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Capital Structure Swaps and Shareholder Wealth

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  • Thomas J. O'Brien
  • Linda Schmid Klein
  • James I. Hilliard

Abstract

We show how capital structure swaps can increase the wealth of a firm's long‐term shareholders when a firm's debt or equity is misvalued. We review the conventional rule that a firm should issue equity and use the proceeds to retire outstanding debt (an equity‐for‐debt swap) when equity is overvalued, or repurchase equity with proceeds of new debt (a debt‐for‐equity swap) when equity is undervalued. We also analyse the more complex case where a firm's debt and equity are both undervalued, showing the optimal swap may be to issue undervalued equity, contrary to the conventional rule.

Suggested Citation

  • Thomas J. O'Brien & Linda Schmid Klein & James I. Hilliard, 2007. "Capital Structure Swaps and Shareholder Wealth," European Financial Management, European Financial Management Association, vol. 13(5), pages 979-997, November.
    • Handle: RePEc:bla:eufman:v:13:y:2007:i:5:p:979-997
    DOI: 10.1111/j.1468-036X.2007.00391.x
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