Evidence on the Association between Mergers and Capital Structure

Abstract

This article examines whether merger per se may be related to changes in the capital structure of the participating firms. The findings are consistent with the existence of merger-related incentives to increase financial leverage for a significant subset of merging firms. No evidence has been found that supports the latent debt capacity hypothesis. There is a strong relationship between merger accounting procedures (purchase vs. pooling) and relative increases in leverage accompanying mergers. This relationship reflects the potential for increased debt capacity and/or wealth shifting by the managements of acquiring firms. The terms of purchase of the acquired company were consistent with an immediate increase in leverage in the merging entities. Analysis of the year-by-year relative leverage positions of purchase merger firms indicates an immediate and persistent relative increase in financial leverage. Similar investigation of pooling accounting mergers detects no such systematic changes in leverage. Finally, analysis of the relationship between pre-merger cash flow correlation for merging firms and relative changes in leverage tend to support both the increased debt capacity theory and the coinsurance wealth transfer theory.