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Capital Structure Swaps and Shareholder Wealth
Author(s) -
O'Brien Thomas J.,
Schmid Klein Linda,
Hilliard James I.
Publication year - 2007
Publication title -
european financial management
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.311
H-Index - 64
eISSN - 1468-036X
pISSN - 1354-7798
DOI - 10.1111/j.1468-036x.2007.00391.x
Subject(s) - gearing ratio , swap (finance) , equity capital markets , equity ratio , equity value , equity risk , equity (law) , business , capital structure , monetary economics , return on equity , debt , financial system , debt to equity ratio , financial economics , economics , finance , internal debt , private equity , debt levels and flows , political science , stock exchange , law , population , demography , sociology , nonprobability sampling
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.