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Asset Volatility and Capital Structure: Evidence from Corporate Mergers

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  • Oliver Levine

    (Wisconsin School of Business, University of Wisconsin–Madison, Madison, Wisconsin 53706)

  • Youchang Wu

    (Lundquist College of Business, University of Oregon, Eugene, Oregon 97403)

Abstract

We exploit cross-sectional variation in the predictable changes in asset volatility following corporate acquisitions to identify the effect of business risk on capital structure. We find that postmerger changes in leverage and cash holdings are strongly predicted by expected asset volatility changes estimated using premerger information. These capital structure adjustments are partly achieved through the choice of payment method. Our findings provide direct evidence for the coinsurance effect of mergers on debt capacity. More broadly, they suggest that firm risk is a first-order determinant of leverage, consistent with the tradeoff theory of capital structure. Our coefficient estimates imply that a one-standard deviation decline in a firm’s asset volatility corresponds to a 7.5-percentage point increase in leverage.

Suggested Citation

  • Oliver Levine & Youchang Wu, 2021. "Asset Volatility and Capital Structure: Evidence from Corporate Mergers," Management Science, INFORMS, vol. 67(5), pages 2773-2798, May.
    • Handle: RePEc:inm:ormnsc:v:67:y:2021:i:5:p:2773-2798
    DOI: 10.1287/mnsc.2020.3607
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    1. Li, Shengfeng & Hoque, Hafiz & Liu, Jia, 2023. "Investor sentiment and firm capital structure," Journal of Corporate Finance, Elsevier, vol. 80(C).

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