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Title: M&A Activity and the Capital Structure of Target Firms

Author(s): Mark Flannery, Jan Hanousek, Anastasiya Shamshur and Jiri Tresl

Publication Date: June 2020

Keyword(s): leverage deficit, M&A and target capital structure

Programme Area(s): Financial Economics

Abstract: Using a large sample of European acquisitions, we find that acquired firms substantially close the gap between their actual and optimal leverage ratios. The bulk of this adjustment occurs quite rapidly â?? within a year of the acquisition. The typical over-levered firm adjusts its debt-to-assets ratio from 34.4% in the year before acquisition to 20% in the year after. (The adjustment is smaller, but still quite rapid, for targets that had been under-leveraged.) These adjustments occur primarily through debt issuances or retirements. We also investigate whether target firms' pre-merger leverage contributes to the probability of them being acquired. We find that firms further away from their optimal leverage are more likely to be acquired: for an average firm, an increase in the absolute leverage deviation from 1% to 10% of total assets increases the probability of being acquired by 4.1% to 5.6% (The larger effect applies to over-leveraged firms.) Overall, our results provide support for the trade-off theory of capital structure and suggest that financial synergies have a significant role in the typical European acquisition decision.

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Bibliographic Reference

Flannery, M, Hanousek, J, Shamshur, A and Tresl, J. 2020. 'M&A Activity and the Capital Structure of Target Firms'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=14911