Do Capital Structure Adjustments by Takeover Targets Influence Acquisition Gains?

Published date01 May 2017
Date01 May 2017
The Financial Review 52 (2017) 171–198
Do Capital Structure Adjustments
by Takeover Targets Influence
Acquisition Gains?
Tomas Jandik
University of Arkansas
Justin Lallemand
University of Denver
We link debt issuances by target companies around takeover announcements to en-
hanced target bargaining power in negotiations with bidders over merger synergy gains in
completed takeovers. Announcements of debt issuances by targets—especially new bank
loans—are associated with more positive target equity returns relative to those made by
nontargets, particularly for debt issuances immediately surrounding the takeover announce-
ment. At least some of these gains to targets come at the expense of bidder shareholders,
as bidder equity abnormal returns at target debt issuance are negative. We further show
that targets issuing debt are primarily those with relatively low acquisition abnormal re-
turns, consistent with initially poor target bargaining power. Subsequent debt issuances by
targets increase the likelihood of positive adjustments to acquisition premiums offered by
Corresponding author: Daniels College of Business, University of Denver, 2101 S. University Blvd.,
Denver,CO 80210; Phone: (303) 871-4402; E-mail:
We would like to thank an anonymous referee and Srinivasan Krishnamurthy (Editor) for their helpful
comments and suggestions that greatly improved the paper. We also thank Kathy Fogel, Paul Irvine,
Swami Kalpathy, Wayne Lee, Antonio Macias, Alexey Malakhov, Vassil Mihov, Sebastian Reinartz,
Craig Rennie, Thomas Shohfi, Tim Yeager, as well as seminar participants at Texas Christian University,
University of Arkansas, University of Denver, the 2015 Financial Management Association conference,
the 2013 Financial Management Association European conference, and the 2013 European Financial
Management Association conference. All remaining errors are our own.
C2017 The Eastern Finance Association 171
172 T. Jandik and J.Lallemand/ The FinancialReview 52 (2017) 171–198
Keywords: debt issuance, mergers and acquisition gains, bank debt
JEL Classifications: G32, G34
1. Introduction
Financial literature has linked capital structure decisions to merger and acqui-
sition (M&A) events. Higher debt levels maintained by potential takeover targets
are associated with lower takeover likelihood (Palepu, 1986; Billett, 1996; Billett
and Xue, 2007). For targets subjected to takeover attempts, Stulz (1988), Harris and
Raviv (1988) and Israel (1991) argue that by increasing debt, target managers can
retire shares held by investors with the lowest reservation values, while simultane-
ously increasing managerial equity stakes, and thus, managerial bargaining power.
Together, these theoretical models predict target company debt levels to increase in
anticipation of, and in response to, takeover attempts. Given that leverage increases
by targets enhance managerial bargaining power, these increases should result in
higher returns to target shareholders as improved bargaining power allows the target
to renegotiate for a greater share of merger synergy gains, coming at the expense
of bidder shareholders. Consequently, debt issues should be primarily undertaken by
targets with weak ex ante bargaining power.1
Although the theoretical models by Stulz (1988), Harris and Raviv (1988) and
Israel (1991) were developed a number of years ago, there exists only limited empir-
ical evidence of the influence of target company leverage on outcomes of completed
acquisition events. Billett and Ryngaert (1997) find that higher leverage levels are
associated with enhanced equity gains to targets. However, the authors link this ob-
servation to a purely mechanical premium leveraging effect, as opposed to enhanced
bargaining power,showing that for more highly levered targets, a set amount of acqui-
sition gains allocated to the target is divided over fewerremaining shares. We control
for this potential leveraging effect in our analyses, but instead focus on the role of
bargaining power shifts resulting from debt adjustments in merger negotiations.
Based on the analysis of 3,555 targets of successful takeover attempts from 1991
through 2010, we find results consistent with the redistribution of anticipated merger
1In addition to the concentration of equity ownership through recapitalization, targets may also benefit
from the signaling effect associated with new debt issuance. Corporations issuing debt have been found
to realize positive abnormal equity returns around the announcement of new debt (e.g., Mikkelson and
Partch, 1986), especially when new debt is provided by banks (James, 1987; Lummer and McConnell,
1989; Billett, Flannery and Garfinkel, 1995). Debt issuance announcements provide a positivesignal about
the quality of the issuer’s assets (Myers and Majluf, 1984) and about the willingness of external investors
to commit resources to the company. The signal of higher asset quality may enable targets to demand a
higher acquisition premium as financial literature generally associates higher relative target values with
larger target gains. Furthermore, the signaling of higher asset quality has the potential to attract additional
bidders. Both of these channels should be associated with greater takeover premiums accruing to the target.

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