Why Do Distressed Firms Acquire?
59 Pages Posted: 31 May 2016 Last revised: 17 Jan 2018
Date Written: August 1, 2017
In recent years, acquisition made by distressed firms have become economically important. This paper explores the rationale behind such acquisitions using a natural experiment. Exploiting a recent tax change, which reduces debt restructuring costs for certain creditors and decreases bankruptcy risk, I identify the causal link between financial distress and acquisitions. Upon an exogenous reduction in the probability of bankruptcy, distressed firms react by cutting 41% of cash spending on acquisitions. Moreover, distressed firms refocus by decreasing 63% of the transaction value of diversifying acquisitions. The evidence supports the diversification hypothesis, which states that distressed firms acquire to diversify bankruptcy risk, rather than the growth opportunity hypothesis, which states that distressed firms acquire to capture external growth opportunities and revive growth. These findings indicate a new effect of financial distress on investment decisions, that is, pressure to meet debt obligations creates an incentive for firms to diversify via acquisitions.
Keywords: acquisitions, financial distress, bankruptcy, diversification, corporate investment
JEL Classification: G31, G33, G34
Suggested Citation: Suggested Citation