The role of level and structure of target debt in the takeover process

This dissertation consists of two essays studying the role of level and ownership structure of target debt in the context of both successful and cancelled acquisition attempts. The first essay examines the impact of the leverage of target firms on the returns to their equityholders at the announcement of takeovers. I find that target's leverage is positively related to not only returns to target equityholders, but also to total combined takeover gains to target and bidder shareholders. Most importantly, I examine the impact of the structure of debt ownership (bank, public, and private non-bank debt) on equityholders. Target stock returns at takeover announcements are (1) negatively affected by the dispersion of debt claims, (2) positively affected by the presence of public or private, non-bank dominated, debt, (3) negatively affected by risky debt (coinsurance effect), and (4) negatively affected by bank debt when there is a single bank relationship (hold-up effect). Overall, the results are consistent with the predicted positive impact of target leverage on target and total returns, and with the power of certain creditors to capture part of the takeover gains. In particular, I find that the coinsurance and hold-up effects are associated with bank dominated capital structures, consistent with the active role assigned to banks in the literature.; In the second essay, significant increases in the level of target leverage have been documented following unsuccessful takeover attempts. Interpreting the increased leverage as managerial commitment to improved performance, corporate performance and leverage should be positively related. If, however, the increased leverage leads to further managerial entrenchment then corporate performance and leverage should be negatively related. I examine both motivations for the leverage increase. I also argue that changes in the composition of debt are important, besides changes in the level of leverage. In particular, bank debt has been assigned a beneficial proactive monitoring role in the literature. Besides confirming the increase in the level of leverage, I also document increases in bank debt surrounding cancelled takeovers. As a result, I find a complex relation between corporate performance and debt use: Overall, the relation between corporate performance and increases in leverage is negative, as predicted by a dominant entrenchment effect. However, increases in bank debt reduce the adverse effect of the increase in the level of leverage.