Leverage -reducing exchange offers and managerial incentives: An empirical analysis
Leverage-reducing exchange offers are consistently associated with a reduction in shareholder wealth. This study examines the motivations behind these exchange offers in light of their negative impact on shareholders' wealth by characterizing a sample of 151 firms conducting leverage-decreasing exchange offers between 1980 and 1993 and comparing them with a sample of similar firms that do not undertake such offers.^ In line with prior findings, I document significantly negative abnormal returns associated with the offer announcements in my sample. I find that a majority of the firms are financially distressed, as evidenced by low Altman's Z-scores, and develop a matching sample of firms which are similar to the exchange offer firms in terms of financial distress levels, firm size, and industry classification, and which did not undertake a leverage-reducing exchange offer.^ The exchange offer firms have significantly lower insider stock ownership than the matching sample, suggesting that managers of the exchange offer firms could have relatively stronger incentives to place their own interests before those of shareholders. The exchange offer firms also generally have larger boards of directors, which are potentially less effective monitors of managerial behavior. Furthermore, logit regression analysis suggests insider ownership plays a significant role in determining whether an exchange offer is conducted by a distressed firm, even when controlling for firm size, capital structure, and the relative amount of public debt outstanding.^ I find that the prompt liquidation of most of the exchange offer firms would result in a zero payoff to shareholders, indicating that shareholders would generally prefer an exchange offer to liquidation. However, most of the matching firms attempt to weather their financial difficulties without a debt restructuring, and are more successful in avoiding bankruptcy than the exchange offer firms. Thus, a policy of riding out the financial distress might be preferable to an exchange offer. Collectively, the negative shareholder reaction to the offers, lower insider stock ownership, and higher frequency of bankruptcy associated with the exchange offer firms suggest that shareholders of financially distressed firms might favor avoiding leverage-reducing exchange offers. ^
Major Professor: John J. McConnell, Purdue University.
Business Administration, Management|Economics, Finance
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