Projected Operating Efficiencies, Credit Ratings and the Creation of Debt Capacity

Abstract

AbstractWe examine whether improved operating efficiencies increase borrowing levels for the acquiring firm and how they intervene with the debt rating level. The increase in leverage is positively related to the projected operating synergies. Our results show that for every dollar of forecasted synergy, the acquirer raises 22 cents of debt. Acquirers with high credit rating drive these results. Adding more debt while forecasting large synergies leads to improvement in debt rating for investment grade acquirers only. The positive market announcement return of high-synergy deals with large debt capacity supports the conjecture that the market views the improved debt capacity as value enhancing once bidders disclose larger synergy forecasts. Gains that can be explained by projected synergies predict the issuance of new debt—namely, a 1% synergy-induced merger gain leads to net debt issues of 0.925%.

Keywords: cost reductions, operating efficiencies, revenue enhancement, debt capacity, acquisitions