Cash Acquirers: Can Free Cash Flow, Debt and Institutional Ownership Explain Long Run Performance?

40 Pages Posted: 28 Mar 2011  

Alan Gregory

University of Exeter - Xfi Centre; University of Exeter Business School

Yuan-Hsin Wang

affiliation not provided to SSRN

Date Written: March 23, 2011

Abstract

Cash acquirers are an interesting sub-group of acquirers. Whereas the overall evidence seems to suggest the majority of mergers and acquisitions destroy shareholder value in the long term, cash-financed acquisitions do not appear to do so. Yet this seems at variance with the prediction from Jensen’s “free cash flow” (FCF) hypothesis, which argues that high levels of free cash flow and unused borrowing capacity are likely to encourage low-value mergers. In contrast, the “pecking order” theory offers a different perspective, where managers conserve cash flow to undertake positive NPV investments. Furthermore, having adequate financial resources available post-merger may be important in developing the potential opportunities that the merger brings. We argue that the stronger position of shareholders, as opposed to firm managers, in the UK compared to the US makes the FCF hypothesis less relevant in the UK, and show that low leverage and high FCF may be advantageous provided shareholder monitoring is adequate. By analysing both announcement period and long term returns, we show that acquirers with high levels of FCF are superior performers, and that any long-run under-performance of cash acquirers appears to be associated with low cash resources and low institutional ownership.

Keywords: Free Cash Flow, Shareholder Monitoring, Acquisitions

JEL Classification: G14, G34

Suggested Citation

Gregory, Alan and Wang, Yuan-Hsin, Cash Acquirers: Can Free Cash Flow, Debt and Institutional Ownership Explain Long Run Performance? (March 23, 2011). Available at SSRN: https://ssrn.com/abstract=1793094 or http://dx.doi.org/10.2139/ssrn.1793094

Alan Gregory (Contact Author)

University of Exeter - Xfi Centre ( email )

University of Exeter
Xfi Building, Rennes Dr.
Exeter, EX4 3BZ
United Kingdom

University of Exeter Business School ( email )

Streatham Court
Xfi Building Rennes Dr.
Exeter, EX4 4JH
United Kingdom

Yuan-Hsin Wang

affiliation not provided to SSRN ( email )

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