We are deeply indebted to Richard Rendleman. Much of our article is based on his ideas in an unpublished paper. Also, his many suggestions greatly improved our presentation, but he is not responsible if we have made any errors. We also acknowledge helpful suggestions from Roger Broberg, Tom Chemmanur, Anjo Koeter-Kant, Phil Lane, Gilles Renaud, Pat Terrion, and an anonymous reviewer. We are especially grateful to Richard T. Jones for his assistance with the derivation of the key formulas. The financial support of the Keith B. Johnson Distinguished Finance Faculty Award, University of Connecticut, and the Spencer Educational Foundation is gratefully acknowledged. Correspondence: Thomas O'Brien.
Capital Structure Swaps and Shareholder Wealth
Article first published online: 23 OCT 2007
European Financial Management
Volume 13, Issue 5, pages 979–997, November 2007
How to Cite
O'Brien, T. J., Schmid Klein, L. and Hilliard, J. I. (2007), Capital Structure Swaps and Shareholder Wealth. European Financial Management, 13: 979–997. doi: 10.1111/j.1468-036X.2007.00391.x
- Issue published online: 23 OCT 2007
- Article first published online: 23 OCT 2007
- capital structure;
- asymmetric information
We show how capital structure swaps can increase the wealth of a firm's long-term shareholders when a firm's debt or equity is misvalued. We review the conventional rule that a firm should issue equity and use the proceeds to retire outstanding debt (an equity-for-debt swap) when equity is overvalued, or repurchase equity with proceeds of new debt (a debt-for-equity swap) when equity is undervalued. We also analyse the more complex case where a firm's debt and equity are both undervalued, showing the optimal swap may be to issue undervalued equity, contrary to the conventional rule.