Signaling, Financial Slack and Corporate Acquisitions

Helen M Bowers, Norman H Moore and K S Maurice Tse

Review of Quantitative Finance and Accounting, 2000, vol. 15, issue 3, 195-216

Abstract: This paper shows that under certain conditions a firm's decision concerning the optimal medium of exchange to use in acquiring another firm is related to the decision of which source of capital should be used to finance long-term projects. An example of this type of interaction occurs when the firm's only source of financing a positive net present value project is an equity issue. In a Myers and Majluf (1984) world of asymmetric information the value maximizing strategy for the firm is to forego the public equity offering and instead use a stock offer to acquire a firm possessing financial slack. The process is modeled using an extension of the Myers and Majluf (1984) model and demonstrates how the acquisition alternative allows managers to separate the signals regarding the investment and financing decisions. Including net pension assets into our measure of financial slack, we provide empirical supports for the ability of the extended model to explain observed merger activity. Copyright 2000 by Kluwer Academic Publishers

Date: 2000
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