Asset Volatility and Capital Structure: Evidence from Corporate Mergers

Management Science (Forthcoming)

72 Pages Posted: 22 Feb 2014 Last revised: 20 Jan 2020

See all articles by Oliver Levine

Oliver Levine

University of Wisconsin - Madison

Youchang Wu

University of Oregon - Lundquist College of Business

Date Written: January 17, 2020

Abstract

We exploit cross-sectional variation in the predictable changes in asset volatility following corporate acquisitions to identify the effect of business risk on capital structure. We find that post-merger changes in leverage and cash holdings are strongly predicted by expected asset volatility changes estimated using pre-merger information. These capital structure adjustments are partly achieved through the choice of payment method. Our findings provide direct evidence for the coinsurance effect of mergers on debt capacity. More broadly, they suggest that firm risk is a first-order determinant of leverage, consistent with the trade-off theory of capital structure. Our coefficient estimates imply that a one standard deviation decline in a firm's asset volatility corresponds to a 7.5 percentage point increase in leverage.

Keywords: Capital structure, Mergers and acquisitions (M&As), Corporate cash holdings, Financial synergy

JEL Classification: G30, G32, G34

Suggested Citation

Levine, Oliver and Wu, Youchang, Asset Volatility and Capital Structure: Evidence from Corporate Mergers (January 17, 2020). Management Science (Forthcoming) , Available at SSRN: https://ssrn.com/abstract=2399154 or http://dx.doi.org/10.2139/ssrn.2399154

Oliver Levine (Contact Author)

University of Wisconsin - Madison ( email )

975 University Avenue
Madison, WI 53706
United States

HOME PAGE: http://oliverlevine.com

Youchang Wu

University of Oregon - Lundquist College of Business ( email )

1280 University of Oregon
Eugene, OR 97403
United States

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