Capital Structure and Takeover Defences

In this paper we show how the signalling effect of debt described by Ross (1977) does not work in an environment of hostile takeovers. This is because the effect of debt is to concentrate voting rights in the hands of the incumbent management, "jamming" the signal and preventing any value-enhancing takeover. We show how poison pills, by removing the threat of takeover, can restore the signalling function of debt and increase investment and efficiency. We obtain a large range of prediction about capital structure and takeovers in line with the US experience in the 1980s, and also discuss the relevance of takeover defences of the present takeover wave.