A note on debt capacity in mergers

Abstract

Debt capacity is commonly thought to increase in a corporate merger. This note observes that the very concept of debt capacity appears to have evolved over time. In keeping with this, a fresh definition of debt capacity is proposed, placing the concept firmly in the context of optimal capital structure. The note proceeds to show, relying on a widely accepted model of optimal capital structure under corporate and personal taxation, namely that proposed by De Angelo and Masulis (1980) that debt capacity generally decreases in a merger, contrary to the usual result.