Long-term stock returns after a substantial increase in the debt ratio

Abstract

Prior studies consistently indicate that the announcement of an increase in the debt ratio will be accompanied by a rise in the stock price. In attempting to examine the long-term stock returns following a substantial increase in debt, this study shows that the stock price could negatively react to the increase in debt in some cases, and that only firms with less financial risk will experience positive long-term stock returns. In addition, firms with independent directors, with a CEO concurrently serving as the chairman of the board, that are controlled by a family or with low growth opportunities are more likely to experience a better long-term stock performance after an increase in debt, suggesting that board composition and growth opportunities play central roles in determining the long-term stock returns following an increase in the debt ratio.