| Abstract: | The notion of an interior optimum capital structure is the central issue of this study. The purpose of the dissertation is to test for the existence of an interior optimum. This was accomplished by sampling firms which reduced their financial leverage position by exchanging common equity for a portion of their outstanding long-term debt, and measuring the influence which the firm's debt-equity ratio, and the relative size of the leverage reduction, exerted on the change in shareholders' wealth during the announcement period. Logistical regression analysis is employed to explore the relationship of capital structure choice and common equity value. The dependent variable is dichotomous in nature: it takes on the value of zero if the residual return to shareholders is negative surrounding the announcement date, and positive one otherwise. The three predictor variables include the interaction of the pre-event debt/equity ratio with the relative reduction in financial leverage, the interaction of the pre-event debt/equity ratio with the timing of the exchange of equity for debt, and the timing of the exchange (main effect). Each of these three variables are significant at the 90 percent level of confidence, and the model as a whole is significant at the 95 percent level. Two main effects, the pre-event debt/equity ratio and the relative size of the exchange, do not prove significant when interaction is considered. The degree of statistical significance and the sign associated with the remaining predictor variables support the notion of an interior optimum capital structure. If firms are moving in the direction of an interior optimum capital structure via an exchange or "swap" of equity for debt then one should witness a correspondent increase in shareholder wealth. And, if firms are moving away from an optimum; then one should see a decline in shareholders wealth. The evidence suggests that managers of highly levered firms produce shareholder benefits by reducing financial leverage if the size of the debt reduction is significant, while managers of less levered firms, and/or managers who make only minor changes in their firm's leverage position, destroy shareholders wealth by the reduction of financial leverage. |
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