Financing and Takeovers

47 Pages Posted: 19 Jul 2006  

Erwan Morellec

Ecole Polytechnique Fédérale de Lausanne; Swiss Finance Institute

Alexei Zhdanov

Pennsylvania State University

Date Written: October 2006


This paper analyzes the interaction between financial leverage and takeover activity. We develop a dynamic model of takeovers in which the financing strategies of bidding firms and the timing and terms of takeovers are jointly determined. In the paper, capital structure plays the role of a commitment device, and determines the outcome of the acquisition contest. We demonstrate that there exists an asymmetric equilibrium in financing policies with endogenous leverage, bankruptcy, and takeover terms, in which the bidder with the lowest leverage wins the takeover contest. Based on the resulting equilibrium, the model generates a number of new predictions. In particular, the model predicts that the leverage of the winning bidder is below the industry average and that acquirers should lever up after the takeover consummation. The model also relates the dispersion in leverage ratios to various industry characteristics, such as the volatility of cash flows, effective tax rates, and bankruptcy costs.

Keywords: takeovers, option games, real options, capital structure

JEL Classification: G13, G32, G34

Suggested Citation

Morellec, Erwan and Zhdanov, Alexei, Financing and Takeovers (October 2006). Swiss Finance Institute Research Paper No. 06-22. Available at SSRN: or

Erwan Morellec (Contact Author)

Ecole Polytechnique Fédérale de Lausanne ( email )

College of Management
Extranef Quartier UNIL-Dorigny
1015 Lausanne, CH-1015


Swiss Finance Institute

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4

Alexei Zhdanov

Pennsylvania State University ( email )

University Park
State College, PA 16802
United States


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