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

Author

Listed:
  • 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.

Suggested Citation

  • Andrew P. Dickerson & Heather D. Gibson & Euclid Tsakalotos, 1996. "Internal vs External Financing of Acquisitions: Do Managers Squander Retained Profits?," Studies in Economics 9618, School of Economics, University of Kent.
  • Handle: RePEc:ukc:ukcedp:9618
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    Cited by:

    1. Driffield, Nigel & Pal, Sarmistha, 2006. "Do external funds yield lower returns?: Recent evidence from East Asian economies," Journal of Asian Economics, Elsevier, vol. 17(1), pages 171-188, February.

    More about this item

    Keywords

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

    JEL classification:

    • G34 - Financial Economics - - Corporate Finance and Governance - - - Mergers; Acquisitions; Restructuring; Corporate Governance
    • L1 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance
    • L2 - Industrial Organization - - Firm Objectives, Organization, and Behavior

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