Financing-Motivated Acquisitions

The following post comes to us from Isil Erel, Yee Jin Jang, and Michael Weisbach, all of the Department of Finance at The Ohio State University.

In the paper, Financing-Motivated Acquisitions, which was recently made publicly available on SSRN, we evaluate the extent to which acquisitions lower financial constraints on a sample of 5,187 European acquisitions occurring between 2001 and 2008. Each of these targets remains a subsidiary of its new parent, so we can observe the target’s financial policies following the acquisition. We examine whether these post-acquisition financial policies reflect improved access to capital.

Managers often justify acquisitions with the logic that they can add value to targets by facilitating the target’s ability to invest efficiently. In addition to the operational synergies emphasized by the academic literature, financial synergies potentially come from the ability to use the acquirer’s assets to help finance the target’s investments more efficiently. However, examining this view empirically is difficult, since for most acquisitions, one cannot observe data on target firms on subsequent to being acquired. Because of disclosure requirements in European countries, we are able to construct a sample of European acquisitions containing financial data on target firms both before and after the acquisitions. We use this sample to test the hypothesis that financial synergies are one factor that motivates acquisitions.

Our approach is to evaluate whether the financial management decisions of target firms change when their firm is acquired in ways consistent with their becoming less financially constrained. Theory suggests that financial constraints should lead managers to increase cash holdings, to increase the cash flow sensitivity of cash as well as the cash flow sensitivity of investment, and to decrease investment. If constraints are eased when a firm is acquired, then these effects should be reversed. In our sample, we document that subsequent to an acquisition, managers do in fact lower their cash holdings, lower the sensitivity of cash holdings to cash flow, lower the sensitivity of investment to cash flow, and increase the quantity of their investments. These results suggest that financial constraints are lowered for target firms when they are acquired. Lowering these constraints can lead target firms to undertake more positive net present value investments, and consequently provide a motive for the acquisition.

Moreover, we document that these effects are most important in deals when one expects that financial constraints are more important. In particular, the reduction in financial constraints appears to be more important for firms that were not subsidiaries prior to the acquisition and for smaller targets. In addition, the reduction in financial constraints occurs in both diversifying and same-industry acquisitions. This cross-deal pattern of empirical results suggests that they reflect reductions in financial constraints and not other factors.

These results suggest that financial synergies are one factor leading firms to purchase other firms. Value is created in these deals because target firms can finance more of their value-increasing investments. While we emphasize that while financial synergies appear to be important factors leading to acquisitions, they are not the only source of value. Factors such as operational synergies and wealth transfers also are important determinants of acquisitions. From our results, it is impossible to quantify the importance of financing motivation relative to other factors. Nonetheless, it is clear that doing so would greatly add to our understanding of why certain firms combine with others.

The full paper is available for download here.

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