The impact of capital structure on stock prices

A question from Yahoo! Answers:

How to measure impact of capital structure on stock prices?

This is done using a technique called “event study”. You begin by defining the event. In your case the event could be an announcement of a bond issue, or an announcement of a bank loan (note that it usually makes sense to distinguish between the two, since the reaction to bank loan announcements is often more positive than that to bond issue announcements). Then, you find all instances of that event in your target universe during your period of study. With any luck, you will have a few hundred instances of the event.

Next, you do two things at the same time. You convert from absolute time scale (dates) to relative time scale (days before/after the event) and from raw stock prices to abnormal returns (abnormal return = stock return – beta * market return).

Now you can begin the study in earnest. You can see whether stocks in your sample showed any abnormal performance around the event, whether this abnormal performance occurred before or after the event, and how consistent it was.

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