Why Do Distressed Firms Acquire?

59 Pages Posted: 31 May 2016 Last revised: 17 Jan 2018

See all articles by Eden Quxian Zhang

Eden Quxian Zhang

Monash University; Erasmus University Rotterdam (EUR) - Rotterdam School of Management (RSM)

Date Written: August 1, 2017

Abstract

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

Zhang, Eden Quxian, Why Do Distressed Firms Acquire? (August 1, 2017). Paris December 2016 Finance Meeting EUROFIDAI - AFFI, Asian Finance Association (AsianFA) 2018 Conference, Available at SSRN: https://ssrn.com/abstract=2786721 or http://dx.doi.org/10.2139/ssrn.2786721

Eden Quxian Zhang (Contact Author)

Monash University ( email )

900 Dandenong Rd
Caulfield East, Victoria 3145
Australia

Erasmus University Rotterdam (EUR) - Rotterdam School of Management (RSM)

Rotterdam
Netherlands

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