Capital Structure and the Market for Corporate Control: The Defensive Role of Debt Financing



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    • The University of Michigan School of Business Administration, Ann Arbor. I wish to thank Artur Raviv for his guidance and assistance in writing this paper, I thank Laurie Bagwell, Elazar Berkovitch, Tom Brener, Susan Chaplinsky, Harry DeAngelo, Mike Fishman, Itzhak Gilboa, Jacob Glazer, Rob Heinkel, Morton Kamien, Marc Lipson, M. P. Narayanan, Greg Niehaus, Dan Siegel, Yossi Spiegel, René Stulz, and the referee for their helpful comments and suggestions. Of course, I bear full responsibility for any errors and misconceptions contained in this paper.


A capital structure theory based on corporate control considerations is presented. The optimal debt level balances a decrease in the probability of acquisition against a higher share of the synergy for the target's shareholders. This leads to the following implications: (i) the probability of firms becoming acquisition targets decreases with their leverage, (ii) acquirers' share of the total equity gain increases with targets' leverage, (iii) when acquisitions are initiated, targets' stock price, targets' debt value, and acquirers' firm value increase, and (iv) during the acquisition, target firms' stock price changes further; the expected change is zero and the variance decreases with targets' debt level.