Date of Award

3-2014

Degree Type

Thesis

Degree Name

Master of Science (MS)

Department

Economics and Finance

First Advisor

Tyler Brough

Abstract

Value maximization of a firm depends heavily on the financial leverage of the company. This is measured by the debt-­‐to-­‐equity ratio, which explains what proportions of debt and equity are being used to finance the firm’s assets. By adjusting this ratio, firms can influence their stock performance.

In this study, I estimate the value function for each firm and take the derivative with respect to the debt-­‐to-­‐equity ratio. By setting this equal to zero, I solve for the optimal debt-­‐ to-­‐equity ratio or the ratio that maximizes firm value. The difference between the optimal and historically observed debt-­‐to-­‐equity ratios is called the margin.

Variables like market capitalization, trading volume, and book-­‐to-­‐market ratio can influence margin, as my test results show. Furthermore, I find that margin can influence stock returns of the firm, and it does so in a negative and significant way.

By minimizing margin, companies are able to influence the magnitude of stock returns.

4-1-2014

Included in

Economics Commons

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