The impact of capital shocks on M & A transactions

This paper aims to examine whether an exogenous shock to the supply of financial capital mitigates agency conflicts between managers and shareholders and incentivizes managers to channel available financial resources into value-increasing acquisitions.

The authors use a difference-in-differences approach to mitigate endogeneity concerns. To address the concern that substantial differences between the treatment and control groups may violate the parallel-trend assumption of the D-in-D approach, the authors use a propensity score-matching procedure and construct a matched sample for their empirical analysis.

The authors find that below-investment-grade firms are significantly less likely to make acquisitions relative to unrated firms following the collapse of the junk bond market in 1989. Conditional on initiating a successful acquisition, below-investment-grade acquirers are less likely to acquire diversifying targets and public targets, but more likely to acquire subsidiary targets. In addition, below-investment-grade acquirers experience higher post-merger operating and stock performance for acquisitions initiated in the post-shock period.

The authors demonstrate that capital shocks negatively impact managers’ propensity to make acquisitions, which are considered a well-established outlet for agency conflicts between managers and shareholders. In addition, managers who are subject to capital shocks tend to manage available financial resources more efficiently and make better acquisition decisions that lead to greater value creation.