Capital Structure and Corporate Financing Decisions: Theory, Evidence, and Practice

P1: TIX/XYZ P2: ABC

JWBT436-c04 JWBT436-Baker February 10, 2011 8:34 Printer Name: Hamilton

CAPITAL STRUCTURE AND FIRM RISK 69

debt offerings and significantly negative price effects at the announcement of con-

vertible debt offerings. These results are weakly consistent with the idea that

increases in financial leverage decrease equity values. However, attributing the

decrease in equity values to increases in risk alone is difficult. Equity values may

also decrease if debt offerings signal poor operating performance, as in Miller and

Rock (1985), or indicate that the firm’s securities are overvalued, as in Myers and

Majluf (1984). Although additional tests do not provide strong support for either

of these alternatives, they do not give much credence to the risk explanation either.

Equally troubling to proponents of the risk explanation are results showing that

equity offerings are also associated with negative announcement period returns

(see, e.g., Asquith and Mullins 1986; Masulis and Korwar 1986). Apparently, equity

values decrease with any external financing announcement regardless of whether

the transaction increases or decreases financial leverage.

Spiess and Affleck-Graves (1999) focus on long-run stock returns following

debt offerings. Based on a sample of 2,229 public debt offerings over the period

from 1975 to 1989, the authors show that firms issuing either straight or convertible

debt underperform benchmark portfolios in the subsequent five years. In other

words,increasesin financial leverage ...