Does debt affect firm value in Taiwan.docVIP

Does Debt Affect Firm Value in Taiwan? A Panel Threshold Regression Analysis Feng-Li Lin,a Tsangyao Chang b a Associate Professor, Department of Accounting, Chaoyang University of Technology, Taichung, Taiwan. Ph.D candidate, College of Business, Feng Chia University, Taichung, Taiwan, E-Mmail:fengli168@ bPh.D., Professor of Economics, Department and Graduate Institute of Economics Feng Chia University, Taichung, Taiwan,E-Mail:tychang@.tw Abstract This paper analyzes whether leverage affects firm value and does so using a panel of 196 Taiwanese listed companies during the thirteen-year 1993-2005 period. We employ an advanced panel-threshold regression model to test whether there is an “optimal” debt ratio which causes there to be threshold effects and asymmetrical relationships between debt ratio and firm value. We adopt Tobin’s Q as proxy for firm value. We find that there are two threshold effects between debt ratio and firm value, and these are 9.86% and 33.33%.When the debt ratio is less than 9.86%, Tobin’s Q (i.e., firm value) increases by 0.0546%, with an increase of 1% in the debt ratio. When the debt ratio is between 9.86% and 33.33%, Tobin’s Q increases but by only 0.0057%, with an increase of 1% in the debt ratio. But when the debt ratio is greater than 0.3333, there is no relationship between debt ratio and firm value. We therefore conclude that there must be an optimal debt ratio of less than 33.33% at which point firm value stops increasing. These results are consistent with the trade-off theory, which suggests that there is a static amount of debt which prompts managers to find the “optimal capital structure” that maximizes firm value when the benefits of debt equal the marginal cost of debt. Keywords: Tobin’s Q, Panel- threshold effect, Debt ratio 1. Introduction Theories vis-à-vis business finance in the modern sense date as far back as Modigliani and Miller’s (1958) capital structure irrelevance proposition which posited that firm value an