An Investigation Of The Determinants Of BTs Debt Levels From 1998-2002: What Does It Tell Us About The Optimal Capital Structure?

Abstract

Over the period 1998-2001, British Telecom (BT) dramatically increased its debt levels, from 4.8bn in 1998 to 31bn in 2001. This was accompanied by a dramatic decrease in the firms share price. Subsequent pressure from analysts and investors induced BT to use a rights issue to substantially reduce debt in 2002 (from 31bn to 18.4bn). However, the share price has continued to fall, but not so dramatically. Hence, BT provides an ideal case study of the effects of capital structure on firm value. In this case study, we will consider such questions as:

a) Why did BT take on so much debt? Why did it cause firm value to fall, when many capital structure theories suggest a positive relationship between leverage and firm value?

b) Why has the reduction in debt not caused an increase in equity value?

c) Was BT beyond its optimal debt/equity ratio from 1998-2001? Is it still beyond the optimum?

d) Does BT have an optimal capital structure? What is it? Is it static? What are the trade-offs involved?

e)Does BTs case hold lessons for other firms?