When is Equity More than Just Financing? Evidence from Strategic Alliances

47 Pages Posted: 1 Oct 2012 Last revised: 22 Jan 2013

See all articles by Sudha Krishnaswami

Sudha Krishnaswami

University of New Orleans - College of Business Administration

Eduardo Pablo

Minnesota State University Moorhead

Venkat Subramaniam

Tulane University

Date Written: September 30, 2012

Abstract

A strategic alliance is a hybrid organizational form that is between an arms length contract and a full-fledged merger between firms. In some alliances firms take a minority equity stake in the partner firm. We refer to these as equity alliances. Using data on 759 alliances, we examine the motivation for the use of equity in alliances. We study whether equity is intended to strengthen the contractual performance of the alliance or whether it is primarily a means of financing for the capital constrained partner in the alliance. Consistent with the incomplete contracts theory, we find that equity is more likely to be used in alliances where the exact nature and the sharing of the output is ambiguous. We also find that equity is more likely to be used when the difference in bargaining powers between the partners is higher, such as when the partners differ significantly in size, market power, and growth opportunities. Finally, we find that equity alliances are especially likely when the smaller partner (which is almost always the partner selling equity) is high growth but is capital constrained. Thus, equity from alliance partners is a viable alternative source of capital for such firms. Consistent with the view that equity usage mitigates contracting costs and capital constraints, the market reaction to equity alliances is significantly higher compared to other alliances. Overall, the evidence suggests that the market views equity investments in alliances as more valuable than toeholds taken by potential acquirers without a product market relationship.

Suggested Citation

Krishnaswami, Sudha and Pablo, Eduardo and Subramaniam, Venkat R., When is Equity More than Just Financing? Evidence from Strategic Alliances (September 30, 2012). Midwest Finance Association 2013 Annual Meeting Paper, Available at SSRN: https://ssrn.com/abstract=2154659 or http://dx.doi.org/10.2139/ssrn.2154659

Sudha Krishnaswami

University of New Orleans - College of Business Administration ( email )

2000 Lakeshore Drive
New Orleans, LA 70148
United States
504-280-6488 (Phone)
504-280-6397 (Fax)

HOME PAGE: http://www.uno.edu/~skrishna

Eduardo Pablo (Contact Author)

Minnesota State University Moorhead ( email )

Moorhead, MN 56563
United States
218-4774655 (Phone)

Venkat R. Subramaniam

Tulane University ( email )

A.B. Freeman School of Business
New Orleans, LA 70118
United States
504-865-5493 (Phone)
504-862-8327 (Fax)

HOME PAGE: http://www.tulane.edu/~vencat

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