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Valuation implications of capital structure: a contextual approach

  • Begona Giner
  • Carmelo Reverte
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    In this paper, the Ohlson (1995) valuation model is used to analyse the informative value of firm capital structure, decomposing the book value of equity in its two main components (i.e., total assets and liabilities) in order to test whether investors price them in a different way. We adopt a contextual approach and analyse the value relevance of debt taking into account the signalling and 'optimal' financial structure theories as well as the relationship between the cost of debt and return on investment. The sample used comprises all the non-financial Spanish firms listed in the Madrid Stock Exchange during the period 1991-7. Our results seem to support the 'optimal' capital structure theory since departures of the debt-to-equity ratio from its 'optimal' (or target) level are negatively perceived by the market. The debt valuation parameter is higher (lower) for those firms with a cost of debt above (below) return on investment. In addition, and consistent with the signalling theory, debt seems to be a positive signal for firms facing good prospects. This effect is strongly significant for those cases in which return on investment exceeds the cost of debt.

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    Article provided by Taylor & Francis Journals in its journal European Accounting Review.

    Volume (Year): 10 (2001)
    Issue (Month): 2 ()
    Pages: 291-314

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    Handle: RePEc:taf:euract:v:10:y:2001:i:2:p:291-314
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    1. Myers, Stewart C, 1984. " The Capital Structure Puzzle," Journal of Finance, American Finance Association, vol. 39(3), pages 575-92, July.
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    8. Masulis, Ronald W, 1983. " The Impact of Capital Structure Change on Firm Value: Some Estimates," Journal of Finance, American Finance Association, vol. 38(1), pages 107-26, March.
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    10. Kothari, S. P. & Zimmerman, Jerold L., 1995. "Price and return models," Journal of Accounting and Economics, Elsevier, vol. 20(2), pages 155-192, September.
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    13. Collins, Daniel W. & Maydew, Edward L. & Weiss, Ira S., 1997. "Changes in the value-relevance of earnings and book values over the past forty years," Journal of Accounting and Economics, Elsevier, vol. 24(1), pages 39-67, December.
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    15. Myers, Stewart C., 1984. "Capital structure puzzle," Working papers 1548-84., Massachusetts Institute of Technology (MIT), Sloan School of Management.
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