Evidence on the Association between Mergers and Capital Structure

Abstract

theories relating capital structure decisions to the act of merger, among them (1) the latent debt capacity (LDC) merger incentive, (2) the increased debt capacity (IDC) merger incentive, and (3) coinsurance wealth transfer effects of merger. The LDC merger rationale holds that under-utilization of the potential tax subsidy on interest payments by one firm creates an incentive for acquisition by another firm whose management will fully utilize the acquired firm's debt potential [17]. The IDC merger rationale, as developed by Lewellen [17], states that merger may result in a decrease in the likelihood of default at premerger debt levels, thus creating debt capacity for the postmerger firm which exceeds the firms' combined (weighted average) premerger debt capacities. Given a tax incentive to use debt financing, shareholders would therefore benefit from the merger