The Art of Capital Restructuring: Creating Shareholder Value through Mergers and Acquisitions

CHAPTER 22

Financial Restructuring

OTGONTSETSEG ERHEMJAMTS

Assistant Professor of Finance, Bentley University

KARTIK RAMAN

Associate Professor of Finance, Bentley University

INTRODUCTION

Beginning with the pioneering work of Modigliani and Miller (1958), capital structure theories emerged by relaxing the assumptions of efficient capital markets as well as perfect market assumptions, especially taxes, bankruptcy costs, asymmetric information, and transaction costs (e.g., Kraus and Litzenberger, 1973; DeAngelo and Masulis, 1980; Myers and Majluf, 1984; Fischer, Heinkel, and Zechner, 1989; Leland, 1994, 1998). Another set of capital structure theories developed by Jensen and Meckling (1976), Myers (1977), and Jensen (1986) emphasizes the contracting role of debt in influencing corporate policies through the effects on managerial incentives. Still another set of theories, influenced by the work of Ritter (1991), drops the assumption of market efficiency and advances hypotheses based on windows of opportunity and inertia. In particular, Baker and Wurgler (2002) and Welch (2004) argue that the costs of issuing debt and equity vary over time due to market inefficiencies and thus create potential opportunities for firms to benefit by timing external financing decisions.

Recognizing that various factors influence firms to dynamically rebalance their capital structures over time, recent empirical studies examine the speed at which firms adjust toward their target leverage, ultimately offering ...