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The Combined Effects of Free Cash Flow and Financial Slack on Bidder and Target Stock Returns


  • Smith, Richard L
  • Kim, Joo-Hyun


This article examines the extent to which takeovers mitigate the underinvestment problem of S. C. Myers and N. S. Majluf (1984) and the free-cash-flow problem of M. C. Jansen (1986). Using accounting data, bidders are classified as 'high free cash flow,' 'slack poor,' or 'other.' Bidder, target, and total returns are highest for acquisitions that combine slack-poor and free-cash-flow firms. The widely cited negative returns of bidders are concentrated among combinations where bidders and targets are similarly classified. Cross-sectionally, bidder returns are more positive when associated with capital structure and liquid asset changes that mitigate bidder slack or free-cash-flow problems. Copyright 1994 by University of Chicago Press.

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  • Smith, Richard L & Kim, Joo-Hyun, 1994. "The Combined Effects of Free Cash Flow and Financial Slack on Bidder and Target Stock Returns," The Journal of Business, University of Chicago Press, vol. 67(2), pages 281-310, April.
  • Handle: RePEc:ucp:jnlbus:v:67:y:1994:i:2:p:281-310

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    References listed on IDEAS

    1. Douglas W. Diamond & Philip H. Dybvig, 2000. "Bank runs, deposit insurance, and liquidity," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win, pages 14-23.
    2. Myers, Stewart C. & Majluf, Nicolás S., 1945-, 1984. "Corporate financing and investment decisions when firms have information that investors do not have," Working papers 1523-84., Massachusetts Institute of Technology (MIT), Sloan School of Management.
    3. Kyle, Albert S, 1985. "Continuous Auctions and Insider Trading," Econometrica, Econometric Society, vol. 53(6), pages 1315-1335, November.
    4. Diamond, Douglas W. & Verrecchia, Robert E., 1981. "Information aggregation in a noisy rational expectations economy," Journal of Financial Economics, Elsevier, vol. 9(3), pages 221-235, September.
    5. Stewart C. Myers & Nicholas S. Majluf, 1984. "Corporate Financing and Investment Decisions When Firms Have InformationThat Investors Do Not Have," NBER Working Papers 1396, National Bureau of Economic Research, Inc.
    6. Myers, Stewart C. & Majluf, Nicholas S., 1984. "Corporate financing and investment decisions when firms have information that investors do not have," Journal of Financial Economics, Elsevier, vol. 13(2), pages 187-221, June.
    7. Mark Rubinstein., 1989. "Market Basket Alternatives," Research Program in Finance Working Papers RPF-187, University of California at Berkeley.
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