Leverage Changes and Growth Options in Mergers and Acquisitions
51 Pages Posted: 27 Jul 2012 Last revised: 1 Apr 2015
Date Written: March 30, 2015
We develop and empirically test a trade-off model for the analysis of leverage changes in mergers and acquisitions. This study extends prior findings of a post-merger increase in leverage for the acquiring firm by linking this leverage increase to merging firms that are less correlated, create significantly larger growth options, have lower bankruptcy costs and lower volatility. Specifically, we show that acquiring firms are more likely to finance diversifying acquisitions with debt as equity holders exploit the increased debt capacity with higher leverage resulting in total merger gains that are positively associated with financial synergies. This study further corroborates recent theoretical evidence of a U-shaped relationship between growth options and leverage theoretically and empirically in the context of mergers.
Keywords: Capital Structure, Mergers and Acquisitions, Growth Options, Trade-off Model
JEL Classification: G13, G32, G34, L25
Suggested Citation: Suggested Citation