Acquisition Values and Optimal Financial (In)Flexibility

62 Pages Posted: 3 Mar 2008 Last revised: 20 Feb 2015

See all articles by Ulrich Hege

Ulrich Hege

Toulouse School of Economics; European Corporate Governance Institute (ECGI)

Chris Hennessy

London Business School

Date Written: February 10, 2010


This paper analyzes optimal financial contracts for an incumbent and potential entrant accounting for prospective asset mergers. Exercising a first-mover advantage, the incumbent increases his share of surplus by issuing public debt that appreciates in the event of merger. Incumbent debt reduces the equilibrium value of entrant assets and thus reduces the return to (likelihood of) entry through two channels: venture capitalists recover less in default and ownership rights provide weaker managerial incentives. High incumbent leverage has a countervailing cost since the resulting debt overhang prevents ex post efficient mergers if merger surplus is low. Event risk covenants limiting counterparty debt are optimal for the incumbent, further limiting the entrant's share of merger surplus. A poison-put covenant is also optimal for the incumbent, allowing him to extract the same surplus with lower debt face value.

Keywords: Acquisitions, Mergers, Entry, Financial Contracting, Capital Structure, Event-Risk Covenants

JEL Classification: G32, G34, G31

Suggested Citation

Hege, Ulrich and Hennessy, Christopher, Acquisition Values and Optimal Financial (In)Flexibility (February 10, 2010). EFA 2008 Athens Meetings Paper. Available at SSRN: or

Ulrich Hege (Contact Author)

Toulouse School of Economics ( email )

Place Anatole-France
Toulouse Cedex, F-31042
+33 5 61 12 86 01 (Phone)

HOME PAGE: http://

European Corporate Governance Institute (ECGI)

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels

HOME PAGE: http:/

Christopher Hennessy

London Business School ( email )

Sussex Place
Regent's Park
London, London NW1 4SA
United Kingdom

Here is the Coronavirus
related research on SSRN

Paper statistics

Abstract Views
PlumX Metrics