Explaining Acquirer Returns: Does Asset Tangibility and Financial Slack Play a Role?

Abstract

Acquirer fixed effects alone offer more explanatory power for the variation in takeover returns than an exhaustive list of deal and firm characteristics combined. The interquartile range of 5% between the 25th and 75th percentile acquirer fixed effect is comparable to the interquartile range of acquirer returns. This difference results in significant incremental value creation for shareholders of the acquiring firm. Exploiting serial acquirers and extracting the estimated acquirer fixed effect, this paper explores the economic factors behind this statistical concept. I find that the acquirer’s asset tangibility, or the level of tangible assets held by the firm, is negatively associated with the estimated acquirer fixed effect. This could signal that a higher level of borrowing capacity is vulnerable to similar agency concerns as Jensen’s (1986)“Free Cash Flow Hypothesis.” I use asset tangibility as a proxy for financial slack in the classification structure of Smith and Kim (1994) to analyze acquirer returns. This paper shows that Low-Collateral/High-Investment acquirers perform better on average than High-Collateral/Low-Investment, High-Collateral/High-Investment, and Low-Collateral/Low-Investment acquirers. This contradicts Myers and Majluf's (1984) theory suggesting that maintaining financial slack is beneficial for bidding firms. The modest increase in explanatory power when using the financial slack classifications as fixed effects suggest that certain firms are “better” acquirers irrespective of their financing constraints relative to investment opportunities and irrespective of established explanatory factors.