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

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.