Merger Decisions and Inside Debt

40 Pages Posted: 4 Nov 2012

See all articles by Yixin Liu

Yixin Liu

University of New Hampshire

David C. Mauer

University of North Carolina (UNC) at Charlotte

Yilei Zhang

University of North Carolina (UNC) at Charlotte

Date Written: October 2, 2012

Abstract

Executive pensions and deferred compensation, collectively referred to as inside debt, tend to align CEO incentives with those of debt holders. Although CEO equity compensation is well known to induce risk-shifting incentives and thereby add to the agency cost of debt, too much inside debt may drive incentives to reduce risk and thereby increase the agency cost of equity. We study this effect of inside debt by examining firms’ incentives to pursue diversifying acquisitions. We find that when the CEO-firm relative debt-to-equity ratio is greater than one, firms undertake value-destroying diversifying acquisitions that are anticipated to decrease overall firm volatility. Our findings are stronger for smaller firms. We further find that when the CEO-firm relative debt-to-equity ratio is greater than one, the merger pushes the ratio toward one which is consistent with the direction suggested by optimal contracting theory.

Keywords: diversifying acquisitions, inside debt, managerial incentives

JEL Classification: G31, G34, J33

Suggested Citation

Liu, Yixin and Mauer, David C. and Zhang, Yilei, Merger Decisions and Inside Debt (October 2, 2012). Available at SSRN: https://ssrn.com/abstract=2170895 or http://dx.doi.org/10.2139/ssrn.2170895

Yixin Liu

University of New Hampshire ( email )

Durham, NH 03824
United States
603-862-3357 (Phone)

David C. Mauer (Contact Author)

University of North Carolina (UNC) at Charlotte ( email )

9201 University City Boulevard
Charlotte, NC 28223
United States
704-687-7707 (Phone)

Yilei Zhang

University of North Carolina (UNC) at Charlotte ( email )

9201 University City Boulevard
Charlotte, NC 28223
United States

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