Date of Award
1984
Document Type
Thesis
Degree Name
Master of Science
Department
Business
First Advisor
Jan Kniffen
Second Advisor
Jack Kirk
Third Advisor
Jean A. Hudson
Abstract
The study of the impact of the announcement of various investment decisions of firms on their security values has occupied a central role in research in the area of finance. One has merely to skim the title pages of finance journals to confirm this preeminent position. The studies, to date, have generally used the Capital Asset Pricing Model to analyze the impact of these announcements. The development of the literature in the area of contingent claim pricing provides a new methodology in tackling the above issues. This thesis uses the option pricing framework to study the effects of two specific firm investment decisions--mergers, and stock repurchases.
The first essay examines the pure financial effects of conglomerate mergers. Using the technique for valuing compound options, equations are derived for post-merger values of equity, short-term debt, and long-term debt. With the help of these valuation equations it is shown that the merger can result in wealth transfers from equity to both debts, from equity and one debt to the other debt, and from long-term debt to equity and short-term debt. The existence of these wealth transfers provide a rationale for the protective covenants against mergers that are commonly seen in debt contracts. In addition, it is shown that these protective covenants imply that the post-merger capital structure of the firm would be different from a simple pooling of the pre-merger capital structure of the individual firms.
The second essay examines the effects of an announcement by a firm to repurchase a fraction of its outstanding equity . Given the existence of protective covenants in debt contracts against repurchases, and the voting rights of shareholders, it is theoretically shown that a repurchase must convey some information about the firm's future prospects for it to be approved by all securityholders. In addition, it is shown that the signal must be firm value increasing, and firm risk decreasing. The theoretical signaling effects of repurchases are also shown to be consistent with empirical results obtained in recent studies.
Recommended Citation
Lichtenberg, Gary G., "Corporate Investment Decisions and Security Values" (1984). Theses. 984.
https://digitalcommons.lindenwood.edu/theses/984
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