Signalling Future Firm Value by Issuing Debt - An event study of bond announcements in the US stock market

Abstract

In the presence of asymmetric information, firms may use leverage to provide positive information about firm value to the market. An increase in leverage by issuing debt can be interpreted as a credible signal as it may indicate that a firm's future earnings are sufficient to manage its debt obligations. In this paper, the event study methodology is applied to analyse the announcement effect of bond issuances for public US companies from 1994 to 2024. We find evidence that straight debt has a positive and statistically significant effect, with an abnormal return of 0,22% over a three-day period [-1,1]. In comparison, the announcement of convertible debt had a significant negative effect of -3,94% in the same period. Firm characteristics are also analysed, to capture factors that influence these results. Issue size, growth opportunities, and credit risk are found to impact abnormal returns of straight debt. The paper´s findings indicate that there are large differences in the signalling effect between bond types and that the market reaction depends on different firm characteristics.