Market Valuation of Interest-Cost Savings from Debt Refinancing

Posted: 14 Aug 2001 Last revised: 29 Jan 2014

See all articles by Al (Aloke) Ghosh

Al (Aloke) Ghosh

UNC Charlotte

Steven B. Lilien

City University of New York (CUNY) - Stan Ross Department of Accountancy

Steve C. Lim

Texas Christian University - M.J. Neeley School of Business

Abstract

A significant volume of long-term debt was refinanced by corporate America in the early 1990s. We argue that a majority of the refinancing was undertaken to improve the firm's cash flow performance. Firms replacing high-coupon long-term debt with low-coupon debt were able to increase their present and future cash flows because of the low interest rate environment. Since interest-cost savings are certain till the maturity of the debt, the market will capitalize these savings at a higher rate than earnings from other operations. Our cross sectional regression analysis shows that the earnings response coefficient on interest-cost savings is significantly higher than the coefficient on residual earnings from other operations. Overall results suggest that the market was able to unscramble the cash flow implications of debt refinancing and capitalize interest-cost savings in firms' stock prices.

JEL Classification: G31, G35, G14

Suggested Citation

Ghosh, Al (Aloke) and Lilien, Steven B. and Lim, Steve, Market Valuation of Interest-Cost Savings from Debt Refinancing. Journal of Financial Statement Analysis, 1998, Available at SSRN: https://ssrn.com/abstract=271376

Al (Aloke) Ghosh (Contact Author)

UNC Charlotte ( email )

9201 University City Blvd
Charlotte, NC 28223
United States

HOME PAGE: http://www.alokeghosh.com

Steven B. Lilien

City University of New York (CUNY) - Stan Ross Department of Accountancy ( email )

One Bernard Baruch Way, Box B12-225
New York, NY 10010
United States
646-312-3163 (Phone)
646-312-3161 (Fax)

Steve Lim

Texas Christian University - M.J. Neeley School of Business ( email )

2900 Lubbock Street
Fort Worth, TX 76129
United States
817-257-7536 (Phone)

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