Conferences at Department of Economics, University of Toronto, RCEF 2012: Cities, Open Economies, and Public Policy

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Optimal Captial Structure and Growth Options in Mergers and Acquisitions

Elettra Agliardi, Amir Amel-Zadeh, Nicos Koussis

Last modified: 2012-06-27


We develop and empirically test a dynamic trade-off model for the analysis of the optimal capital structure in mergers and acquisitions. The model captures financial and operational synergies and accommodates growth options resulting from the merger. The model predicts that merging firms that have lower correlation of cash flows, have larger merger gains, reduce debt before the merger and increase leverage more significantly after the merger. We further find that mergers which result in a decrease in volatility and bankruptcy costs due to the merger, are more likely to reduce debt prior to acquisition and have higher increases in leverage after the merger. Moreover, the model predicts that positive changes in growth options of the merged firm relative to the growth options of the acquirer and target firms will monotonically enhance merger gains and that growth opportunities have a U-shaped relationship with leverage. Using a large sample of US acquisitions between 1980 and 2010 we provide evidence in support of the model. Our findings are consistent with a dynamic capital structure theory which endogenizes investment and capital structure decisions under the existence of growth opportunities

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