FREE online courses on Financial Management and Creating Value - Chapter 1 - Recapitalizations - Recaps

 

On the other side of restructurings are recapitalizations (recaps) of the business. The evidence is strong that recaps do in fact enhance values. Even if a company borrows heavily to simply pay out large dividends can boost values. Recaps send a message to the marketplace about what management thinks.

 

One important element in many recaps is the use of debt. Debt helps enhance values. Why? It seems that when an organization operates under heavy debt loads management is forced to make better decisions for the shareholders. Under high debt, the company must make interest payments and this forces management to watch how it invests scarce resources. Management is more likely to look for ways to preserve cash. In the absence of debt, managers have a tendency to overpay for acquisitions, misuse surplus funds, and disregard returns on invested capital. Therefore, carrying high levels of debt can be a simple and effective way to keep managers working on behalf of higher values.