How Does a Firm's Capital Structure Affect Stock Performance?
31 Pages Posted: 12 Jul 2015
Date Written: 2013
This paper examines the relationship between capital structure and shareholder returns in the UK between 1980 and 2008. Expanding on Modigliani and Miller’s (1958) Proposition 2, returns are estimated using the asset pricing models of CAPM, Fama and French and of Carhart. The analysis shows that gearing (in the form of debt finance) is a characteristic that influences stock returns and that, in contrast to accepted finance theory, is negatively related to estimated returns. This relationship is tested empirically for robustness with other risk factors such as corporate tax rates and industry concentration, the results remain consistent throughout the analysis. If confirmed, the negative impact of debt financing on shareholder returns should trigger a major rethink on corporate financing strategies.
Keywords: Stock Returns, Gearing, Asset Pricing Models, Risk Factors
JEL Classification: G12, G14, G17, G32
Suggested Citation: Suggested Citation