Stock Returns and the Competitive Effects of Debt

81 Pages Posted: 17 Mar 2012 Last revised: 24 Nov 2015

See all articles by Rogerio Mazali

Rogerio Mazali

Catholic University of Brasilia

Jaideep Shenoy

University of Connecticut

Sheri Tice

Tulane University - A.B. Freeman School of Business

Date Written: August 1, 2015

Abstract

Prior studies examine real firm behavior and show that high debt makes a firm vulnerable in the product market. In this study, we assess the economic magnitude of competitive effects of debt by examining stock returns. For identification, we use a double-layer of contrasts by conditioning our tests across the business cycle and varying product differentiation environments. Firms with high relative-to-industry debt experience significantly lower stock returns during recessions but similar returns during normal times compared to firms with low relative-to-industry debt. The results are driven by the sub-sample of firms with low product differentiation where the competitive effects of debt should be the strongest. Returns are 9% lower during recessions for firms with above industry median debt in this sub-sample. This finding is robust to alternative explanations such as endogeneity, mechanical leverage effects, business risk, debt overhang, and customer warranty concerns. We also link real effects to stock returns by showing that debt-induced sales growth is a significant determinant of stock returns. Our finding that the competitive effects of debt have an economically significant effect on stock returns is important to investment bankers who advise firms on capital structure decisions, chief financial officers, corporate treasurers, and equity money managers.

Keywords: Product markets, leverage, predation, stock returns, product market competition

JEL Classification: G32, G33, L11, L10

Suggested Citation

Mazali, Rogerio and Shenoy, Jaideep and Tice, Sheri, Stock Returns and the Competitive Effects of Debt (August 1, 2015). AFA 2013 San Diego Meetings Paper. Available at SSRN: https://ssrn.com/abstract=2023711 or http://dx.doi.org/10.2139/ssrn.2023711

Rogerio Mazali

Catholic University of Brasilia ( email )

SGAN 916, Módulo B, Asa Norte
Brasília, DF 70790-160
Brazil
+55 61 3448-7192 (Phone)

HOME PAGE: http://www.ucb.br

Jaideep Shenoy (Contact Author)

University of Connecticut ( email )

School of Business
2100 Hillside Road
Storrs, CT 06269
United States

Sheri Tice

Tulane University - A.B. Freeman School of Business ( email )

A.B. Freeman School of Business
7 McAlister Drive
New Orleans, LA 70118
United States
504-865-5469 (Phone)
504-865-6751 (Fax)

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