Asset Volatility and Capital Structure: Evidence from Corporate Mergers

Oliver Levine () and Youchang Wu ()
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Oliver Levine: Wisconsin School of Business, University of Wisconsin–Madison, Madison, Wisconsin 53706
Youchang Wu: Lundquist College of Business, University of Oregon, Eugene, Oregon 97403

Management Science, 2021, vol. 67, issue 5, 2773-2798

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 postmerger changes in leverage and cash holdings are strongly predicted by expected asset volatility changes estimated using premerger 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 tradeoff 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; trade-off theory; mergers and acquisitions (M&A); financial synergy; corporate cash holdings (search for similar items in EconPapers)
Date: 2021
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Citations: View citations in EconPapers (4)

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Persistent link: https://EconPapers.repec.org/RePEc:inm:ormnsc:v:67:y:2021:i:5:p:2773-2798

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