Does debt affect firm value in Taiwan? A panel threshold regression analysis

Abstract

This article analyses whether leverage affects firm value and does so using a panel of 196 Taiwanese listed companies during the 13-year (1993–2005) period. We employ an advanced panel threshold regression model to test whether there is a ‘threshold’ debt ratio which causes there to be 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%, we find Tobin's Q increases by only 0.0057%, with an increase of 1% in the debt ratio. But when the debt ratio is greater than 33.33%, there is no relationship between debt ratio and firm value. We therefore conclude that there must be a threshold 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.

Acknowledgements

We thank an anonymous referee and the APE's editor Professor Mark Taylor for several useful comments and suggestions. All these make this article more valuable and readable. Any errors that remain are our own.

Notes

¹ ‘Davies' Problem’ exists when the testing statistics follow a nonstandard distribution because of the existence of nuisance parameters (Davies, 1977, 1987).

² Note that statistic (17) tests a different hypothesis from statistic (15) discussed in the previous section. LR ₁(γ₀) tests H₀ : γ = γ₀, while F(γ) tests H₀ : α₁ = α₂.

³ Readers are referred to Hansen (1999) (Appendix: Assumptions 1–8).