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Internal vs External Financing of Acquisitions: Do Managers Squander Retained Profits?

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  • Andrew P. Dickerson

    ()

  • Heather D. Gibson
  • Euclid Tsakalotos

    ()

Abstract

This paper investigates the proposition that the source of financing of new investment has a bearing on its profitability. One important argument in the literature is that managers who have control over investment finance are more likely to pursue their own goal of firm growth, while managers who have to raise funds externally are monitored more closely by the financial markets and hence are more likely to act in shareholders' best interests. Thus, the profitability of externally financed investment should be greater than that from internally financed investment. We focus on investment in acquisitions and, as in previous studies, we show that there is a negative net impact of such investment on long-run profitability. Moreover, when we distinguish the means by which acquisitions are financed, we find that this negative net impact derives from externally financed acquisitions, while internally financed acquisitions would appear to have no significant impact on profitability. Our results therefore do not support the hypothesis that managers squander internal funds on poor investment projects. More significantly perhaps, we find evidence to suggest that capital markets and financial institutions do not generate the anticipated beneficial effects.

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Bibliographic Info

Paper provided by Department of Economics, University of Kent in its series Studies in Economics with number 9618.

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Date of creation: Dec 1996
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Publication status: Forthcoming in Oxford Bulletin of Economics and Statistics, 2000
Handle: RePEc:ukc:ukcedp:9618

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Postal: Department of Economics, University of Kent at Canterbury, Canterbury, Kent, CT2 7NP
Phone: +44 (0)1227 764000
Fax: +44 (0)1227 827850
Web page: http://www.ukc.ac.uk/economics/

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Keywords: Investment Financing; Free Cash Flow; Acquisitions; Company Performance;

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Cited by:
  1. Sarmistha Pal, 2005. "Do External Funds Yield Lower Returns? Recent Evidence From East Asian Economies," Development and Comp Systems 0512021, EconWPA.

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