the nature of information conveyed by pure capital structure changes

ECONOMICS EISEVIER Journal of Financial Economics 36 (1994) 899126

The nature of information conveyed by pure capital structure changes

Kshitij Shah

Department of Accounting & Finance, University qf Auckland, Auckland, New Zealand

(Received April 1993; final version received December 1993)

Abstract

This study investigates the information conveyed by intrafirm exchange offers. I find that leverage increases and leverage decreases convey qualitatively different information. Leverage-increasing offers appear to lower investors’ assessment of risk of the firm’s common stock, but do not appear to change their expectations of cash flows; leverage- decreasing offers appear to lower investors’ expected cash flows, but do not appear to change their assessment of risk. The nature of changes in leverage, capital outlays, and dividends is also asymmetric. Further, I find that, for leverage-increasing offers, corporate control activity does not explain the information content or its asymmetry.

Key words: Capital structure; Exchange offers; Information; Financial distress; Corporate control JEL classfcation: G32

1. Introduction

Firms occasionally offer new securities in exchange for existing securities with different priority claims. Previous studies conclude that the substantial stock- price reactions which accompany the announcements of intrafirm exchange offers (and also various other capital structure changes) are most consistent with

This study is based on my dissertation at the University of Oregon. I would like to thank Wayne

Mikkelson (chair), Larry Dann, Megan Partch, Van Kolpin, Ronald Lease (the referee), and Clifford Smith (the editor) for their valuable comments. I have also benefited from comments from Alyce

Campbell, Terrence O’Keefe, Peggy Wier, and seminar participants at the University of Oregon, the University of Alberta, the University of Auckland, and the University of Miami.

0304-405X/94/$07.00 Q 1994 Elsevier Science BV. All rights reserved SSDI 0304405x9400775 v

an ‘information effect’. Moreover, it is often presumed that the information conveyed by offers that raise financial leverage is similar but opposite in content to the information conveyed by offers that reduce financial leverage. Yet the nature of the information conveyed by leverage changes remains unclear.

1 investigate the information content of exchange offers. My sample is com- prised of 175 leverage-increasing and 191 leverage-decreasing exchange offers over the period 1970-1988. I compare the operating cash fows and risk of offer firms to other firms in the same industry. I also examine patterns of leverage, capital outlays, and dividends surrounding exchange offers, and the extent to which the results are contingent upon corporate control events and corporate default.

My results contradict the presumption that leverage increases and leverage decreases simply convey opposite information about the same set of economic variables. I find that offers which increase financial leverage (such as offers that substitute debt for equity) are associated with a decline in the risk of the firm’s common stock, but no change in cash flows. In contrast, offers which decrease financial leverage (such as offers that substitute equity for debt) are associated with lower future cash flows, but no change in the risk of the firm’s common stock. This asymmetry is surprising given that no extant theories predict the direction of a change in leverage to reveal qualitatively different information about firm performance.

I explore several other characteristics of exchange-offer firms to identify additional differences in important economic variables between firms that engage in leverage-increasing and leverage-decreasing exchange offers. The patterns of leverage, capital outlays, and dividends reveal other asymmetries, reinforc- ing the conclusion that the two types of offers convey different information.

Both leverage-increasing and leverage-decreasing offer firms are substantially more levered than their industry counterparts prior to the exchange offers. Leverage-decreasing offer firms, in particular, show increases in leverage in the pre-offer years until, on average, they are more than twice as levered as the other firms in their industry just prior to the offers. Post-offer leverage changes are in the direction implied by the offers. Thus, following the offers, firms announcing leverage-increasing offers move further away from the average industry leverage, whereas those announcing leverage-decreasing offers move towards the average industry leverage. The magnitudes of leverage changes are also asymmetric: the leverage increases following leverage-increasing offers are small and transitory, whereas leverage decreases following leverage-decreasing offers are large and sustained.

Capital outlays of leverage-increasing firms over the nine years surrounding the offers are comparable to other firms in their industry, suggesting that the decline in asset risk is unlikely to be due to substitution of assets. The announcement returns for these firms do not seem to reflect expectations of improved operations, new profitable projects, or acquisitions. The risk reduction and

K. Shah/Journal t$ Financial Economics 36 (1994) 89-126 91

announcement returns are consistent with investors’ reassessment of the riski- ness of firm’s assets, possibly because managers forgo opportunities to invest in risky, dissipative projects. Other reasons for the reassessment of risk could exist, however, and the precise channel by which risk information is transmitted remains unexplained.

Leverage-decreasing firms have capital outlays that are similar to those of other firms in their industry in the pre-offer period; however, their operating cash flows are relatively poor. These offers mark the beginning of a period in which financial leverage and capital outlays are reduced, yet operating cash flows continue to be poor. Investors are unlikely to be completely surprised by these offers (which in a majority of cases retire debt for common stock) given their firms’ very high leverage levels, low operating cash flows, and average pre-offer capital outlays. In contrast, leverage-increasing offers (which in a majority of cases retire common stock for debt) are perhaps more surprising to investors, since there is nothing in the performance measures I examine to indicate that they can be anticipated.

The evidence on dividends provides additional support for the above conclusions. For leverage-increasing offers, tests generally fail to detect any significant differences between the offer firms and their industry firms in the dividend per share, the changes in dividends per share, or the overall fraction of firms paying dividends, either before or after the offers. For leverage-decreasing firms, differences in dividends paid are statistically significant. When compared to the firms in their industry, most firms do not pay dividends, more decrease them, and fewer increase them. This disparity widens after the offers.

I also investigate whether corporate control events or explicit or anticipated debt default can explain the observed findings. A majority of offers are unrelated to corporate control events over an extended period both before and after the offers. When I analyze the performance of offer firms that do not experience any corporate control events, I find results which are similar to the total exchange-offer sample. Known financial distress is confined to a subset of firms attempting to reduce leverage. Their operating cash flows are similar to other leverage-decreasing offer firms, but they exhibit much higher pre-offer leverage and a greater reduction in leverage, capital outlays, and dividends in the post-offer years. Since the qualitative performance of these subsamples is similar to the overall exchange-offer sample, I conclude that the information content or its asymmetry between leverage-increasing and leverage-decreasing offers is not explained by control activity or corporate default.

In the next section, 1 describe prior related work and the stock-price behavior around exchange offers. An examination of the operating cash flows and risk of exchange-offer firms follows in Section 3. Leverage changes, capital outlays, and dividends are analyzed in Section 4. The performance of subsamples is

92 K. Shah/Journal qf Financial Economics 36 (1994) 89-126

summarized in Section 5, and concluding remarks are presented in Section 6. The Appendix contains a detailed description of the characteristics of exchange offers and their firms.

2. Prior related work and stock-price behavior

2. I. Prior related work

Masulis (1978) first recognized that intrafirm exchange offers provide an opportunity to study leverage changes which are not linked to significant changes in assets. These transactions are approximately pure capital structure changes and are unlikely to be motivated primarily by a desire to infuse or disgorge cash. Studies that have examined exchange offers include Masulis (1980,1983), McConnell and Schlarbaum (198 l), Pinegar and Lease (1986), Cornett and Travlos (1989), and Copeland and Lee (1991).

The earlier studies of intrafirm exchange offers focus primarily on the announcement wealth effects of security holders. These studies do not uncover or note the asymmetry in either the stock returns (which, as seen below, differ not only in signs but also in their magnitudes) or the earnings and risk performance of the offer firms. For instance, in Masulis (1980), a part of the analysis reverses the signs of wealth changes in leverage-decreasing offers, and analyzes these offers together with leverage-increasing offers. The implicit assumption is that the two types of offers are similar in all aspects except for the direction of the leverage effects.

Recent studies investigate the earnings behavior surrounding exchange offers, but concentrate on earnings per share (EPS); they do not distinguish the effects of operating performance from other mechanical effects of leverage changes, such as changes in interest payments and taxes. In Cornett and Travlos (1989), regressions linking announcement returns to debt-equity exchange offers and unexpected EPS do not show a strong relation for leverage-increasing offers, but consistently find a relation for leverage-decreasing offers. These results are similar to the findings of this study. Cornett and Travlos do not, however, report the magnitudes of unexpected EPS and do not examine risk changes. Copeland and Lee (1991) examine earnings and risk changes surrounding exchange offers and swaps. The unexpected EPS changes in their study for leverage-increasing offers are statistically insignificant. They do not report the statistical significance of pairwise changes in betas for their entire sample, although the magnitude of the average change appears to be similar to that observed here. Copeland and Lee’s conclusion is that leverage-increasing and leverage-decreasing offers reveal information about earnings and risk that is opposite in content. The evidence

K. Shah/Journal of Financial Economics 36 (1994) 89-126 93

from other types of capital structure changes also reveals a conflicting picture of the information conveyed.’

Researchers have recently focused their attention on learning more about contractual arrangements, and how and why they are revised. Exchange offers are uncommon events, and potentially reapportion contractual and noncontrac- tual obligations in a dramatic manner. Yet prior studies of intrafirm exchange offers have given little attention to the circumstances surrounding the offers. A hostile corporate control environment, unusually high or low leverage, and financial distress are potential motives for as well as causes of undertaking exchange offers. The role of corporate control events and financial distress in undertaking exchange offers is investigated in section 5.2

2.2. Stock-price behavior around exchange ofers

To put the announcement-returns evidence from prior studies in a broader perspective, I examine the stock-price behavior surrounding the exchange offers over longer periods. The sample of 175 leverage-increasing and 191 leverage- decreasing exchange offers over the period 1970-1988 and the firms used in this study are described in the Appendix. Fig. 1 plots average cumulative market- adjusted returns (i.e., the return in excess of the return on an equally-weighted

‘Studies that have separately examined firm performance surrounding changes in capital structure include Healy and Palepu (1990) and Jain (1989) for common stock issues, Dann, Masulis, and

Mayers (1991) and Hertzel and Jain (1991) for common stock repurchases, Ofer and Natarajan

(1987) for calls of convertible debt, and Lys and Sivaramakrishnan (1988) and Israel, Ofer, and Siegel

(1989) for equity-for-debt swaps. Dann, Masulis, and Mayers (1991) and Hertzel and Jain (1991) find

evidence of improved earnings and lower risk following announcements of tender offer repurchases.

The evidence surrounding seasoned issues of common stock is conflicting. Healy and Palepu (1990)

find no evidence of inferior earnings following common stock offers, but find increases in risk. Jain

(1989) finds that analysts lower earnings estimates around seasoned common stock offers. In

addition, Brous (1989) finds that common stock issues convey unfavorable information about

short-run earnings prospects. Equity-for-debt swaps, popular in the early 1980’s are institutionally

different from the.exchange offers examined here and are excluded in this study; see Roger and

Owers (1985) Finnerty (1985), Hand (1989), and Defeo, Lambert, and Larcker (1989). Debt-for-debt

exchange offers, such as those examined in Dietrich (1984) are also excluded since securities of the

same class are issued and retired. The seminal ideas of Spence (1973) on job-market signaling

underlie most theoretical models that establish a link between capital structure events and informa-

tion about firm value. Smith (1986), Masulis (1988) and Harris and Raviv (1991) review the capital

structure theory and evidence.

*The role of capital structure changes in facilitating or fending-off takeovers, particularly via

exchange offers, is discussed in Dann and DeAngelo (1988), Harris and Raviv (1988) and Stulz (1988). On the other hand, the cost of resolving financial distress can be limited to the costs associated with leverage-decreasing exchange offers. Gertner and Scharfstein (1991) and Brown,

James and Mooradian (1993) model the use of exchange offers in financial distress.

94 K. ShahlJournal cf Financial Economics 36 (1994) 89-126

4

100

-35 -~ ‘. . . ‘,~ . .

-40 -

Fig. 1. Average cumulative market-adjusted returns over 200 trading days surrounding announce-

ments of 175 leverage-increasing and 191 leverage-decreasing intrafirm exchange offers over the

period 197OG1988. Market-adjusted returns are computed using an equally-weighted index of

NYSE/AMEX or OTC firms, depending on the exchange listing of the offer firms. The day of

announcement is designated as day 0 (horizontal axis).

index for the 200 trading days surrounding the offer announcement day, designated as day 0). The stock-price impact of various types of offer announcements is similar, but somewhat smaller in magnitude, to that reported by Masulis (1980). Consistent with prior studies, redemption of equity or securities convertible into equity results in stock-price increases, whereas issues of equity or securities convertible into equity result in stock-price decreases.

However, there is a tendency for the common stock of firms announcing leverage-increasing offers to underperform the market in days prior to announcements. Over days - 100 to - 20, the mean cumulative market-adjusted return is - 3.9% and the median is - 4.6%, both significant at the 1% level. The offer announcements reverse this trend. The average two-day (cumulated over days - 1 and 0) and five-day (cumulated over the interval - 2 to 2) abnormal announcement returns for leverage-increasing exchange offers are 6.9% and 7.9%, both significant at the 1% level.3 The relation between the

3The risk-adjusted announcement returns are computed from market-model parameters using

continuous compounding and an equally-weighted market index. Tests of significance follow procedures in Mikkelson and Partch (1988). Five-day announcement windows are used to fully

capture the effect of offer announcements. The assimilation of information from leverage-decreasing

offers appears to occur appears to occur over a wider interval.


two-day announcement returns and the prior cumulative market-adjusted returns is negative and significant at the 5% level. This evidence is similar to the stock-price behavior prior to tender offer repurchases of common stock (Dann, Masulis, and Mayers, 1991).

The evidence for leverage-decreasing offers is striking. Announcements of these offers follow substantial common stock losses relative to the market, with this trend continuing after the offers. Over days - 100 to - 20, the mean and median cumulative returns are - 17.8% and - 8.0%, with p-values close to zero. This observation is unlike seasoned offerings of common stock, which are more likely to occur after a rise in stock prices (Asquith and Mullins, 1986; Lucas and McDonald, 1990). Larger prior losses are associated with larger losses at the announcement; this relation is significant at the 10% level, using a two-tailed test. For leverage-decreasing exchange offers, the average two-day and five-day announcement returns are - 2.9% and - 3.9%, also statistically significant at the 1% level. Note that the direction as well as the magnitudes of announcement returns differ between leverage-increasing and leverage-decreasing offers.

3. Firm performance surr&nding exchange offers

3.1. Abnormal cash flows

I focus on measures of cash flows that reflect the way assets are managed. I report two measures of cash flows over a nine-year period centered on offer announcements. The first measure is operating cash flow, defined as sales minus cost of goods sold and selling, general, and administrative expenses (Compustat data item A13), which measures cash flow from operations and excludes depre- ciation. The second measure is cash flow net of investment outlays, defined as operating cash flow minus capital expenditures plus sales of property, plant, and equipment (Compustat data items Al3 minus Al28 plus A107); it excludes the effects of changes in working capital. Both of these measures are unaffected by mechanical changes in interest and tax payments resulting from exchange offers. I scale the cash flows by fiscal year-end sales to increase comparability across firms. However, using total assets at either the beginning or end of the fiscal year to scale cash flows does not change my conclusions,

For assessing cash flows as well as other variables, I examine abnormal levels, relative to the industry norm, in the nine years surrounding offer announcements, as well as raw changes in these variables from the year prior to the offer announcements to each of the five subsequent years. The pattern of industry- adjusted cash flow levels indicates whether performance surrounding exchange offers improves or deteriorates relative to the industry. In conjunction with the changes in cash flows, this approach allows me to distinguish, for instance,


whether an increase in a performance measure from pre- to post-offer years represent a correction of underperformance relative to the industry norm or an improvement of performance to a level above the industry norm. Examining only raw or industry-adjusted changes in performance measures (e.g., those estimated from time-series forecast errors or analysts’ revisions) provides incom- plete evidence on whether unusual performance exists. Indeed, when abnormal levels of cash flows persist over time, documenting changes in performance measures alone may fail to detect unusual operating characteristics, and hence can potentially introduce a Type II error (incorrectly accepting the null hypothesis of no abnormal performance).

To measure abnormal cash flow levels, I subtract the median scaled cash flow of the matching industry firms from the scaled cash flow of the offer firms. All firms (excluding offer firms) with the same four-digit SIC code on the corresponding Compustat tape are used to determine median industry cash flow~.~ I assume, under the null hypothesis, that positive and negative deviations from the median industry cash flows are equally likely, and that, on average, they are zero. I also compute changes in scaled cash flows in the announcement fiscal year and the four years that follow from the fiscal year preceding offer announcements. I use p-values from Wilcoxon signed-rank tests to judge the statistical significance of abnormal cash flows. The mean values (which are not reported here) are sensitive to outliers in a few instances, but usually confirm the inferences at higher levels of significance than those reported here. Unadjusted scaled cash flows are also reported to gauge the economic significance of abnormal cash flows.

The median abnormal cash flows (rounded off to the nearest cent) are reported in Table 1. Year 0 is the fiscal year in which the offers are announced. For leverage-increasing offers, panel A offers almost no evidence of changes in either abnormal operating cash flow or cash flow net of investment outlays in any year relative to year - 1. Magnitudes of industry-adjusted performance measures, as well as changes from year - 1, are close to zero in every year. Although not reported in the table, I find that the abnormal cash flow measures

4Hence, firms found on Compustat’s Primary file are matched with other firms on that file, OTC

firms are matched with OTC firms, and those found on the Research files are matched with other firms on the corresponding Research file. This procedure partially controls for firm size and

survivorship bias, since Compustat elects to put firms in the Primary file based on greater ‘investor interest’ (these firms tend to be larger), while firms that subsequently stop reporting to the SEC for

various reasons are transferred to the Research files. In an alternative procedure which explicitly controls for firm size, 1 use one industry and Compustat file-matched firm which was closest in terms

of book value of assets to the offer firm. The median difference in size of offer and industry firms using this procedure is 25%. The results from this alternative procedure are similar to those reported

here, and I do not report them.

K. ShahJJournal of Financial Economics 36 (1994) 89-126 91

are almost evenly divided between positive and nonpositive observations, and when cash flows are scaled by assets, the measures are statistically insignificant in every year. Leverage-increasing offers do not precede increases in operating cash flows. This evidence is in contrast to prior studies which suggest that leverage increases convey favorable information about earnings; Cornett and Travlos (1989) and Copeland and Lee (1991) for intrafirm exchange offers and Dann, Masulis, and Mayers (1991) and Hertzel and Jain (1991) for tender offer repurchases.

In panel B, on the other hand, the median unadjusted operating cash flow for firms which announce leverage-decreasing offers is lower by 3 to 6 cents per dollar of sales relative to other firms in the industry in all of the pre-offer years. Post-offer operating cash flows are similarly below their industry firms. These results indicate a prolonged period of poor operating performance by firms which announce leverage-decreasing offers, consistent with the long-run decline in cumulative market-adjusted stock returns. The unadjusted measures range from 8 to 9 cents per dollar of sales in the post-offer years. Hence, the median firm underperforms industry firms by over 33%.The signed-rank p-values associated with industry-adjusted cash flows are close to zero for all years except year 4. Although operating cash flows per dollar of sales in years 1, 2, and 4 are marginally higher than in year - 1, the changes are insufficient to make the offer firms’ cash flows comparable to those of median industry firms. (However, attrition in the sample size over the post-announcement years potentially imparts an upward bias to median changes in cash flows.‘)

A different pattern emerges in cash flows net of investment outlays for firms announcing leverage-decreasing offers. In the pre-offer years, the unadjusted measures range from 2 to 4 cents per dollar of sales. However, the median industry-adjusted cash flows are - 3 to - 4 cents (statistically significant at the 5% level or better). Hence, according to this measure, the median firm underperforms industry firms by 50% or more in the pre-offer years. In the announcement year and the four years that follow, industry-adjusted cash flows net of investment outlays are generally statistically indistinguishable from zero. The median changes in post-offer years from year - 1 are positive, and statistically significant in years 1 and 4. In conjunction with the evidence on operating cash flow above, these results suggest that any improvement in cash flows net of investment outlays is obtained primarily by either curtailing capital expenditure

5The potential for upward bias, particularly in the later years, is corroborated by the fact that 23%

of the sample firms that announce leverage-decreasing offers are delisted by their exchange as of the

fourth year following the offers, compared to only 5% of their industry firms. The difference is more pronounced for firms known to be in financial distress (38% are delisted compared to 8% of their industry firms). The fraction of leverage-increasing offer firms delisted is small (4%) and similar to

that of their industry firms.

Tab

le

1 M

edia

n un

adju

sted

an

d in

dust

ry-a

djus

ted

oper

atin

g ca

sh

flow

s of

fi

rms

anno

unci

ng

175

leve

rage

-inc

reas

ing

and

191

leve

rage

-dec

reas

ing

intr

afir

m

exch

ange

of

fers

in

the

pe

riod

19

70-1

988

Fisc

al

year

-4

Pane

l A

. L

ever

age-

incr

easi

ng

offe

rs

1) O

pera

ting

cash

,jf

o~v/

Sale

s

Una

djus

ted

leve

l 0.

09

Indu

stry

-adj

uste

d le

vel

0.00

C

hang

e fr

om

year

~

1

-3

-2

-1

0 1

2 3

4

0.09

0.

1 I

0.11

0.

12

0.12

0.

12

0.12

0.

12

- 0.

00

O.O

Ob

0.01

’ 0.

00

0.00

0.

00

0.00

0.

00

0.00

0.

01

0.00

-

O.O

lb

0.00

# of

off

ers

106

109

111

112

108

101

92

80

73

2) (

Ope

ratin

y ca

sh

jlow

-

Capi

tal

expe

nditu

res

+ Sa

le

of

prop

erty

, pl

ant,

and

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pnw

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06

0.06

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lb

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00

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0.

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00

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C

hang

e fr

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year

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I 0.

00

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0.

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0.00

~

0.0

0

# of

off

ers

83

100

106

106

103

100

92

80

73

Pane

l B

. L

ever

age-

decr

easi

ng

offe

rs

1. O

pera

ting

cash

jkn

v/S

ale~

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l 0.

10

0.09

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08

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0.

09

0.08

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uste

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- 0.

04”

- 0.

03”

- 0.

05”

- 0.

06”

- 0.

05”

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04”

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05”

- 0.

05”

- 0.

03’

Cha

nge

from

ye

ar

- 1

0.01

0.

01”

0.02

b 0.

01

0.02

’

# of

off

ers

96

99

98

101

99

90

78

63

47

2. (

Ope

ratin

g ca

sh J

low

-

Cap

ital

expe

nditu

res

+ S

ale

of p

rope

rty,

pl

ant,

and

equi

pmen

t)/S

ales

Una

djus

ted

leve

l 0.

04

0.03

0.

04

0.02

0.

04

0.05

0.

04

0.05

0.

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Indu

stry

-adj

uste

d le

vel

- 0.

03”

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04

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- 0.

01

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01

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- 0.

02

- 0.

01

Cha

nge

from

ye

ar

~ 1

0.01

O

.Olb

0.

02

0.02

0.

03”

# of

off

ers

94

96

96

99

97

87

75

61

46

Cha

nges

in

sca

led

cash

fl

ows

are

com

pute

d fr

om

year

-

1, w

here

ye

ar

0 is

the

fi

scal

ye

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in w

hich

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chan

ge

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rs

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d.

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stry

-adj

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d ca

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flow

le

vels

are

co

mpu

ted

by s

ubtr

actin

g m

edia

n sc

aled

in

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ry

cash

fl

ow.

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stry

fi

rms

com

pris

e al

l ot

her

firm

s ha

ving

th

e sa

me

four

-dig

it SI

C

code

as

the

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ange

of

fer

firm

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Indu

stry

m

atch

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for

235

offe

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of 3

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T

he

num

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of m

atch

ed

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.

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l.

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st

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10%

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vel

loo K. Shah/Journal of Financial Economics 36 (1994) 89-126

or accelerating sale of property, plant, and equipment, or both. This observation is confirmed below by a separate examination of capital outlays.

Unlike leverage-increasing offers, periods of unusual operating cash flow surround leverage-decreasing offers. These results are similar to the findings of Cornett and Travlos (1989) and Copeland and Lee (1991) for exchange offers, and to Jain (1989) for seasoned issues of common stock, but unlike the findings of Healy and Palepu (1990) who also examine seasoned issues of common stock but do not find any evidence of lower earnings.

3.2. Abnormal changes in systematic risk

In order to investigate whether exchange-offer announcements convey information about the systematic risk (beta) of the firm’s common stock, I compute ordinary least squares estimates of market-model slope coefficients using continuous compounding of returns and an equally-weighted market index. (Scholes-Williams betas, which adjust for thin, asynchronous trading, yield qualitatively similar results.) I compute five year-to-year changes (two pre-event, one event-period, and two post-event) using six nonoverlapping intervals of 250 trading days each (excluding the 41 days surrounding the offer announcements) to define event years. No industry adjustment is necessary since expected changes for other firms are zero. Moreover, expected changes in the common stock beta of offer firms and proposed leverage changes are inconsistent with exchange-offer announcement returns (Hamada, 1972). Nonetheless, I compare these changes in risk to changes in a random sample of other firms having the same four-digit SIC codes and exchange listing to see whether the risk changes can be explained by industry trends and to determine the influence of offer clustering (see the appendix)‘.

These results are reported in Table 2. In panel A, the median systematic risk of leverage-increasing firms in the pre-announcement years - 3 to - 1 is con- siderably higher than that of industry firms. For instance, the median betas in years - 3 and - 2 are over 1.3; those of industry firms are close to 1.0. This finding is consistent with higher financial leverage (reported below). In the post-announcement years 1 to 3, the offer firms’ betas, on average, are comparable to those of industry firms. T-tests as well as Wilcoxon rank-sum tests reject equality between the offer and industry firms’ betas at the 5% level or better for years - 3 to - 1, but fail to reject equality at the 10% level for years 1 to 3. This result is mostly due to a fall in beta following the announcements of leverage- increasing offers, when the median systematic risk of the common stock of

‘Four-digit SIC code matches on an alternative exchange (NYSE/AMEX or NASDAQ), or if

necessary, three-digit matches are used in a few instances where four-digit matches having the same

exchange listing are unavailable.

K. Shah/Journal of Financial Economies 36 (1994) 89-126 101

Table 2 Median changes in systematic risk (beta) estimated from market model parameters of firms

announcing 175 leverage-increasing and 191 leverage-decreasing intrafirm exchange offers in the

period 1970-1988 and of their comparison industry firms

Offer firms Industry firms

Year

Median Change # of Median Change

beta in beta % >o offers beta in beta

Panel A. Leverage-increasing offers

-3 1.32 1 .oo -2 1.34 0.02 52.8 157 1.05 -1 1.17 - 0.09b 40.5 158 1.07

1 1 .oo - 0.20” 34.2 161 0.9 1 2 1.02 - 0.01 46.9 147 1.03 3 1.04 - 0.09b 44.0 134 0.98

- 0.02

0.02

- 0.08’

- 0.02

- 0.02

Panel B. Leverage-decreasing offers

-3 1.36 1.02 -2 1.31 0.08 53.9 165 0.96 -1 1.23 0.00 50.0 166 0.94

1 1.33 0.05 53.3 165 0.95 2 1.17 - 0.08” 44.7 152 0.96 3 1.23 - 0.09” 47.1 123 0.92

- 0.03 46.3 162

0.04 52.7 165 ~ 0.02 47.6 165

- 0.05 46.7 165

- 0.06 43.2 148

% > 0 # of offers

47.6 149 51.6 151 40.1 152

48.0 154

48.3 147

Beta estimates are from ordinary least squares market models which exclude 41 days surrounding

announcement day 0. Changes in beta are first differences. % >O is percent of beta change observations greater than zero. The estimation intervals of 250 tradng days are defined relative to

announcement day 0 as follows:

- 3: trading days ~ 770 to - 521 + 1: trading days + 21 to + 270 - 2: trading days - 520 to - 271 + 2: trading days + 271 to + 520 - 1: trading days - 270 to - 21 + 3: trading days + 521 to + 770

Industry firms comprise of one randomly selected firm for each offer having the same four-digit SIC

code and exchange listing as the offer firm. In a few cases no four-digit matches were found, and

three-digit matches were used.

“Wilcoxon signed-rank test significant at the 1% level.

‘Wilcoxon signed-rank test significant at the 5% level.

‘Wilcoxon signed-rank test significant at the 10% level.

leverage-increasing offer firms declines from 1.2 in the pre-announcement year to 1.0 in the post-announcement year. The median change of - 0.20 is significant the 1% level, and only 34% of the changes are positive.’

‘The magnitude of the average decline in beta is consistent with the observed announcement returns.

Assuming a risk-free rate of 10% and market risk premium of 8%, the average decline in beta translates to a 7.5% return for a share of stock of firms (with perpetual, level cash flows) announcing

leverage-increasing offers. This return is close to the 6.9% observed average announcement return.

102 K. ShahiJoumul of Finuncial Economics 36 (1994) 89-126

The declines in beta appear to be permanent and are opposite to the change implied by an increase in financial leverage. The persistence of lower risk implies that the lower systematic risk is not a result of a temporary floor (due to truncation of the distribution at offer prices) in common stock value which is in effect while the offers involving common stock are outstanding (see Bhagat, Brickley, and Loewenstein, 1987). The median number of calendar days from the commencement of offers to their conclusion is only 41. As these offers propose, and as confirmed below, actually increase financial leverage, the fall in common stock beta appears to be driven by a fall in the systematic risk of the firms’ assets. Declines in common stock beta also are observed in years - 1 and 3, but their magnitudes are small compared to the changes surrounding exchange-offer announcements. Similar declines are not found in industry firms; the changes in industry firms’ betas are generally insignificant. This evidence is similar to declines in beta documented surrounding repurchases of common stock, which also increase leverage (Dann, Masulis, and Mayers, 1991; Hertzel and Jain 1991). Given that no evidence of abnormal operating cash flow exists, it appears that investors revise downward their estimates of systematic risk, and hence the discount rate for cash flows, when leverage-increasing offers are announced.

Panel B reports the results for leverage-decreasing offers. The median systematic risk of leverage-decreasing firms is higher than that of industry firms in all of the years examined. This finding is corroborated by two- sample tests at the 1% level or better, and is consistent with higher leverage (reported below). The median change in common stock systematic risk for leverage-decreasing offer firms over the pre- to post-offer years is insignificant. Although some evidence exists of small systematic risk declines in years 2 and 3, these are further removed from offer announcements, and their direction is inconsistent with the announcement returns. Changes in the systematic risk of industry firms are also insignificant. These findings contrast sharply with the conclusions in previous research that the systematic risk of common stock increases following leverage-decreasing exchange offers and swaps (Copeland and Lee, 199 1) and seasoned common-stock issues (Healy and Palepu, 1990). Unlike the findings in prior studies, leverage-decreasing offers examined here do not precede increases in the systematic risk of common

stock. The asymmetry in the nature of information conveyed by leverage-increasing

and leverage-decreasing exchange offers is unexpected. Extant theories of capital structure do not predict that leverage-altering events reveal qualitatively different information depending on the direction of the change in leverage. In the following sections, I explore the potential causes of this asymmetry by examining leverage changes, capital outlays, dividends, and circumstances dealing with threats to corporate control and financial distress.


4. Leverage changes, capital outlays, and dividends around exchange offers

4.1. Leverage changes

Exchange offers have been presumed to bring about major changes in financial leverage as securities of different priorities are retired as well as issued in the same transaction (e.g., Masulis, 1980, p. 140). In Table 3, I report median levels and changes in leverage ratios of the offer firms and their industry firms over the nine years surrounding the offer announcements. The industry firms’ statistics are based on the median values of all other firms having the same four-digit SIC codes as the offer firms. I report two measures of financial leverage. The market value leverage ratio is the book value of long-term debt (Compustat item A9) divided by the sum of the book value of long-term debt, the carrying value of preferred stock (item A130), and the market value of common stock (product of items Al99 and A25), all at fiscal year-end. The book value leverage ratio is the book value of long-term debt divided by the book value of total assets (item A6) at fiscal year-end. Year 0 is the fiscal year in which the exchange offers are announced.’

The pattern of leverage for leverage-increasing offer firms is intriguing. The median pre-announcement leverage does not show much variation, although these firms are more levered than their industry firms. In year - 1, the median market leverage of offer firms is 0.40 compared to 0.33 for their industry firms; the median book leverage is 0.24 compared to 0.21 for their industry firms. These differences are statistically significant at the 5% level. The median market leverage in the announcement year rises further to 0.44, and the median book leverage rises further to 0.28. These increases, however, are not permanent. The market and book leverage of leverage-increasing firms tend to fall back toward their pre-offer levels; the median market and book leverage in year 4 are 0.40 and 0.26. These findings are in accord with the changes in leverage in years 0 to 4 from year - 1 also reported in Table 3. The median changes in market and book leverage from year. - 1 to 0 are 0.04 and 0.01 (statistically significant at the 1% level), whereas the changes in leverage from year - 1 to year 4 are insignificant. These changes are not explained by similar changes for matching industry firms.

‘These measures of leverage are susceptible to fluctuations from factors unrelated to issues and

redemptions of securities. For example, higher market prices of common and higher retained profits

of firms will result in declines in market and book leverage ratios. Therefore, changes in leverage of firms performing well will be biased downward. Lower market prices of common and losses will result in increases in market and book leverage ratios. Therefore, changes in leverage of firms

performing poorly will be biased upward. These biases make the detection of leverage changes due

solely to issues and redemptions of securities as in exchange offers difficult.

104 K. Shah/Journal c$Financial Economics 36 (1994) 89-126

Table 3

Median market and book leverage levels and changes of firms announcing 17.5 leverage-increasing

and 191 leverage-decreasing intrafirm exchange offers over the period 1970- 1988 and of their

comparison industry firms

Offer firms Industry firms

Market leverage Book leverage Market leverage Book leverage Fiscal

year Level Change Level Change N Level Change Level Change N


-4 0.39 0.21 119 0.29 0.19 121

-3 0.40 0.24 122 0.3 1 0.22 122

-2 0.37 0.23 123 0.33 0.2 1 121

-1 0.40 0.24 12s 0.33 0.2 1 122

0 0.44 0.04” 0.28 O.Old 120 0.36 - 0.00 0.2 1 O.Olb 120 1 0.44 0.03” 0.2x 0.02” 112 0.32 - 0.02 0.2 1 0.00 119

2 0.44 0.04’ 0.26 0.02;’ 102 0.30 - 0.02” 0.20 0.00’ 111

3 0.45 0.02 0.28 0.02” 89 0.28 ~ 0.02” 0.20 0.00 102

4 0.40 0.02 0.26 0.00 79 0.27 ~ 0.02 0.2 1 0.00 98


-4 0.48 0.35 111 0.24 0.18 108

-3 0.50 0.3x 118 0.24 0.18 107

-2 0.55 0.42 120 0.23 0.18 107

-1 0.58 0.4 I 120 0.23 0.19 109

0 0.47 ~ 0.05” 0.35 ~ 0.03” 117 0.21 0.00 0.19 0.00 109

1 0.43 - 0.08” 0.36 - 0.07” 106 0.20 ~ 0.00 0.19 0.00 103

2 0.45 - 0.08” 0.34 - 0.03” 94 0.23 0.00 0.20 0.00 90

3 0.41 - 0.14” 0.31 - 0.06” 75 0.21 - 0.00 0.18 0.00 76

4 0.37 - 0.20” 0.26 - 0.11” 53 0.22 - 0.03 0.20 0.00 56

Year 0 is the fiscal year of offer announcements. Changes in leverage in years 0 to 4 are computed by

subtracting leverage in year - 1. N is the sample size. Industry leverage statistics are computed from

median leverage levels and changes in leverage of firms on Compustat files having the same

four-digit SIC codes as the offer firms. Industry matches for 235 offers are found using a total of

3,233 firms; the number of matched industry firms per offer varies. Market leverage is measured as

book value of long-term debt divided by the sum of book value of long-term debt plus carrying value

of preferred stock plus market value ofcommon stock, all at fiscal year-end. Book leverage is measured as book value of long-term debt divided by book vlaue of total assets. both at fiscal year-end.

“Wilcoxon signed-ranked test significant at the 1 o/o level. ‘Wilcoxon signed-ranked test significant at the 5% level. ‘Wilcoxon signed-ranked test significant at the 10% level.

Leverage-decreasing offer firms, which also have higher leverage than their industry firms in year - 4, show additional increases in leverage in years - 3 through - 1. Their leverage is more than twice that of industry firms by year


- 1. For these firms, the median market leverage increases from 0.48 in year - 4 to 0.58 in year - 1, and then falls to 0.47 in the announcement year 0. Over

the same intervals, the median book leverage increases from 0.35 to 0.41 and falls back to 0.35. The median changes in market and book leverage from year - 1 to year 0 are - 0.05 and - 0.03, both significant at the 1% level. In

post-offer years, these firms display additional declines in leverage. The median market and book leverage in year 4 of these firms are 0.37 and 0.26. The median market and book leverage changes from year - 1 to year 4 are - 0.20 and - 0.11, both significant at the 1% level. These changes occur when the industry

leverage ratios show little variation. In every instance, the median change in leverage of the industry counterparts is insignificant.

In summary, the announcement-year changes in leverage are statistically significant and consistent with the direction implied by the exchange of securities in the offers. The patterns of leverage changes over time, however, differ markedly between the two types of offers. Leverage-increasing offer firms, having higher-than-industry leverage, show additional increases in leverage in the announcement year, and hence move further away from their industry counterparts. The increases, however, are small and transitory; these offers are not harbingers of dramatic and permanent increases in financial leverage. On the other hand, leverage-decreasing offer firms, exhibiting higher and increasing leverage prior to the offers, show leverage declines in the announcement and subsequent years, moving towards the average industry leverage level. The changes in leverage are large and sustained.’

Note that the magnitudes of announcement returns do not correspond to the magnitudes of the leverage changes that follow. For leverage-increasing offer firms, large announcement stock-price gains (7% on average) are associated with small and transitory leverage increases. For leverage-decreasing offer firms, small announcement stock-price losses (3% on average) are associated with large and sustained leverage decreases. This lack of correspondence between

‘1 have examined leverage in year 5 (not reported), which confirms that the leverage increases are

transitory and leverage decreases are sustained. For instance, for leverage-increasing offers, the

median market and book leverage in year 5 are 0.36 and 0.26, respectively. The median changes in

changes in market and book leverage over the interval - 1 and 5 are both 0.00 and statistically

insignificant. The observed patterns cannot be attributed to shifts in debt maturity; measures that

include short-term debt show similar patterns. Further, the evidence reported later shows that, for

a subset of leverage-increasing offers not associated with a threat to corporate control (61% of the

total sample), the reversals in leverage are manifest by year 2. I have also tested whether offer firms’ leverage is statistically different from industry firms’ leverage over the nine years. Both two-sample t-tests and Wilcoxon tests show that market and book leverage are higher in almost all the years at the 5% level, or better. The only two statistically insignificant differences at the 10% level are from

Wilcoxon tests in years - 3 and ~ 2 for book leverage of leverage-increasing firms.

106 K. Shah/Journal of Financial Economics 36 (1994) 89-126

leverage changes and stock-price reactions is most likely due to the degree to which the offers are anticipated by investors.”

4.2. Capital outlays

A separate examination of capital outlays serves two purposes. First, it can confirm the earlier conclusion that leverage-decreasing firms bring their cash flows net of investment outlays to levels comparable to those of industry firms in the post-offer years primarily by curtailing capital outlays. Second, an examination of capital expenditures in conjunction with the sale of property, plant, and equipment gives evidence on whether exchange offers accompany asset changes by documenting a net increase, decrease, or replacement of assets. For instance, abnormally high capital expenditures which are offset by the sale of assets would indicate unusual levels of asset replacement. This observation, in turn, would support the possibility that risk declines documented earlier for leverage- increasing firms are due to subsequent replacement of assets.

I examine capital expenditures (Compustat data item A128) and net capital expenditures, with the latter defined as capital expenditures minus sale of property, plant, and equipment, (items Al28 minus A107). The method of computing abnormal measures of capital outlays is analogous to that for operating cash flows. The results are reported in Table 4.

No significant departures from the industry norm in capital expenditures and net capital expenditures are noted for leverage-increasing firms. Although the median industry-adjusted capital expenditures are statistically significant in some years, their magnitudes are close to zero. When scaled by assets (not reported), the median industry-adjusted capital expenditures are statistically insignificant in all years. Changes in capital expenditures and net capital expenditures are also insignificant. Further, a review of the Wall Street Journal Index does not reveal widespread restructuring of assets surrounding leverage- increasing offers. The evidence indicates that additions and changes to capital stock are comparable to industry firms around offer announcements.

The lack of unusual investment activity is consistent with the lack of unusual operating cash flows, and suggests that the declines in systematic risk of

“In other words, given the history of cash flows and leverage, the leverage increases of leverage- increasing offer firms, although small and transitory, are unanticipated. This evidence also suggests

that the role of the unexpected gain in tax benefits (assuming permanent increases in leverage) in explaining announcement returns of leverage-increasing offers is likely to be overstated. Similarly,

leverage declines of leverage-decreasing offer firms are large and sustained, but less unanticipated.

This observation suggests that the role of the unexpected loss of tax benefits in explaining

announcement returns to leverage-decreasing offers is also likely to be overstated (e.g., Masulis, 1983).


common stock reported earlier are most likely due to market reassessment of the risk of existing assets. Of course, the precise source of the reduction in risk is unknown, but it is unlikely that announcement returns embody expectations of improved operations, new profitable projects, or acquisitions. One possible reason for the reassessment is that managers are forgoing opportunities to invest in risky, dissipative projects by credibly binding their free cash flows (cash flows in excess of those needed to fund value-adding projects; see Jensen, 1988).

The investment outlays of leverage-decreasing firms are, on average, similar to other firms in their industries in years - 4 to - 2. These firms curtail their capital expenditures and net capital expenditures by an average of 2 cents per do!!ar of sales relative to their industry firms beginning in year - 1. The lower investment rates are statistically significant at the 5% level or better, and only small fractions of the industry-adjusted measures are positive (not reported). The unadjusted investment rates are 2 to 3 cents per dollar of sales; hence, the magnitudes of industry-adjusted investment outlays imply a reduction in investment rates of about 40% to 50% relative to their industry firms. Changes in capital outlays are negative and statistically significant over intervals - 1 to 2 and - 1 to 3.

Leverage-decreasing offers accompany lower subsequent rates of investment. It cannot be ascertained that this behavior is unusual, given the investment opportunities facing these firms. However, the extent of retrenchment cannot be attributed solely to the overall conditions in the industry, as these firms underin- vest and underperform relative to other industry firms. It appears that the response of managers faced with high leverage and continued poor operating cash flows is to reduce fixed contractual payments and curtail capital outlays, most likely to avoid or resolve financial distress. The results are broadly consistent with the prediction by Gertner and Scharfstein (1991) that, condi- tional on out-of-court settlement, distressed firms will invest less. This evidence is also similar to the lower investment rates documented in a sample of financially distressed Japanese firms by Hoshi, Kashyap, and Scharfstein (1990).

4.3. Dividends

While we know little about what level of dividends to expect and how managers select a dividend policy, the evidence from prior studies suggests that managers are reluctant to make transitory changes in dividends (Lintner, 1956; Black, 1976; Marsh and Merton, 1987). Indeed, changes in dividends appear to reflect long-run shifts in managers’ assessment of firm prospects, and can thus lend further support to the evidence on cash flows and risk.

I focus on dividends per share, which are unaffected by fluctuations in stock price and earnings. In Table 5, panel I, dividend per share is defined as the annual total dollar amount of cash dividends declared on common (Compustat item A21) divided by the number of common shares outstanding at fiscal

E

Tab

le

4

Med

ian

unad

just

ed

and

indu

stry

-adj

uste

d ca

pita

l ou

tlays

of

fir

ms

anno

unci

ng

175

leve

rage

-inc

reas

ing

and

191

leve

rage

-dec

reas

ing

intr

afir

m

exch

ange

offe

rs

in t

he

peri

od

1970

-198

8

Fisc

al

year

-4

-3

-2

Pane

1 A

. L

ever

age-

incr

easi

ng

offe

rs

1) C

apit

al

expe

ndit

ures

/Sal

es

Una

djus

ted

leve

l 0.

04

0.04

0.

04

Indu

stry

-adj

uste

d le

vel

0.00

O

.OO

h O

.Olb

Cha

nge

from

ye

ar

- 1

# of

off

ers

106

110

111

2) (

Cap

ital

ex

pend

itur

es

- Sa

le

qfpr

oper

ty,

plan

t, an

d eq

uipm

ent)

/Sal

es

Una

djus

ted

leve

l 0.

03

0.03

0.

03

Indu

stry

-adj

uste

d le

vel

- 0.

00

0.00

0.

00

Cha

nge

from

ye

ar

- 1

# of

off

ers

83

101

106

-1

0

0.04

0.

04

0.00

’ 0.

00

- 0.

00

113

109

0.03

0.

03

0.00

0.

00

0.00

107

104

1

0.04

O.O

Ob

0.00

102

0.03

0.00

0.00

101

2

0.04

0.00

- 0.

00

92

0.03

0.00

- 0.

00

92

3 4

0.04

0.

04

0.01

0.

00

- 0.

00

- 0.

00

80

73

0.03

0.

03

0.00

-

0.00

- 0.

00

- 0.

00

80

73

Pane

l B

. L

ever

age-

decr

easi

ng

offe

rs

1) C

apit

al

expe

ndit

ures

/Sal

es

Una

djus

ted

leve

l 0.

05

0.06

0.

05

Indu

stry

-adj

uste

d le

vel

0.00

-

0.00

-

0.01

C

hang

e fr

om

year

-

1

# of

off

ers

96

98

91

2) (

Cap

ital

ex

pend

itur

es

~ S

ale

of pr

oper

ty,

plan

t, an

d eq

uipm

ent)

/Sal

es

0.04

0.

03

0.03

0.

03

0.02

” -

0.02

” -

0.02

” -

0.02

” -

O.o

ob

- 0.

00

- 0.

01’

101

99

89

78

0.03

0.

04

- 0.

02”

- 0.

02b

- O

.Olb

-

0.00

64

48

Una

djus

ted

leve

l

Indu

stry

-adj

uste

d le

vel

Cha

nge

from

ye

ar

- 1

# of

off

ers

0.05

0.

05

0.04

0.

03

0.03

0.

02

0.03

0.

03

0.03

- 0.

00

- 0.

00

- 0.

01

0.02

” -

0.02

-

0.02

” -

0.02

” -

0.02

” -

0.01

b

- 0.

00

- 0.

01

- 0.

00

- 0.

00

- 0.

00

95

97

97

101

99

89

78

64

48

Cha

nges

in

sca

led

cash

fl

ows

are

com

pute

d fr

om

year

-

1, w

here

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ar

0 is

the

fis

cal

year

in

whi

ch

exch

ange

of

fers

ar

e an

noun

ced.

In

dust

ry-a

djus

ted

cash

flow

le

vels

are

co

mpu

ted

by s

ubtr

actin

g m

edia

n sc

aled

in

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ry

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fl

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stry

fi

rms

com

pris

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her

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s ha

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th

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me

four

-dig

it SI

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code

as

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firm

s.

Indu

stry

m

atch

es

for

235

offe

rs

are

foun

d us

ing

a to

tal

of 3

,233

fi

rms.

T

he

num

ber

of m

atch

ed

indu

stry

fi

rms

per

offe

r va

ries

.

“Wilc

oxon

si

gned

-ran

ked

test

si

gnif

ican

t at

th

e 1%

le

vel.

bWilc

oxon

si

gned

-ran

ked

test

si

gnif

ican

t at

th

e 5%

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vel.

‘Wilc

oxon

si

gned

-ran

ked

test

si

gnif

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t at

th

e 10

%

leve

l.

Tab

le

5

Cha

nges

in

ann

ual

divi

dend

s pe

r sh

are

of f

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s an

noun

cing

19

1 le

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d 17

5 le

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8 an

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stry

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stry

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07

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ffer

O

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0.00

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0.00

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00G

0.25

0.

00G

0.27

0.

00~0

.33

0.00

-0.3

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%

> 0

Off

er

45.9

48

.6

51.0

52

.3

55.0

56

.6

57.0

60

.8

59.7

Indu

stry

53

.2

55.2

57

.9

58.9

58

.9

57.5

57

.9

55.6

54

.9

N

Off

er

135

144

147

151

151

143

135

130

119

Indu

stry

14

3 14

5 14

5 14

6 14

6 14

6 14

5 14

4 14

2

Pane

l B

. L

ever

age-

decr

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ng

offe

rs

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ian

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er

0.00

0.

00

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00

0.00

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00

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stry

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Ql-Q

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ffer

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0.00

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5 O

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~0.0

0”

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%

>o

Off

er

39.6

35

.0

29.2

” 21

.3”

15.1

” 16

.6

17.5

” 18

.6”

23.4

Indu

stry

43

.3

40.5

38

.7

37.1

33

.1

32.0

31

.4

32.6

32

.4

N

Off

er

154

163

168

174

172

157

149

140

124

Indu

stry

17

3 17

3 17

3 17

5 17

5 17

5 17

5 17

5 16

9

~~

__

____

-

(II)

CH

AN

GE

S IN

D

IVID

EN

D

PER

SH

AR

E

Pane

l A

. L

ever

age-

incr

easi

ng

offe

rs

Fisc

al

year

-1

too

- 1

to

1 -

1 to

2 -1

t03

-1

to4

Med

ian

Off

er

0.00

0.

00

0.00

0.

00

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stry

0.

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%

> 0

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er

41.6

50

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11.0

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b 18

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b

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stry

3.

4 4.

8 4.

9 4.

9 5.

1

N

Off

er

145

137

129

124

111

Indu

stry

14

6 14

6 14

4 14

2 14

0

Pane

l B

. L

ever

age-

decr

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ng

offe

rs

- ~~

_~

~__~

-1

too

- 1

to

1 -1

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.04

9.9”

15

.6b

14.6

16

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19.3

b

20.0

24

.0

27.4

29

.1

31.9

11.1

” 8.

4 11

.8”

11.8

” 13

.4”

1.7

4.0

2.9

4.0

4.2

171

154

144

135

119

175

175

175

175

166

N

Tab

le

5 (c

ontin

ued)

(III

) D

IVID

EN

D

INIT

IAT

ION

S A

ND

O

MIS

SIO

NS

Fisc

al

year

-3

to

-1

0 1

to

3

Pane

l A

. L

ever

age-

incr

easi

ng

offe

rs

%

Initi

atin

g O

ffer

14

.58h

7.

09”

14.6

9

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stry

8.

83

2.24

4.

35

%

Om

ittin

g O

ffer

7.

64

1.42

5.

59

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stry

4.

73

1.75

5.

43

Pane

l B

. L

ever

age-

decr

easi

ng

offe

rs

%

Initi

atin

g O

ffer

4.

94’

1.23

5.

10

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stry

2.

45

1 .oo

3.

41

%

Om

ittin

g O

ffer

16

.05”

6.

13”

3.82

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stry

4.

21

1.61

4.

0 I

Div

iden

d pe

r sh

are

is d

efin

ed

as t

he t

otal

an

nual

do

llar

amou

nt

of d

ivid

end

on

com

mon

st

ock

divi

ded

by t

he

num

ber

of c

omm

on

shar

es

outs

tand

ing

at

fisc

al

year

-end

. Q

l&Q

3 ar

e th

e fi

rst

and

thir

d qu

artil

es,

%

> 0

and

%

< 0

are

perc

ent

grea

ter

than

ze

ro

and

perc

ent

less

tha

n ze

ro,

and

N i

s th

e sa

mpl

e

size

. A

fir

m t

hat

pays

a

divi

dend

in

a g

iven

ye

ar

is s

aid

to b

e in

itiat

ing

a di

vide

nd

in t

hat

year

if

the

perv

ious

tw

o an

nual

di

vide

nds

per

shar

e ar

e ze

ro.

A f

irm

that

pa

ys

no

divi

dend

in

a g

iven

ye

ar,

havi

ng

paid

di

vide

nds

in t

he

perv

ious

tw

o ye

ars,

is

sai

d to

be

om

ittin

g di

vide

nd

in t

hat

year

.

“,b,

cSup

ersc

ript

s de

note

st

atis

tical

si

gnif

ican

ce

at

the

1%.

5%,

and

10%

le

vel,

resp

ectiv

ely,

fo

r te

sts

of d

iffe

renc

es

betw

een

exch

ange

of

fer

and

indu

stry

stat

istic

s.

For

divi

dend

pe

r sh

are

and

chan

ges

in

divi

dend

pe

r sh

are,

th

e te

st

empl

oyed

is

a

two-

sam

ple

Wilc

oxon

ra

nk-s

um

test

. Fo

r fr

eque

ncy

(pro

port

ion)

da

ta,

the

test

s em

ploy

tw

o-si

ded

Pear

son

x2 s

tatis

tic.


year-end (item A25). In panel II, changes in annual dividends per share from year - 1 are reported for the announcement year and the four years that follow. Finally, fractions of firms initiating and omitting dividends are reported in panel III. A firm that pays a dividend in a given year is said to be initiating a dividend in that year if the previous two annual dividends per share are zero; it is said to be omitting a dividend in a given year if a zero dividend in that year is preceded by positive dividends in the previous two years.

Since dividends per share cannot be below zero, a broader inspection of its distribution is necessary. Therefore, in addition to the medians, I also report the first and third quartiles, the proportion of firms paying dividends, and the proportions of positive and negative changes in dividends per share. Corres- ponding statistics from a sample of their industry firms, matched using four-digit SIC codes, are reported separately. Tests of departures from the industry norm are noted using Wilcoxon rank-sum statistics for dividend per share levels and changes data, and Pearson x2 statistics for frequency (proportion) data.

For leverage-increasing offers in panel I-A, the Pearson x2 statistics fail to detect significant differences in any year in the proportions of offer and industry firms paying dividends. In addition, the levels of dividends per share are statistically different from the industry norm only in years 3 and 4. In panel II-A, although the median changes in dividends per share of offer firms are zero for the first four of the five intervals, the distributions of the changes are different from that of industry firms in intervals - 1 to 0 and - 1 to 1 at the 10% and 5% levels, respectively. Since changes in dividend per share are skewed to the right and different from zero at the 1% level using Wilcoxon signed-rank tests in all intervals (not noted in the table), both the offer firms’ and their industry firms’ dividends, on average, are rising. Curiously, relatively larger fractions of offer firms reduce their dividends in all of the post-offer intervals (panel II-A), but relatively larger fractions of them also initiate dividends before and after the offers (panel III-A). These differences are significant at the 5% level or better.

No clear pattern of dividends emerges for leverage-increasing offers. The evidence in Table 5 suggests that, since a significant fraction actually reduce dividends, it is primarily a few firms which cause the dividends of leverage- increasing firms to outpace the generally-rising industry dividends in years 3 and 4. It is difficult to draw an unambiguous inference from this evidence. Recall that no abnormal cash flows exist, and the precise source of risk reduction remains unclear. Also, we do not know whether or how managers alter dividends when asset risk is lower, although some conjectures are possible. For instance, if the source of risk decline is the transformation of an uncertain investment opportunity to a tangible project, then managers may respond by curtailing dividends to finance growth. On the other hand, if the source of risk decline is the dis- carding of risky investment opportunities, then managers may initiate or increase dividends and engage in leverage-increasing exchange offers concurrently.

114 K. Shah/Journal qf’ Financial Economics 36 (1994) 89-126

For leverage-decreasing offers, the evidence is more straightforward. In panel I-B, greater proportions of offer firms pay no dividends, or lower dividends, than their industry counterparts; the Wilcoxon and Pearson tests of differences in dividends per share between offer and industry firms are significant at the 1% level in years - 1 to 3. In these years, about half as many offer firms pay dividends (the fractions of offer firms paying dividends range from 15% to 21%, versus 32% to 38% for their industry firms). Correspondingly, a vast majority of dividend changes are zero, larger fractions are negative, and lower fractions are positive, relative to their industry firms (panel II-B). All of these differences are statistically significant, mostly at the 1% level. The fraction of firms omitting dividends is significantly higher in the interval - 3 to - 1 and in year 0 at the 1% level (panel III-B). These results are consistent with the offer firms experiencing or anticipating financial distress, and being con- strained by covenants (Ofek, 1993). The evidence also confirms the suggestion in Miller and Rock (1985, p. 1046): ‘. . .the best place for empirical researchers to look for evidence of dividend signalling may well be among firms falling into adversity, not because they then start signalling, but because they stop.’

5. An examination of other circumstances surrounding exchange offers

5.1. The role qf‘corporate control events

In order to investigate whether abnormal performance surrounding exchange-offer announcements is related primarily to control contests, 1 classify offers into those that have control events in the surrounding period and those that do not. Control events include takeovers and hostile merger attempts, proxy contests, block acquisitions, board seat contests, dual class recapitaliz- ations, and enactment of antitakeover provisions reported in the Wall Street

Journal Index in the four years centered on offer announcements. There are 107 leverage-increasing and 124 leverage-decreasing offers that have no control events, representing 61% and 65% of their total samples, respectively.

The above definition of a control event is intentionally broad. The offers that do not experience such an event are unlikely to be in anticipation or in defense of control contests. The likelihood that such offers reveal information related to the market for corporate control or that the offer firms’ performance is affected by a control threat should be minimal. As such, a majority of exchange offers in this sample are neither in response to existing threats, nor in anticipation of eventual future threats to corporate control. I have replicated the entire analysis for the subsamples of offers which are not associated with control events. Since these results closely resemble those for the overall sample, I merely summarize them here.

The announcements of leverage-increasing offers are associated with average two-day and five-day abnormal returns of 8.1% and 9.0% (both significant at

K. Shah JJournal of Financial Economics 36 (1994) 89-126 115

the 1% level) despite the absence of any control events. For this subsample, the increases in financial leverage are quite small, and are reversed by the second year following exchange-offer announcements. No abnormal operating and investment cash flows are observed in any year. The dividends paid are similar to those for the total sample. The median decline in systematic risk of 0.17 is significant at the 5% level, and is similar in magnitude to the median decline observed for the total sample. Leverage-increasing offers appear to convey information about risk but not about cash flows.

The results for leverage-decreasing offers in this subsample are almost iden- tical to the overall sample. The average two-day and five-day announcement returns are - 2.2% and - 2.9%, both significant at the 1% level. These firms show significantly negative industry-adjusted operating cash flows in eight out of the nine years examined, sustained declines in market and book leverage, negative abnormal capital outlays following the offers, and little difference in dividend patterns from their total sample. The median change in systematic risk from the pre- to post-offer interval is insignificant. Leverage-decreasing offers appear to convey information about cash flows but not about risk.

The similarity of abnormal performance to the overall sample suggests that the abnormal performance of exchange-offer firms is not explained by activity in the market for corporate control.”

5.2. The role ofJinancia1 distress

I further classify offers according to those that have reports in the Wall Street Journal Index or in the Dow Jones News Retrieval reports indicating imminent or existing default or bankruptcy (in financial distress) and those that do not (not in financial distress). Not surprisingly, of the 66 offers made by financially distressed firms, 65 are leverage-decreasing. Hence, I exclude leverage-increasing offers from this analysis.12

“On the other hand, control events seem to have a significant influence on performance. Leverage-

increasing exchange offers associated with control events have lower announcement returns (4.9%,

on average), higher-than-industry operating cash flows and capital outlays in years - 3 to 1, larger

pre- to post-offer declines in beta, larger leverage increases which are sustained up to year 5, and

larger pre- and post-offer dividend payouts, relative to the subsample not experiencing control

events. Most of these differences are significant at the 5% level or better. Leverage-decreasing offers

associated with control events exhibit worse operating cash flows, an earlier reduction in capital

outlays, and smaller declines in leverage, relative to the subsample not experiencing control events.

These and other subsample results are formally described in Shah (1992).

12The one leverage-increasing offer made by a financially distressed firm is by Bohack Corporation, proposing an exchange of nonconvertible debt for existing common. The effort was only partly

successful, resulting in 60,426 shares tendered of the 500,000 that were sought. Three months later,

the company filed for Chapter 11.


In general, the performance of leverage-decreasing firms in financial distress and those not in financial distress is similar to the overall sample, and for brevity, I merely highlight the important characteristics. Offer firms in the financial distress appear to have higher leverage than those not in financial distress, and their declines in leverage in the post-offer years are larger. For instance, market and book leverage in year - 1 are 0.73 and 0.59, compared to 0.55 and 0.37 for firms not in financial distress. The magnitudes of industry- adjusted operating cash flows are comparable to nondistressed firms. Financial- ly distressed firms are also slower in curtailing capital outlays; the reduction in capital expenditures is evident only in the announcement year, which is a year later than for nondistressed firms. Once begun, financially distressed firms limit capital outlays more severely. Their net capital expenditures are lower by 6 to 7 cents per dollar of sales at the median in the post-offer years, whereas those of nondistressed firms are lower by 2 to 3 cents per dollar of sales, both relative to their industry firms. The impact of known financial distress is also clearly evident in the dividend paid; virtually none of the financially distressed firms pay dividends after year - 1, whereas roughly 25% of the nondistressed firms continue to do so. For both subsamples, no statistically significant changes in beta are noted.

These results indicate that leverage-decreasing offers made by firms not explicitly known to be in financial distress are in response to circumstances that are qualitatively similar to those for financially distressed firms. Note also that inordinately high pre-offer leverage and severe reductions in post-offer capital outlays and dividends are associated with firms known to be in financial distress. Distressed firms are relatively slower in implementing steps that conserve cash, but when they do so, their actions are more drastic. Leverage-decreasing offers, in general, can be viewed as preemptive measures undertaken by managers anticipating financial distress.’ 3

5.3. The role qf other jiuctors

I also investigate performance for various other subsamples, including i) leverage-decreasing offers by firms that are experiencing neither a control event nor financial distress, ii) leverage-increasing offers by calendar period, i.e., 1970-1979 and 1980-1988, iii) leverage-decreasing offers in the period 1980-1988, iv) offers that retire common stock and solely or partly issue straight debt (debt-for-common offers), v) offers that retire straight debt and solely or

13As a rough indication of their success, I found that among the 113 leverage-decreasing offers where the final outcome could be determined, 90% of the offers are completed, i.e., they result in the

exchange of some securities, although they are also more likely to be extended and revised than

leverage-increasing offers.

K. Shah/ Journal of Financial Economics 36 (1994) 89-126 117

partly issue common stock (common-for-debt offers), vi) offers that involve common stock as the security either issued or retired, and vii) offers excluding oil and gas extraction firms. I can report that the conclusions are not materially different for these subsamples relative to the total sample. In particular, I find no evidence of superior operating cash flows in the subsamples of leverage-increasing offers, although I do find declines in systematic risk. For leverage-decreasing offers, I find no evidence of risk increases, but I do find inferior cash flows.

Finally, I investigate the link between abnormal returns surrounding exchange-offer announcements and subsequent abnormal cash flows and risk. Although the regressions have poor overall explanatory power (as evidenced by adjusted R’s at or below 0.05) I find a statistically significant negative relation between two-day announcement returns to leverage-increasing offers and the change in beta from pre- to post-offer years in regressions that exclude the cash flow term but include firm size (total assets) as an additional explanatory variable. I also find a statistically significant positive relation between five-day announcement returns to leverage-decreasing offers and the sum of industry-adjusted operating cash flows in fiscal years 0 to 4 in regressions that exclude the change in beta term. In addition, net capital expenditures are negatively related to the announcement returns of leverage- decreasing firms, suggesting that investors anticipate, and react favorably to, subsequent lower investment outlays. These results are statistically significant at the 10% level using two-tailed tests, and the conclusions are not materially affected when I use the White (1980) correction for heteroscedasticity. None of the regressions, which were symmetrically estimated for both types of offers, show statistically significant cash flow coefficients for leverage- increasing offers, or statistically significant risk coefficients for leverage- decreasing offers.

Despite their statistical significance, the magnitudes of the coefficients in the regressions are too small to explain economically significant portions of announcement returns. At least two reasons for the lack of a good fit exist. First, the total announcement-period return is a biased measure of the information content of an exchange offer if the offer is made at a premium (see Rosenfeld, 1982; Vermaelen, 1981). The lack of data on market values of securities issued and retired preclude isolating the information effect from a premium effect in announcement returns surrounding exchange offers. Second, the abnormal cash flows and risk changes most likely have measurement errors. Cross-sectional averages eliminate these kinds of measurement errors (Tables 1 and 2), and yield stronger results. Prior studies which link announcement returns to capital structure events and subsequent abnormal earnings and risk changes have also found the relation to be economically and (largely) statistically insignificant (Healy and Palepu, 1990; Hertzel and Jain, 1991; Dann, Masulis, and Mayers, 1991).

118 K. Shah/Journal of Financial Economics 36 (1994) 89-126

6. Concluding remarks

This study directly contrasts the nature of the information which investors apparently infer from announcements of leverage-increasing and leverage-decreasing exchange offers. The study complements the existing body of literature that examines firms’ economic performance surrounding financial events, and finds different results. The evidence here does not support the presumption that leverage-increasing and leverage-decreasing offers disclose information about the same economic variables that is simply opposite in sign or interpretation; rather, the information conveyed is asymmetric.

I find that offers that increase financial leverage are followed by periods of lower systematic risk of common stock, but no unusual cash flows; offers that decrease financial leverage are followed by periods of lower cash flows, but no unusual changes in risk. This asymmetry persists even after controlling for factors that may influence the findings, such as corporate control events, corporate default, calendar-period clustering, and the classes of securities issued and retired. The patterns of leverage changes, capital outlays, and dividends surrounding the offers also reveal other unexpected asymmetries which support the contention that the two types of offers convey different information.

For leverage-increasing firms, the lack of abnormal operating and investment cash flows, the small and transitory leverage increases, and the large reduction in systematic risk are unexpected. It is unlikely that the substantial announcement returns surrounding these offers are a result of expectations of improved operations, new profitable projects, or acquisitions. The evidence is consistent with investors revising downward their estimates of asset risk and, consequently, lowering the discount rate for cash flows. Just how or why such information is inferred remains a puzzle. The evidence for leverage-decreasing offer firms is less surprising. These firms sustain industry levels of investment outlays in the pre-offer period, while their operating cash flows are relatively poor. Financial leverage increases to twice the industry leverage just prior to the offers. The offers mark the beginning of a period in which leverage, investment outlays, and dividends are reduced, yet the operating performance continues to be poor. Long-run cumulative market-adjusted returns show striking declines both before and after the leverage-decreasing offers.

Leverage-increasing offers, which typically retire common stock, have announcement stock-price reactions, risk declines, and leverage changes that are similar to those associated with tender offer repurchases of common stock for cash. However, I find no evidence of the superior operating cash flows that previous authors have noted for common stock repurchases. The evidence of superior earnings surrounding tender offer repurchases probably reflects the nature of that event; tender offer repurchases are large, one-time cash dividends.

K. Shah/Journal qf Financial Economics 36 (1994) 89-126 119

Leverage-decreasing offers, which typically issue common stock, also have announcement stock-price reactions that are similar to seasoned issues of common stock for cash. However, unlike some prior studies on seasoned common stock issues, I find no evidence of risk increases or superior pre-offer stock-price performance. The leverage-decreasing offers examined here are most likely undertaken in response to financial distress resulting from prolonged underperformance, and they signal retrenchment.

Appendix

This appendix describes the distribution of intrafirm exchange-offers over the calendar period 1970-1988, as well as the classes of securities retired and issued in the offers, the distribution of offers by the two-digit SIC codes of the offering firms, and the firm size.

I identified 366 intrafirm exchange-offers by firms listed on NYSE (179 offers), AMEX (109 offers), and NASDAQ (78 offers). Of these offers, 270 were identified from the Dow Jones New Retrieval service. The remaining were identified from a search of the Registered Offering Statistics tape of the Security and Exchange Commission, the Wall Street Journal Index, and the Investment Dealers’ Digest.

The following criteria determined whether an offer was included in the sample: i) the offer was open to all security holders of an affected class, which excludes private exchange offers with individual investors, employees, banks, and brokerage houses (swaps); ii) the issued and retired securities were from different classes; iii) the cash disbursement was less than 30% of the value of securities retired; and iv) an exchange offer involving the redemption of more than one type of security unambiguously implied a unidirectional change in leverage.

The distribution of offers over the sample period presented in Table A. 1 shows some clustering of offers. Leverage-increasing offers outnumber leverage-decreasing offers 101 to 12 in the years 1973-1980. The period 1981-1988 shows leverage-decreasing offers outnumbering leverage-increasing offers 177 to 72. I know of no systematic bias in the sampling procedure that can account for this clustering by calendar period. l4 The analysis in this study investigates the possible effects of clustering. No unusual concentration is found in a particular calendar month or on a particular day of the week.

“Leverage-increasing exchange offers in the sample are further clustered in the years 1973-1976 and 1979-1981, when the overall economy suffered oil supply shocks and stock prices were at histori- cally low levels. The exchange offers in Masulis (1980) and the tender offer repurchases in Dann,

Masulis, and Mayers (1991) exhibit clustering in the years 1973-1974 and 1976-1978.

120 K. Shah/Journul qf Financial Economics 36 (1994) 89-126

Table A. 1

Distribution of 175 leverage-increasing and 191 leverage-decreasing intrafirm exchange offers

announced in the period 1970-1988 by calendar year and direction of intended leverage changes

Year Leverage-increasing

offers

Leverage-decreasing Total offers offers

1970 I 0 1

1971 1 1 2

1972 0 1 I 1973 10 I 11

1974 21 I 22

1975 8 1 9

1976 12 I 13

1977 8 0 8

1978 8 2 10

1979 20 2 22

1980 14 4 18

1981 15 II 26

1982 9 11 20

1983 3 22 25

1984 6 17 23

1985 16 32 48

1986 7 46 53

1987 7 16 23

1988 9 22 31

Total 175 191 366

The exchange offer announcements were identified from a search of the Dow Jones News Retrieval

Service, the Registered Offerings Statistics tape of the Securities and Exchange Commission, the

Wall Street Journal Index, and Investment Dealer’s Diyrst.

It is difficult to succinctly describe the exchange offers by the type of securities retired and issued. Many potential combinations exist, and many are indeed found in the sample. Often, one type of security is retired in exchange for a package of different securities. As seen in Table A.2, the two most frequent classes of securities retired are common stock and straight debt; these transactions account for 30% and 43% of the total sample. Leverage-increasing exchange offers, in which common stock is retired and straight debt is solely or partly issued, account for 64% of the leverage-increasing sample. Leverage- decreasing offers, in which straight debt is retired and common stock is solely or partly issued, account for 5 1% of the leverage-decreasing sample.

In Table A.3, I report the distribution of exchange-offers firms’ two-digit Standard Industrial Classification (SIC) codes. The sample firms represent 54 two-digit SIC codes. While a concentration of some industries exists in the sample, it is not clear whether these industries are overrepresented from their

Table A.2


Distribution of 175 leverage-increasing and 191 leverage-decreasing intrafirm exchange offers

announced in the period 1970-1988 by composition of securities in the offer

Retire Issue Total

Straight debt Common stock 40

Common stock + Combination 50

Straight preferred stock 5

Straight preferred + Combination 0

Convertible preferred stock 8

Convertible preferred + Combination 5

Total 108

Convertible debt Common stock 20


Straight preferred stock 2

Straight preferred + Combination I Convertible preferred stock 6 Convertible preferred + Combination 2

Total 50

Straight preferred stock Common stock 15


Straight debt 5

Straight debt + Combination 3

Convertible debt 3

Convertible debt + Combination 1

Total 30

Convertible preferred stock Common stock 12


Straight debt 1 Straight debt + Combination 1

Convertible debt 4

Convertible debt + Combination 0

Total 21

Common stock Straight debt 93 Straight debt + Combination 29

Convertible debt 5

Convertible debt + Combination 0 Straight preferred stock 21 Straight preferred + Combination 1

Convertible preferred stock 8

Convertible preferred + Combination 0

Total 157

Grand total 366

Offers are classified according to the two classes of securities retired and issued which are farthest

apart in priority from each other. Combination offers include the further issuance of one or more of

the following: straight and convertible debt, straight and convertible preferred stock, or warrants

and cash. Note that in no combination offer was the direction of the leverage change ambiguous.

122

Table A.3

K. Shah/Journal of‘Financia1 Economics 36 (1994) 89-126

Distribution of 175 leverage-increasing and 191 leverage-decreasing intrafirm exchange offers announced in the period 1970-1988 by their firms’ two-digit Standard Industry Classification (SIC)

codes in decreasing order of frequency

SIC code Industry description

Leverage-increasing Leverage-decreasing

offers offers

Total

67 13 36 35 33 30 73 65 50 26 63 45 20 78 70 34 28 53 32 57 38

29 89 80 79 58 54 48 39

37 24 23 10 72 61

59 22

17

15

64

52

_ Holding and Investment Offices 1s

Oil and Gas Extraction 7 Electrical and Electronic Machinery 11 Machinery, Except Electrical 10

Primary Metal Industries 6

Rubber and Plastics Products 7

Business Services

Real Estate

Wholesale Trade-Durable Goods Paper and Allied Products

Insurance

Transportation by Air

Food and Kindred Products

Motion Pictures

Hotels and Lodging Places

Fabricated Metal Products

Chemicals and Allied Products

General Merchandise Stores

Stone, Clay, Glass and Concrete

Furniture Stores Measuring and Analyzing Instru-

6

5

/ 4

9

4

6

3

6

2

4

5 0

5

ments 0

Petroleum Rehning 2

Miscellaneous Services 2

Health Services 4

Amusement and Recreation Services 0 Eating and Drinking Places 1

Food Stores 4

Communication 2

Miscellaneous Manufacturing Indus-

tries I

Transportation Equipment 4

Lumber and Wood Products 2

Apparel and Other Products 3

Metal Mining 2

Personal Services 3 Credit Agencies Other Than Banks 3 Miscellaneous Retail 0

Textile Mill Products I

Construction 1

Building Construction 2

Insurance Agents, and Service 1 Building Materials 0

19 34

27 34

15 26 I 17

x 14

6 13

6 12

6 11 4 11

1 11

1 10 4 8

2 8

4 7

1 7

S I

3 7

1 6

6 6

0 5

3

0 2

1

2

0 0

3 2

2

2

K. ShahJJournal qf Financial Economics 36 (1994) 89-126 123

Table A.3 (continued)

SIC code Industry description

Leverage-increasing Leverage-decreasing

offers offers

49 Electric, Gas, and Sanitary Services 0 2 2

27 Printing and Publishing 0 2 2

15 Automotive Repair and Garages 0 1 1

62 Security and Commodity Brokers 1 0 1

55 Automotive Dealers and Service 1 0 1

51 Wholesale Trade-Nondurable Goods 0 1 1

44 Water Transportation 0 1 1

40 Railroad Transportation 1 0 1

31 Leather and Leather Products 1 0 1

25 Furniture and Fixtures 1 0 1

12 Coal and Lignite Mining 0 1 1

02 Agricultural Prod. -Livestock 1 0 1 01 Agricultural Prod. -Crops I 0 1

00 Not Known 8 13 21

Grand total 175 191 366

proportion in the overall economy. Except for oil and gas extraction companies, which mostly undertook leverage-decreasing offers, no unusual tendency is found for firms within a particular industry to undertake one type of offer. The influence of oil and gas extraction companies is also investigated.

In Table A.4, I report sizes of offer firms and their matching industry firms in terms of book values of assets and sales and market value of common stock at fiscal year-end prior to the offer announcements. The data are obtained from Compustat, and I define matching industry firms as those having the same four-digit SIC codes, which results in 3,233 matches for 235 offers.

The mean values in the table are driven by the presence of some very large firms in the sample. The median values indicate that leverage-increasing firms are larger in terms of assets and sales, but much smaller in terms of market value of common stock compared to other firms in the same industry. This observation is consistent with the higher leverage documented for these firms, which I report in Section 4. The leverage-decreasing firms are larger than industry firms in terms of assets, but smaller in terms of sales and market value of common stock. This observation is consistent with my findings of higher leverage and poor operating performance, documented in Sections 3 and 4.

Total

offers


Table A.4

Firm size, as measured by total assets, sales, and market value of common stock, at fiscal year-end

prior to 175 leverage-increasing and 191 leverage-decreasing intrafirm exchange offer announce-

ments in the period 1970-1988, for exchange-offer firms and their comparison industry firms

Category Mean


1) Total assers

Offer firms 973.22 Industry Firms 642.12

2) Sales

Offer firms 1017.03

Industry firms 637.27

3) Marker value of common stock

Offer firms 390.8 1

Industry firms 254.1 1


1) Total usset~

Offer firms 1292.92


2) Sales

Offer firms 1213.40


3) Market value of‘common stock

Offer firms 3 18.07


Q] Median Q3 # of offers

42.03 241.11 1136.50

52.06 116.87 392.1 1

50.13 194.90 741.12

62.76 127.14 368.00

10.84 47.60 365.70 124

16.78 58.93 161.40

125

125

69.08 215.24 92 1.23 120

71.36 174.25 678.77

62.87 166.15 594.27 120

54.25 197.49 559.04

16.03 62.48 192.61 119

44.74 105.43 337.56

All figures are in $ millions. Ql and Q3 are first and third quartiles. Total assets and sales are fiscal

year-end book values. Market value of common stock is number of shares times price per share at

fiscal year-end. Industry values are based on the median industry firm having the same four-digit SIC code as offer firms. Industry matches for 235 offers are found using a total of 3,233 firms. The

number of matched industry firms per offer varies.

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