State-dependent risk and M&A

During economic contractions, the asset and capital structures of firms are more likely to deviate from their optimal levels. Target firms, in particular, are more susceptible to such deviations. I study how such deviations affect the bidding firms’ acquisition decision. I find that bidders abstain from taking over targets when the debts and growth options of the targets are over their optimal levels. Further, I show that bidders are more likely to pay a low premium for such targets. Both results are pronounced when the aggregate economy has had a bad shock; these results are associated with higher risks because of the excessive levels of debts and growth options. Overall, these results uncover the impact of the targets’ abnormal debts and growth options on the bidders’ acquisitions, contingent on the state of the economy.