M&A Activity and the Capital Structure of Target Firms

CERGE-EI Working Paper Series No. 661

45 Pages Posted: 27 Oct 2020

See all articles by Mark J. Flannery

Mark J. Flannery

University of Florida - Department of Finance, Insurance and Real Estate

Jan Hanousek

Faculty of Business and Economics, Mendel University in Brno; Centre for Economic Policy Research (CEPR)

Anastasiya Shamshur

Charles University in Prague - CERGE-EI, a joint workplace of Charles University and the Economics Institute of the Czech Academy of Sciences

Jiri Tresl

Charles University in Prague - CERGE-EI, a joint workplace of Charles University and the Economics Institute of the Czech Academy of Sciences

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Date Written: July 1, 2020

Abstract

Using a large sample of European acquisitions, we find that acquired firms substantially close the gap between their actual and optimal leverage ratios. The bulk of this adjustment occurs quite rapidly – within a year of the acquisition. The typical over-levered firm adjusts its debt-to-assets ratio from 34.4% in the year before acquisition to 20% in the year after. (The adjustment is smaller, but still quite rapid, for targets that had been under-leveraged.) These adjustments occur primarily through debt issuances or retirements. We also investigate whether target firms’ pre-merger leverage contributes to the probability of them being acquired. We find that firms further away from their optimal leverage are more likely to be acquired: for an average firm, an increase in the absolute leverage deviation from 1% to 10% of total assets increases the probability of being acquired by 4.1% to 5.6% (The larger effect applies to overleveraged firms.) Overall, our results provide support for the trade-off theory of capital structure and suggest that financial synergies have a significant role in the typical European acquisition decision.

Keywords: M&A, target capital structure, leverage deficit

JEL Classification: G30, G32, G34

Suggested Citation

Flannery, Mark Jeffrey and Hanousek, Jan and Shamshur, Anastasiya and Tresl, Jiri, M&A Activity and the Capital Structure of Target Firms (July 1, 2020). CERGE-EI Working Paper Series No. 661, Available at SSRN: https://ssrn.com/abstract=3688545 or http://dx.doi.org/10.2139/ssrn.3688545

Mark Jeffrey Flannery (Contact Author)

University of Florida - Department of Finance, Insurance and Real Estate ( email )

P.O. Box 117168
Gainesville, FL 32611
United States
352-392-3184 (Phone)
352-392-0103 (Fax)

Jan Hanousek

Faculty of Business and Economics, Mendel University in Brno ( email )

Brno
Czech Republic

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Anastasiya Shamshur

Charles University in Prague - CERGE-EI, a joint workplace of Charles University and the Economics Institute of the Czech Academy of Sciences ( email )

Politickych veznu 7
Prague, 111 21
Czech Republic

HOME PAGE: http://www.cerge-ei.cz

Jiri Tresl

Charles University in Prague - CERGE-EI, a joint workplace of Charles University and the Economics Institute of the Czech Academy of Sciences ( email )

Politickych veznu 7
Prague, 111 21
Czech Republic

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