University of Illinois at Urbana-Champaign; National Bureau of Economic Research (NBER)
Cornell University; National Bureau of Economic Research (NBER)
Boston University School of Management
January 16, 2011
Journal of Financial Economics (JFE), Forthcoming
AFA 2010 Atlanta Meetings Paper
We model the interplay between corporate liquidity and asset reallocation opportunities. Our model implies that financially distressed firms may be acquired by liquid firms in their industries even when there are no operational synergies associated with the merger. We call these transactions "liquidity mergers," since their main purpose is to reallocate liquidity to firms that might be otherwise inefficiently terminated. We show that liquidity mergers are more likely to occur when industry-level asset specificity is high (i.e., industry-specific rents are high) and firm-level asset specificity is low (industry counterparts can efficiently operate the distressed firms' assets). We also provide a detailed analysis of firms' optimal liquidity policies as a function of real asset reallocation. We show that firms are more likely to use credit lines relative to cash if they anticipate liquidity-merger activity in their industry. The model makes a number of predictions that have not been examined in the literature. Using a large sample of mergers, we verify the model's prediction that liquidity-driven acquisitions are more likely to occur in industries with specific, but transferable assets. Using alternative data sources for credit lines, we also confirm the model's prediction that firms are more likely to use credit lines (relative to cash) when they operate in industries in which liquidity mergers are more frequent.
Number of Pages in PDF File: 66
Keywords: Mergers and acquisitions, credit lines, cash, asset specificity, financial distress
JEL Classification: G31
Date posted: March 18, 2009 ; Last revised: February 14, 2012
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