No. 2009-11. Available at SSRN: https://ssrn.com/abstract=1329854

Jiaping Qiu

McMaster University - Michael G. DeGroote School of Business ( email )

1280 Main Street West
Hamilton, Ontario L8S 4M4
Canada

Fan Yu (Contact Author)

Claremont McKenna College - Robert Day School of Economics and Finance ( email )

500 E. Ninth St.
Claremont, CA 91711-6420
United States
(909)607-3345 (Phone)

HOME PAGE: http://www.cmc.edu/academic/faculty/profile.asp?Fac=553

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