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Financing and Takeovers

Author

Listed:
  • Erwan Morellec

    (University of Lausanne, Swiss Finance Institute and CEPR)

  • Alexei Zhdanov

    (School of Management, George Mason University)

Abstract

This paper analyzes the interaction between financial leverage and takeover activity. We develop a dynamic model of takeovers in which the financing strategies of bidding firms and the timing and terms of takeovers are jointly determined. In the paper, capital structure plays the role of a commitment device, and determines the outcome of the acquisition contest. We demonstrate that there exists an asymmetric equilibrium in financing policies with endogenous leverage, bankruptcy, and takeover terms, in which the bidder with the lowest leverage wins the takeover contest. Based on the resulting equilibrium, the model generates a number of new predictions. In particular, the model predicts that the leverage of the winning bidder is below the industry average and that acquirers should lever up after the takeover consummation. The model also relates the dispersion in leverage ratios to various industry characteristics, such as the volatility of cash flows, effective tax rates, and bankruptcy costs.

Suggested Citation

  • Erwan Morellec & Alexei Zhdanov, 2006. "Financing and Takeovers," Swiss Finance Institute Research Paper Series 06-22, Swiss Finance Institute.
    • Handle: RePEc:chf:rpseri:rp0622
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    Keywords

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    JEL classification:

    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G34 - Financial Economics - - Corporate Finance and Governance - - - Mergers; Acquisitions; Restructuring; Corporate Governance

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