Organizational Forms and Wealth Effects of Public Debt Offerings

Abstract

Literature indicates that the multiple-segment firms have higher free cash flows and lower growth opportunities compared to the single-segment firms. It also has been long recognized that leverage helps control the agency costs problem associated with potential corporate over-investment. Based on these findings, two hypotheses, including free cash flow and investment opportunities hypotheses, are proposed in this study to examine the effects of the different organization forms (single-segment vs. multiple-segment firms) on the announcement of public debt offering by Taiwan public traded firms between 1999 and 2005. Free cash flow hypothesis expects that announcement effect of debt offering is more positive for multiple-segment firms than for single-segment firms because the potential for debt offering to reduce over-investment problem should be higher for multiple-segment firms than for single-segment firms. However, single-segment firms on the other hand are predicted to have higher announcement return of debt offerings under the investment opportunities hypothesis. We find that consistent with the investment opportunities hypothesis, the stock market’s responses to the announcement of public debt offering are more favorable for single-segment firms than for multiple-segment firms. The overall findings after several robust checks suggest that leverage works to lessen the over-investment problem for multiple-segment firms.