Debt Financing and Balance-Sheet Collateral: Evidence from Fair-Value Adjustments

Abstract

Using a novel hand-collected dataset of business combination disclosures, we investigate whether reported fair-value adjustments (FVAs) are associated with subsequent changes in the acquiring entity’s borrowing activity and debt contracting terms. FVAs represent the difference between the fair market value and the book value of a target’s net assets at the time of acquisition. We document that FVAs have a significant and positive impact on the balance sheet of the combined entity. Specifically, on average, reported FVAs on non-goodwill assets result in a 60 percent increase in the value of the target’s assets, and a 5.6 percent increase in the total assets of the acquirer. In multivariate analysis we find that FVAs are consistently associated with an increase in debt issuance in the post-deal period. Moreover, we find that this new debt is cheaper, more likely to be secured, has longer-term maturities, and tends to include more balance sheet covenants. Notably, the documented improvement in debt contracting terms is primarily attributable to FVAs on tangible assets, as opposed to intangible assets. Taken together, our findings suggest that fair value measurement of balance sheet assets provides lenders with important credit-relevant information about firms’ collateralizable assets.

Keywords: fair value adjustments, debt contracting, mergers & acquisitions, collateral

JEL Classification: M41, G32, G34, G12