Stock Price Reaction to Announcements of Capital Structure Changes - From an Industry Leverage Ratio Perspective

Abstract: In this paper, we investigate how important a firm’s proximity to the industry debt ratio is to its stock price performance. To achieve this goal, event study methodology is applied on stock price reactions upon the announcement of seasoned equity offerings. Depending on whether the offering moves the debt ratio of the firms “closer to” or “away from” the industry median leverage ratio, the average cumulative abnormal returns are different. Empirical tests on the significance and comparison of the average cumulative abnormal returns are conducted. After controlling for other factors which may affect stock price reactions to seasoned equity offerings, we find that firms moving their leverage ratio closer to industry median have less negative stock price reactions compared to those moving away from it. We therefore conclude that investors see industry median leverage ratios as a benchmark for firms within that industry.