Jurnal Temu 5 Asing

Larger Return to Cash Acquisitions: Signaling Effect or Leverage Effect?
Author(s): KenC. Yook

Source: The Journal of Business, Vol. 76, No. 3 (July 2003), pp. 477-498
Published by: The University of Chicago Press
Stable URL: http://www.jstor.org/stable/10.1086/375255
Accessed: 12-10-2016 06:41 UTC
JSTOR is a not-for-profit service that helps scholars, researchers, and students discover, use, and build upon a wide range of content in a trusted
digital archive. We use information technology and tools to increase productivity and facilitate new forms of scholarship. For more information about
JSTOR, please contact support@jstor.org.
Your use of the JSTOR archive indicates your acceptance of the Terms & Conditions of Use, available at
http://about.jstor.org/terms
The University of Chicago Press is collaborating with JSTOR to digitize, preserve and extend access to
The Journal of Business
This content downloaded from 110.136.229.25 on Wed, 12 Oct 2016 06:41:30 UTC
All use subject to http://about.jstor.org/terms
Ken C. Yook
Johns Hopkins University
Larger Return to Cash Acquisitions:

Signaling Effect or Leverage
Effect?*
I. Introduction This article investigates

the signaling theory and
Previous research examining the role of the method the benefit of debt theory
of payment in explaining announcement returns to bid- to explain higher returns
for bidders offering cash
ding firms in acquisitions finds significant differences rather than stock, using
between cash and stock transactions. Wansley, Lane, Standard and Poors debt
and Yang (1983, 1987), Asquith, Bruner, and Mullins rating reviews and
(1987), Travlos (1987), Franks, Harris, and Mayer changes. Results imply
that cash acquisitions and
(1988), and Brown and Ryngaert (1991) report that stock acquisitions have
returns to bidders tend to be negative and significant different sources of value
in stock acquisitions and slightly positive though not creation. Benefit of debt
significant in cash acquisitions. This empirical evi- seems to be the main
dence of larger returns in cash offers when compared source of value in cash
acquisitions, whereas the
to stock exchange offers implies that choice of synergy effect outweighs
exchange medium has economic significance. the leverage effect in
Several arguments have been advanced to account stock takeovers. Although
for this phenomenon. Since the exchange of stock as stock appears to be used
for the most unsuccessful
payment for an acquisition is a type of new common acquisitions, this study
stock offering and cash payment is likely financed by does not find convincing
new issuance of debt, most of the arguments link dif- evidence that cash is
ferent payment methods in acquisitions to different used for good
types of new security offerings. The pattern of stock acquisitions.
market response in similar fashionhigher returns to
announcements of debt issues as opposed to equity
issuesalso supports the assumed relationship.
Although consensus on the cause of this systematic
empirical pattern is lacking, most of the above em-
* I would like to thank William Hudson for providing the Stan-

dard and Poors Credit Week data.
(Journal of Business, 2003, vol. 76, no. 3)

2003 by The University of Chicago. All rights reserved.
0021-9398/2003/7603-0005$10.00
477
478 Journal of Business
pirical studies interpret their finding as supporting two arguments. One ar-
gument is based on the premise that the market and management do not share
the same information set and that the resulting information asymmetry affects
the choice of exchange medium. In the presence of information asymmetry,
managements choice of financing conveys information about the firms true
value to the market. Market participants interpret a stock-financed (cash-fi-
nanced) acquisition as a negative (positive) signal of the value of the acquiring
firm.
Another argument is based on the premise that share-price effects of capital
structure changes co-vary positively with leverage change. Reduction in
agency costs of equity brought about by the disciplinary role of debt is cited
most often to explain this relationship. Although other potential benefits of
debt financing, such as tax benefit and wealth transfer effect, have been ex-
amined previously, they have not received much empirical support.1
Without being able to offer convincing empirical verification, previous stud-
ies assert that these two effects, signaling and leverage change, are at work
in stock market reaction. Although these arguments are theoretically sound,
research has yet to provide conclusive answers to the question of whether
these two effects can explain the wealth effect phenomenon. One major chal-
lenge in testing these theories is finding appropriate proxies, particularly for
signaling effect, that can be readily observed.
To overcome this challenge, this study proposes a new empirical approach
directed at jointly assessing the two hypotheses on sources of wealth effect
by using Standard and Poors debt rating changes to measure signaling and
leverage change effects. When an acquisition is deemed to cause a significant
change in the combined entitys future cash flows and/or financial leverage,
rating agencies alter the acquisition participating firms debt rating. When a
firms debt rating is being reviewed or changed, the agencies provide a short
comment to justify the action. Specifically, the comment reveals whether the
rating reviews and changes are caused by a significant change in financial
risk or by a change in expected operating performance induced by the ac-
quisition. Using Standard and Poors debt rating changes and comments, this
1. Probably the most prevalent early explanation is that it is driven by the tax code: cash-
payment acquisitions qualified for a stepped-up basis, and noncash payment acquisitions received
the benefits of tax loss and credit carryforward. However, empirical studies have failed to support
this. Although difficulties in accurately measuring the actual tax gains are commonly cited as
the reason, Gilson, Scholes, and Wolfson (1988) show that there is no direct linkage between
tax benefits and payment mode. Another widely examined explanation is the coinsurance effect
and/or latent debt capacity (Lewellen 1971). Bidding firms shareholders benefit from postac-
quisition leverage increases because they minimize wealth transfers to bondholders (Higgins and
Schall 1975; Galai and Masulis 1976; Kim and McConnell 1977; Asquith and Kim 1982).
However, studies find inconclusive evidence that acquisitions cause any type of wealth transfer
between shareholders and bondholders. Kim and McConnell (1977), Asquith and Kim (1982),
and Dennis and McConnell (1986) find no statistically significant wealth transfer from share-
holders to debtholders. On the other hand, Egar (1983) and Settle, Petry, and Hsia (1984) find
that the wealth of bondholders is affected positively by mergers, which implies synergies to
bondholders and/or diversification effect.
Returns to Cash Acquisitions 479
investigation provides new insight into the two long-standing theories in cor-
porate finance: signaling theory and benefit of debt theory.2
The present article is organized as follows. Section II reviews the two
theories that explain market reaction to the choice of payment method. The
empirical design of this study is described in Section III. The sample and data
collection process are explained in Section IV, and Section V presents em-
pirical results. Concluding remarks are provided in Section VI.
II. Sources of Wealth Effect

Acquisitions involve two primary effects: the effect of capital investments,
which may or may not be positive, and the effect of financing. As studies
consistently find that announcement returns to bidding firms making cash
offers are higher than those making stock offers, two schools of thought seek
to explain this phenomenon based on these two effects. The first school of
thought is that cash is likely to be used for positive net present value (NPV)
acquisitions, while the second school of thought is that paying out funds
(instead of using themperhaps wastefullyelsewhere) or issuing debt ben-
efits shareholders. These two theories are reviewed below.
A. The Signaling Theory

Under the assumption that financial markets are not fully efficient, and es-
pecially when there is an information asymmetry between management and
the market, it is possible that managers may choose to use financial policy
decisions to convey positive information to the market. Changes in capital
structure are an obvious candidate for a credible signaling device. While
corporate managers are more likely to issue securities when the market price
of the firms assets in place is higher than managements assessment of their
value, managers will prefer to utilize internally generated funds to finance
investments if they perceive these assets to be undervalued. When external
financing is required, the Myers-Majluf (1984) model contends that debt will
be issued in preference to equity, thereby developing the pecking order hy-
pothesis. A stock issue, which is less favorable to existing stockholders than
debt, signals to the markets that the firms assets in place are overvalued, and
in turn this signal drives down the share price.
The role of asymmetric information in the choice of the method of payment
in the takeover market has been studied theoretically by Hansen (1987), Fish-
man (1989), Berkovitch and Narayanan (1990), Eckbo, Giammarino, and
Heinkel (1990), and Brown and Ryngaert (1991). Each of these studies de-
velops a signaling equilibrium model in which the method of payment conveys
information concerning the value of the bidder to the market. All these models
predict that bidders obtain higher returns when an acquisition is financed with
2. The benefit of debt theory can be labeled differently, as, e.g., discipline of debt theory,
free cash flow theory, or debt monitoring theory.
cash rather than stock, because a bidder with private information about the
value of its assets offers stock only when its shares are overvalued. Although
the pattern of announcement returns casually conforms to this prediction, we
do not have convincing evidence to rule that the signaling effect is the main
source of the wealth effect.
The information disparity between management and outside investors in
the corporate takeover market should be more complex than the one existing
in the new security offering market. Unlike the new security offering market
where private information mainly stems from the value of the issuers assets
in place, the value of the combined entitys assets (i.e., value of the acquisition)
should be the main source of information asymmetry in the takeover market.
Bidders almost always allege that the creation of an enhanced combined effect
is the driving motive for their acquisition attempts and that the acquisition
creates value for shareholders. However, as the potential synergy is not readily
measurable by outside investors, an acquisition creates profound uncertainty
about the prospect of the combined entitys postacquisition operating per-
formance and confusion for outside investors concerning how to value the
acquisition attempt. Therefore, it is more logical to assume that the information
asymmetry in the takeover market stems primarily from synergy of the ac-
quisition and valuation of the combined entity rather than the bidders assets
in place.
Although method of payment is likely to affect share value of participating
firms, it should not be the sole consideration in an acquisition decision. Eco-
nomic considerations should first determine whether a particular firm should
be acquired, then subsequently the financing method should be determined.
Because managers presumably have a better understanding of the impact of
the acquisition on their firms products, markets, strategies, and investment
opportunities, I argue that managers convey inside information about the
synergy to markets via the choice of payment method, regardless of whether
or not it is their intent. In short, bidders are expected to pay cash (stock) if
they feel their assessment of the synergy is higher (lower) than what the
market will assess when the acquisition is announced. Payment method in
acquisitions conveys the bidders assessment of the true value of the combined
entitys assets, coupled with the bidders assessment about the true value of
assets in place.3
3. Economic rationales that have traditionally been suggested to explain synergism include
economies of scale (Jarrell and Bradley 1980), increased monopoly power (Eckbo 1983; Stillman
1983), and product diversification and utilization of excess capacity (Dodd and Ruback 1977).
Lately, two additional theories have emerged. One is that value is created when financial slack-
rich acquiring firms take additional positive-NPV investment that slack-poor target firms might
pass up. Bruner (1988) finds that acquiring firms had significantly more unused debt capacity
before acquisitions, but targets are significantly more levered than a control sample. Bruner also
shows that bidder shareholder returns vary positively and significantly with increase in leverage,
which is consistent with the hypothesis. Another source of value creation is based on the theory
that acquiring firms want to obtain control of target firms assets to replace inefficient management
or to force incumbent management to take up efficient policies as proposed by Morck, Shleifer,
and Vishny (1988) and Martin and McConnell (1991). The spread between the targets current
B. The Benefit of Debt Theory

A fundamental difference between stock and cash acquisitions is that in cash
acquisitions, bidders pay out funds and, in the process, either issue debt, thus
binding themselves to pay out future cash flows, or use up hoarded liquidity.
The increase in leverage (payout of funds) is used to explain higher returns
to cash acquisitions. High leverage not only makes managers work harder
because of the threat of bankruptcy but also mitigates the agency costs of
free cash flow by reducing the cash flow available for spending at the discretion
of managers.
A group of researchers led by Jensen (1986, 1988), Harris and Raviv (1990),
and Stulz (1990) developed a new rationale for borrowing, that is, the benefits
of debt in reducing agency problems and in monitoring managers efficiency.
It is well documented that free cash flow must be paid out to shareholders if
the firm is to be efficient and able to maximize value for shareholders. How-
ever, a conflict between managements best interests and those of the firms
shareholders may deter paying out the free cash flow to shareholders. When
managers begin worrying that their company has too much liquidity and a
lack of good investment projects, an easy response is to attempt overinvest-
ment, such as acquiring other firms, often in a different line of business.
However, the efficient market makes the firms bear the agency costs by paying
less for the firms securities. One device to reduce agency costs caused by
manager-oriented, value-destroying takeovers is to use cash financed with debt
issuance as payment in acquisitions. Debt creation enables managers, in effect,
to bond their promise to pay out future cash flows. The necessity of making
legally binding periodic payments to bondholders forces managers interests
to be more aligned with the interests of shareholders.4
To test this theory, Maloney, McCormick, and Mitchell (1993) examine the
relation between announcement-period returns to acquiring firms and their
preacquisition level of leverage as well as the postacquisition leverage changes.
Finding that acquirers returns vary positively and significantly with preex-
isting level of leverage and also change in leverage, Maloney, McCormick,
and Mitchell conclude that debt improves managerial decision making.
A caveat in relating leverage changes of the bidder to announcement returns
is the coinsurance of debt and/or latent debt capacity (Lewellen 1971), re-
sulting from creditors receiving better protection for their debt from the com-
bined entity than from the individual firms before the acquisition. This en-
hanced protection may be derived from both the earnings cover and asset
market value depressed by the inefficient management and its intrinsic value (or breakup value)
represents the potential profit to the acquiring firm. Martin and McConnell (1991) document that
turnover rate for the top managers of target firms in tender offers significantly increases following
completion of the acquisition and that these target firms were significantly underperforming
industry prior to the acquisition.
4. In addition, as Shleifer and Vishny (1986) argue, in mature industries with limited capital
requirements, heavy debt refinancing has the added benefit of facilitating the concentration of
equity ownership. Concentration of equity ownership in turn either allows for more effective
monitoring of managerial performance by active investors or facilitates takeovers.
cover for the debt obligations. If operating performance is improved and/or

the earnings streams of the two companies are less than perfectly positively
correlated, the consequent increase in earnings and/or reduction in the vari-
ability of such earnings may enable their debt interest obligations to be more
easily met, thereby reducing the risk of default of the combined firm. This
effectively increases the combined firms debt capacity. Therefore, the strength
of synergy and diversification effect and their impact on debt capacity should
be controlled to test the benefit of debt argument accurately.
III. Empirical Design

To test these two theories empirically, Standard and Poors debt rating reviews/
changes triggered by acquisitions are used in this study to measure the strength
of synergy and leverage change. Debt rating reviews/changes and accompa-
nying comments provide two key pieces of information for this study. First,
the comments reveal specifically whether the rating change is caused by change
in financial risk or by change in expected operating performance induced by
the acquisition. Second, the rating decision reveals the new rating and the
number of grades of change, indicating the strength of the effect.
The use of debt rating agencys rating action as a proxy to measure the
announced acquisitions synergy and leverage change effects requires the
assumption that the rating agency either knows or can correctly predict the
size of synergy and leverage change at the announcement of acquisitions.
Whether rating agencies are able to gauge quickly and correctly the economic
impact of highly complex and typically unconsummated acquisitions is an
empirical issue. Whether major debt rating changes bring any new information
not publicly available from other sources to the market, or whether they are
simply summarizing existing information, is still a controversial issue. Debt
rating agencies claim that they have access to inside or privileged information
and that such information on the quality of the firms debt is revealed to the
public through rating actions. To test the information content of rating changes,
studies examine how the market reacts to the announcement of rating changes.
If rating agencies possess superior information regarding a firms financial
condition, rating actions should induce a market response: debt rating change
should affect the wealth of stockholders as well as creditors.
Many studies find significant stock market response to rating changes. Grif-
fin and Sanvicente (1982), Holthausen and Leftwich (1986), Ederington, Ya-
witz, and Roberts (1987), Hsueh and Kidwell (1988), and Hand, Holthausen,
and Leftwich (1992), among others, consistently find that stock prices react
negatively to bond rating downgrades, while upgrades produce statistically
insignificant price response. They conclude that only downgrades convey
significant new information to the market.
One problem with using the rating change as a source of inside or privileged
information is that the actual rating change is preceded by the announcement
of an acquisition with a substantial time lag because the rating agency renders
rating decisions after the acquisition is consummated. It takes typically a
couple of months, but sometimes it takes a longer time period, particularly
in cases of hostile tender offers and contested bids. This time lag implies that
a debt rating change is not necessarily information that is new to the market.
To solve this problem, Standard and Poors Credit Watch is supplemented
for sample collection.5 Credit Watch placements disseminate information to
markets that is timely because Credit Watch placements typically occur im-
mediately after trigger events. Therefore, Credit Watch placements and sub-
sequent rating changes are viewed as reliable foresight proxies for the markets
view of the effects of acquisition on the financial risk of firms involved.
As mentioned above, two primary effects work in cash acquisitions: the
effect of capital investment and the financing effect. If cash is used in high
value-creating acquisitions, the synergy effect lessens the firms financial risk
and increases the value of equity and debt alike. On the other hand, leverage
increase due to cash payment has a definite negative impact on financial risk.
If the synergy effect supersedes the leverage effect, there is an upgrade in
rating. If both effects offset one another completely, there is no change in
rating. A downgrade will result if the leverage effect dominates the synergy
effect.
As illustrated below, Standard and Poors comments support this argument.
For downgrades, Standard and Poors either simply mentions increased fi-
nancial risk due to acquisition-related debt financing or explains that deteri-
oration of financial risk more than offsets potential synergy. The following
two cases illustrate the simple mention of increased financial risk.
After American Stores Co.s tender offer to acquire Lucky Store Inc. in
1988, Standard and Poors lowered American Stores senior debt rating from
A to BBB and commented as follows: Financial risk will increase
sharply as a result of Salt Lake City, Utah based American Stores $2.5 billion
acquisition of Luck Stores Inc (Standard and Poors Credit Week, March 28,
1988).
Following Emerson Electric Co.s agreement to purchase Fischer Controls
International Inc, a unit of Monsanto Co, for $1.275 billion in 1992, the
bidders debt was downgraded from AAA to AAA. Standard and Poors
commented: The downgrades reflect a somewhat more aggressive financial
5. In 1981, Standard and Poors began weekly publication of Credit Watch, in which corporate
and municipal debt ratings are discussed. Standard and Poors Credit Watch provides a list of
firms for which Standard and Poors had initiated a credit review during the week and indicates
whether the review has a positive, negative, or developing implication. Credit Watch placements
provide markets with more timely information for a likely future debt rating change. If Standard
and Poors believes that an acquisition is likely to cause a change in the default risk of the
outstanding debt, bidding firms and/or target firms will be added to Credit Watch. The placement
is followed by a rating decision, at which time the firm is removed from Credit Watch. The
subsequent rating decision can be to either affirm, upgrade, downgrade the debt rating, or to
withdraw the debt rating altogether.
policy than previously anticipated, as evidenced by the increased level of debt

usage following the just completed $1.275 billion Fisher Controls International
acquisition (Standard and Poors Credit Week, August 10, 1992).
The following three cases illustrate the situation in which a downgrade
occurred because increased leverage effect more than offset the synergy arising
from acquisitions.
Following Avnets acquisition of Hall-Mark Electronics Corp. for $345
million in 1993, Avnets debt was downgraded from A to A. Standard
and Poors comments were as follows: Although Avnet Incs merger with
Hall-Mark Electronics Corp. enhances Avnets business profile, with the po-
tential for improving operating efficiencies and earnings, this is more than
offset by the financial impact of the acquisition (Standard and Poors Credit
Week, April 26, 1993).
After Loral Corp.s acquisition of Goodyear Aerospace Corp. for $640
million in 1987, Lorals subordinated debt was downgraded from A to
BBB. Standard and Poors commented: The acquisition of Goodyear Aer-
ospace Corp. enhances Lorals competitive position in the defense electronics
industry by broadening its technology and program base. However, most
measures of financial risk deteriorate significantly (Standard and Poors
Credit Week, January 19, 1987).
In the wake of Beatrice Foods Co.s $2.7 billion offer to Esmark Inc., plus
the assumption of over $1 billion of Esmarks debt in 1984, Standard and
Poors lowered Beatrice Foods Co.s senior debt rating from AA to A and
commented: The rating actions reflect the significant increase in financial
risk which more than offsets the potential for operating synergies arising from
the acquisition of Esmark (Standard and Poors Credit Week, May 28, 1984).
For cases in which rating agencies deem that increased financial risk and
synergism offset each other completely, the rating will not be altered. This
can be confirmed in cases where Standard and Poors places a bidding firm
on its Credit Watch immediately following the acquisition announcement with
a negative implication but later decides to leave the rating unchanged. The
following two cases support this phenomenon.
Immediately following Knight-Ridder Newspapers Inc.s 1986 agreement
to acquire State-Record Co., a newspaper publisher based in Columbia, South
Carolina, the bidder was placed on Credit Watch with a negative implication,
but later its debt rating was left unchanged. Standard and Poors justified this
decision with the following comments: Although Knight-Ridder Newspapers
purchase of the State Record Co. for over $300 million is expected to increase
debt leverage to the mid-40% range from 34% reported on September 30, the
companys well-positioned newspaper businesses are expected to generate
strong and stable cash flows (Standard and Poors Credit Week, November
3, 1986).
Following Textron Inc.s agreement to acquire Cessna Aircraft Co. in 1992,
Textron was placed on Credit Watch with a negative implication, but later its
rating was affirmed. Standard and Poors reason was stated as follows: While
the proposed acquisition of Cessna Aircraft for $600 million reduces financial
liquidity in the near term, anticipated good profitability and cash flow at both
companies should restore the balance sheet in the intermediate term (Standard
and Poors Credit Week, January 27, 1992).
Based on the bond rating reviews/changes triggered by acquisitions, bidders
in cash acquisitions are divided into three subsamples: (1) upgraded, (2) un-
changed, and (3) downgraded groups. Two hypotheses, the signaling hypoth-
esis and the benefit of debt hypothesis, are investigated by comparing abnormal
returns among these three groups at the announcement of acquisitions. Sig-
naling theory implies that the order of magnitude of abnormal returns would
be upgraded group (largest), unchanged group, and downgraded group (small-
est). On the other hand, the benefit of debt theory predicts abnormal returns
in the reverse order: downgraded group, unchanged group, and upgraded
group.
IV. Sample
Sample firms are selected by examining the Compustat Industrial Research
File for all delistings caused by acquisitions during the period 198596. All
delistings are confirmed in the Wall Street Journal Index. Other criteria used
for selection of data are as follows:
1. The medium of payment is cash (nonconvertible debt is considered
cash payment) or stock (common or preferred stock), known at the
time of announcement.
2. Bidding firms are contained in the CRSP files for the time period during
the event date and the estimation period.
3. No major contaminating corporate events announced for the 15 days
surrounding the announcement day.
4. Target is no less than one-tenth the size of the bidder before the
announcement.6
In cases where several acquisitions were made by the same bidder, the
bidder is counted separately for each acquisition made. But the sample includes
only cases where no other acquisition has occurred in the preceding year.
Method of payment is identified from the Wall Street Journal and the Mer-
gerstat Review. The event date is taken as the earlier announcement of the
acquisition in the Wall Street Journal, Mergerstat Review, or the news service
wire report in the LexisNexis Academic database. Application of the above
data requirements results in a final sample of 311 acquisitions, 199 cash
acquisitions, and 112 stock acquisitions.
Next, Standard and Poors Credit Watch is used to find whether a bidding
firm was on the list and whether Standard and Poors specifically mentioned
6. The target firm ought to be big enough to influence the combined firms capital structure.
One-tenth is a compromise between the desires to minimize noise and to have a larger sample.
TABLE 1 Sample Summary

Credit Watch
Implication Subsequent Rating Change
Payment Method Positive Negative Upgrade Affirm Downgrade
Cash 3 88 0 21 69
Stock 24 25 20 10 19
Note.This studys samples are classified according to their implication on the Credit Watch list and
subsequent rating changes. 311 acquisitions are identified during the period 198596. 199 acquisitions were
paid in cash, and the remaining 112 acquisitions were paid in stock. Bidding firms may be added to Credit
Watch when Standard and Poors believes that an acquisition bid is likely to change the rating of outstanding
debt. Implications are designated as negative, positive, or developing. Among 199 cash acquisitions, 88 bidding
firms were listed with negative implications, and three firms with positive implications. 69 bidding firms listed
with negative implications were subsequently downgraded, while the rest of them were affirmed. All bidding
firms listed with positive implications were affirmed. Among 112 stock acquisitions, 25 bidders were listed
with positive implications, and 20 of them were upgraded, while 19 firms out of 25 firms placed with negative
implications were downgraded. The remaining 10 firms were affirmed.
that the placement was caused by the acquisition. When a firm is placed on
Credit Watch, Standard and Poors devotes a paragraph describing the reason
of the placement, a list of debt issues being placed on Credit Watch, and the
implication of the placement, that is, positive, negative, or developing. Only
negative or positive cases are selected, because of the ambiguous nature of a
developing implication. A little less than a half of the 199 cash bidders were
placed on Credit Watch, with 88 negative implications and three positive
implications. In stock acquisitions, 49 bidders were placed on Credit Watch,
with 24 positive implications and 25 negative implications.
After evaluating the credit quality of the firms issues, Standard and Poors
releases a removal notice stating the revised ratings and justifications for the
rating decision. Standard and Poors renders uniform decisions in most cases,
but it also renders a small number of split rating decisions. In a uniform rating
action, all issues of a firms debt are either downgraded, upgraded, affirmed
(left unchanged), or withdrawn altogether. In a split ratings action, different
rating decisions are rendered for different issues of the same debt concurrently.
Typical split rating decisions include upgrade for some issues and affirmation
for other issues, downgrade and affirmation, upgrade and withdrawal, down-
grade and withdrawal, and withdrawal and affirmation. If any issue is down-
graded (upgraded), the bidder is included in the downgraded (upgraded) group.
Table 1 summarizes the sample. Among 88 cash bidding firms listed with
negative implications, 69 firms were subsequently downgraded while the rest
of them were affirmed. All bidding firms listed with positive implications
were affirmed, which indicates that there is no cash bidder whose debt rating
was upgraded in this sample. Among 24 stock bidding firms listed with positive
implications, 20 firms were upgraded, while 19 firms out of 25 firms placed
with negative implications were downgraded. The remaining 10 firms ratings
were affirmed.
Abnormal stock returns and other statistics are calculated using standard
event study methodology developed by Brown and Warner (1985). In applying
this method, market model parameters are calculated using an ordinary least-
TABLE 2 Two-Day (t p 1 to 0) Cumulative Median Abnormal Returns for

Cash Bidders
N CAR % Z-score % Positive
Returns for all cash bidders:
All bidders 199 .71 .81 35.9
Returns for cash bidders classified
by debt rating change:
Downgraded group 69 .09 .12 43.1
Unchanged group 108 1.21 1.45 29.8
Note.Abnormal stock returns and other statistics were calculated using standard event study methodology.
The 7-day cumulative median abnormal returns (CAR) are measured from day 1 to 0. The event date is
taken as the earliest announcement of the acquisition in the Wall Street Journal, Mergerstat Review, or the
news service wire report in the LexisNexis Academic database. The Wilcoxon sign-ranked test is used for the
percent positive. The downgraded group includes bidding firms whose debts were downgraded due to the
acquisition. The unchanged group includes bidding firms that were not listed in Credit Watch. The bidding
firms that were listed on Credit Watch with either positive implications or negative implications that were later
affirmed are excluded in this analysis. Standard and Poors Stock and Bond Guide and Credit Week are used
for the rating change data. The Wilcoxon sign-ranked test is used for the percent positive.
squares regression of each firms returns on the CRSP value-weighted index

over the 225-day interval beginning on day 301 and ending 46 trading days
prior to the event date. Two-day (t p 1 to 0) cumulative abnormal returns
are used to measure the announcement effect.
V. Empirical Results
A. Cash Acquisitions
First, the impact of acquisitions on the wealth of cash offering firms share-
holders is examined. Table 2 presents 2-day (t p 1 to 0) cumulative median
abnormal returns, the Z-scores, and percent positive at the announcement of
the acquisition. All cash bidders experience negative returns of .71%, which
is not significant (Z p .81). This is similar to the results reported by other
studies, for example, Travlos (1987) reports 2-day (t p 1 to 0) abnormal
returns of .50%.
Where cash bidders are divided into two subsamples depending on whether
the bidders debt rating was downgraded or unchanged,7 abnormal return to
bidders in the unchanged group is significantly negative; the 2-day announce-
ment-period cumulative median abnormal return is 1.21%. The correspond-
ing return to downgraded bidders is .09%, which is still negative but sub-
stantially less negative than the average return to overall cash bidders and the
unchanged group. The difference in returns between the unchanged group and
the downgraded group is significant at the .08 level (t-statistics p 1.72). These
results indicate that although negative, larger returns to cash acquisitions than
stock acquisitions are mostly realized by bidding firms whose debt ratings
were downgraded.
The result of significantly larger returns for the downgraded group is con-
7. The unchanged group does not include firms that were listed on Credit Watch initially but
were later affirmed.
sistent with the prediction of the debt benefit theory. However, this theory is
more applicable to bidding firms with free cash flow that can be used for
perquisites or unprofitable investments. Based on a presumption that high free
cash flow firms will make bad acquisitions, the debt benefit would be stronger
when free cash flow firms increase their financial leverage enough so that
their debt ratings are downgraded. In this context, the downgraded group is
broken down into two subgroups, (1) a group of firms plagued by a free cash
flow problem and (2) a group of other firms, in order to compare the an-
nouncement returns of these two groups.
A key component of this analysis is the level of bidding firms free cash
flow. This study employs the proxy for free cash flow developed by Lang,
Stulz, and Walkling (1989). Lang et al. provide an operational definition of
(or proxy for) free cash flow based on the level of a firms total cash flow
and whether or not its Tobins q is below one. They argue that a firm with
Tobins q of less than one does not have profitable internal investment
opportunities.
Following Lang et al., I operationally define firms with free cash flows as
firms with (1) cash flows above the median using Lehn and Poulsens (1989)
definition and (2) a Tobins q below one.8 Using this definition I predict that
returns to downgraded cash bidders with large free cash flow should be less
negative (or more positive) than returns to other downgraded cash acquisitions.
Total cash flow is measured following Lehn and Poulsens (1989)
formula:9
Cash Flow p Operating Income before Depreciation
Interest Expense Taxes (1)
Preferred and Common Dividends.
This cash flow is then standardized by dividing by total assets.
Tobins q ratio is measured using the estimation method suggested by Chung
and Pruitt (1994):10
q ratio p (Market Value of Equity
Preferred Stocks Debt)/Total Assets. (2)
8. Lang et al. have a detailed discussion of the advantages and problems related to this
measure. Of particular importance is that the q I measure and use is an average q and not the
marginal q I would like. If investment opportunities exhibit declining returns, an average q of
one implies a marginal q less than one. However, investment opportunities may not always exhibit
declining returns. This implies that my separation of firms with free cash flow is not as precise
as I would like.
9. Compustat item numbers for each variable are [13 - 15 - (16 - Change in 35) - 19 - 21].
10. Compustat item numbers for each variable are [(25 * 24 11 4 - 5 9) 6]. Debt is
the value of the firms short-term liabilities minus its short-term assets plus value of the firms
long-term debt. Chung and Pruitt (1994) argue that this approximate q ratio estimated by Lin-
denberg and Rosss (1981) algorithm and the percentage of error between two estimators have
been statistically negligible.

Downgraded Cash Bidders Stratified by Tobins q and Cash Flow
N CAR Z
Low q-high CFa downgraded cash bidders 25 1.14 1.67*
The other downgraded cash bidders 44 .78 1.09
news service wire report in the LexisNexis Academic database. Total cash flow is measured following Lehn
and Poulsen (1989). This cash flow is then standardized by dividing by total assets. I measure q ratio using
the estimation method suggested by Chung and Pruitt (1994).
a
Low q firms are those with qs equal to or less than one. High CF firms are those with cash flow to total
assets above the median of the entire sample. Firms with negative cash flow have been omitted, so the number
of high CF firms is greater than the number of low CF firms.
* Significant at the .10 level.
Those with high levels of total cash flow and Tobins q below one are
defined as having free cash flow.
Two-day cumulative median abnormal returns for these two groups are
shown in table 3. The abnormal return for downgraded bidders having free
cash flow is 1.14%, which is significant at the .10 level (Z p 1.67). The
corresponding returns for other downgraded bidders without free cash flow
is .78% (Z p 1.09), which is not significant. It is evident that stockholders
of high free cash flow firms experience significant gains when their debt is
downgraded. The larger positive and significant returns for the downgraded
bidders with free cash flow provides additional evidence to support the benefit
of debt theory. Numerous studies offer similar supportive empirical evidence
for the free cash flow theory (e.g., Harris and Raviv 1990; Stulz 1990; Ma-
loney, McCormick, and Mitchell 1993; Smith and Kim 1994; and Harford
1999).
B. Stock Acquisitions
Although the main focus in this study is the valuation effect of cash acqui-
sitions, in order to further investigate signaling theory, the market reaction to
the announcement of stock acquisitions is examined. Table 4 shows that the
2-day cumulative median abnormal return for all stock bidders is 1.51%,
which is significant at the .05 level (Z p 2.11 ). Again, this result is similar
to previous studies findings. Next, the stock bidders are divided into three
groups according to debt rating changes: (1) upgraded, (2) downgraded, and
(3) unchanged groups. The abnormal returns for the upgraded group and
downgraded group are 2.32% and 4.61%, respectively, with corresponding
Z-values of 2.08 and 3.91.
Considering that an upgraded debt rating may benefit debt holders at the
expense of equity holders as the wealth transfer theory implies, significant
positive returns for the upgraded group can best be explained by the synergy
effect. The following example of an upgrade accompanied by Standard and
Poors comment confirms this view.
Following Columbia Hospitals acquisition of Galen Health Care Inc. for

Stock Bidders
N CAR % Z-score % Positive
Returns for all stock bidders
All bidders 112 1.51 2.11** 21.8**
Returns for stock bidders classified
by debt rating change:
Upgraded group 20 2.32 2.08** 70.7**
Downgraded group 19 4.61 3.91*** 10.9***
Unchanged group 63 1.62 1.96** 20.6**
news service wire report in the LexisNexis Academic database. The Wilcoxon sign-ranked test is used for the
percent positive. The upgraded (downgraded) group includes bidding firms whose debts were upgraded (down-
graded) due to the acquisition. The unchanged group includes the bidding firms that were not listed on Credit
Watch. The bidding firms listed on Credit Watch with either positive implications or negative implications but
that were later affirmed are excluded in this analysis. Standard and Poors Stock and Bond Guide and Credit
Week are used for the rating change data. The Wilcoxon sign-ranked test is used for the percent positive.
** Significant at the .05 level.
*** Significant at the .01 level.
$3.2 billion stock swap, Columbias subordinated debenture was upgraded

from B to A. Standard and Poors commented as follows: The merger
enhances the companys attractiveness as a major provider to large purchasers
of healthcare services and generates substantial cash flow with which the
company will be able to compete in an increasingly difficult healthcare market
place (Standard & Poors Credit Week, June 21, 1993).
These empirical results and Standard and Poors justification for rating
changes indicate that cash is not the typical payment method chosen by bidders
attempting highly successful acquisitions. Furthermore, given that stock pay-
ments tend to decrease leverage, downgrades in stock acquisitions can be
explained by two causes. One is the difference in credit rating between the
bidder and the target. When a bidder acquires a firm with a lower debt rating,
the combined entitys debt rating reflects the consolidated credit profile and
thus the bidders rating will be lowered, provided that the total value of
participating firms does not change, that is, no synergy. Another cause is the
expected decrease in the combined firms value because of either overpayment
or expected deteriorating operating performance, that is, negative synergy.
Large negative returns for the downgraded stock bidders, despite the potential
benefit of wealth transfer from debt holders as the wealth transfer theory
implies, may be explained only by the latter cause.
Contrary to cash acquisitions where downgraded bidding firms earn larger
returns than unchanged bidding firms, upgraded firms earn highly significant
larger returns than both downgraded and unchanged firms in stock acquisitions.
In fact, upgraded stock bidding firms experience the largest positive returns,
whereas downgraded stock bidding firms experience the largest negative re-
turns among all groups of the sample. This result renders an important im-
plication: cash acquisitions and stock acquisitions are two distinct types of
takeovers and their sources of value creation are different. It appears that the
benefit of debt is the main source of value in cash acquisitions whereas the
synergy effects outweigh the leverage effect in stock takeovers. Healy, Palepu,
and Ruback (1997, p. 45) distinguish cash and stock acquisitions as follows:
There were two distinct types of takeovers in our sample: (1) friendly trans-
actions that typically involved stock payment for firms in overlapping busi-
nesses, which we called strategic takeovers, and (2) hostile transactions that
generally involved cash payments for firms in unrelated businesses, which we
labeled financial takeovers.
If hostile financial takeovers are manifestations of free cash flow problems,
the market should react favorably to cash bidders experiencing high capital
structure changes which reduce agency costs. If stock payment is used in
strategic transactions, on the other hand, the market should react favorably
only to takeovers that create positive synergies. The finding that downgraded
stock bidders realize the largest negative returns may imply that nonsynergistic
stock acquisitions are the most value-destroying acquisitions. This type of
acquisition fails to generate both financial synergies and business synergies.
These results strongly support the argument of Jung, Kim, and Stulz (1996)
that firms with valuable investment opportunities are more likely to issue
equity and that the market reaction to equity issues is more favorable for firms
with valuable investment opportunities. It is also consistent with Martin
(1996), who reports that the higher the acquiring firms growth opportunities,
the more likely the acquiring firm is to use stock to finance an acquisition.
In summary, these analyses lead us to two conclusions. First, the benefit
of debt theory explains that the return for cash bidders is larger than for stock
bidders. When bidders are classified according to payment method and debt
rating changes, downgraded cash bidders earn, on average, larger returns than
bidders whose debt ratings were not changed. This is consistent with the
prediction of the benefit of debt theory but contradicts the signaling theory.
In addition, larger returns for the downgraded bidders with large free cash
flow (defined as large cash flow and low Tobins q) reinforce this conclusion.
However, a quite different picture unfolds for stock acquisitions. High positive
abnormal returns for upgraded stock bidders suggest that stock payment is
used for strategic acquisitions. The fact that overall returns for stock acqui-
sitions are significantly negative simply indicates that there are more unsuc-
cessful value-destroying stock acquisitions than successful synergistic stock
acquisitions.
C. Multivariate Analysis
To control for other factors known to affect the announcement returns for
bidders, a cross-sectional ordinary least-squares regression is estimated. The
dependent variable is the 2-day (t p 1 to 0) cumulative median abnormal
return at the announcement of an acquisition. The independent variables in-
clude: (1) a dummy variable for whether the bidding firm is added to the
Credit Watch list and whether the implication is positive or negative, (2) the
number of grades of change if a bond is upgraded or downgraded (if down-
graded, the number has a negative sign);11 (3) the change in the bidders long-
term debt ratio from year t 1 to year t 1 , (4) the bidders q ratio at year
t 1, (5) the bidders cash flow-total assets ratio at year t 1 , (6) a dummy
equal to one if the bidder and target operate in a related business and zero if
otherwise,12 (7) a dummy equal to one if the target management is opposed
to the offer and zero if otherwise (including target managements attitude
undisclosed at the time of announcement), and (8) the ratio of target-to-bidder
market values at year t 1.
This equation is estimated separately for cash offer and stock exchange
groups. The results of these cross-sectional regressions are reported in table
5. The overall results of the regression analysis strengthen the earlier analysis.
For cash bidders, the dummy variable takes the value of one if the firm was
not listed on Credit Watch and zero if the firm was listed with a negative
implication (because no cash bidder was upgraded in the sample). For stock
bidders, the dummy variable takes the value of one if the firm was listed with
a positive implication, and zero if the firm was listed with a negative impli-
cation. The assigned implication on Credit Watch has a significant effect on
bidding firms stock returns even when accounting for other variables. Across
all specifications, the coefficient of the Credit Watch implication variable is
negative for cash acquisitions with the significance level ranging from .11 to
.09, but the variable is positive for stock acquisitions with the significance
level of at least .02. In cash acquisitions, returns are larger when the bidders
debt rating is downgraded, which is consistent with the benefit of debt theory.
On the other hand, returns are larger when the bidders debt rating is upgraded
in stock acquisitions.13 The estimated coefficients indicate that if debt rating
is upgraded due to the acquisition, bidding firm shareholders lose approxi-
mately an average of 14 percentage points abnormal return in cash acquisitions,
whereas they earn an average 9.3 percentage points abnormal return in stock
acquisitions. The number of grades of the rating change, which is expected
to measure the strength of the leverage and synergy effects, is not significant
for both cash and stock acquisition groups.
The coefficient for change in the long-term debt ratio variable is not sig-
nificant or at best marginally significant in the cash acquisition group. When
the variable is estimated without including the implication variable, it is neg-
11. Following Warga and Welch (1993), the following scale is used: AAA p 2, AA p 3,
AA p 4, AA p 5, A p 6, A p 7, A p 8, BBB p 9, BBB p 10, BBB p 11,
BB p 12, BB p 13, BB p 14, B p 15, CCC p 16.
12. There is no standard method to define the relatedness of business. Matching SIC codes,
direct examination of the primary line of business, or revenue-based Herfindahl measure are
used by researchers. Following Maquieira, Megginson, and Nail (1998), I use a direct examination
of the primary line of business listing for each firm in the Moodys Industrial Manual.
13. The dummy variable for whether a stock bidders debt rating was upgraded or unchanged
is also significant at the .06 level. But the dummy for whether a stock bidder was downgraded
or unchanged is not significant.
TABLE 5 Cross-Sectional Regressions of Effect of Credit Watch Implications on

the Returns of the Bidder
Model 1 Model 2 Model 3 Model 4 Model 5
Cash acquisitions:
Intercept 1.3084 .0218 1.1814 1.4192 .0387
(.08) (.10) (.05) (.07) (.06)
Credit Watch implication* 1.3512 1.3812 1.3932
(.09) (.11) (.10)
Number of grades of debt
rating change .9035 .8961
(.42) (.37)
Change in debt ratio .0332 .0313 .0298
(.12) (.14) (.13)
Cash flow/total asset .6211 .6912
(.24) (.20)
Tobins q .1941 .2441
(.29) (.31)
Business relatedness of bid-
der and target .0441 .0381
(.66) (.50)
Target management attitude .0200 .0245
(.26) (.27)
Target market value/bidder
market value .0041 .0037
(.04) (.05)
2
Adjusted R .14 .06 .15 .17 .16
Stock acquisitions:
Intercept 2.9814 .0318 .4775 2.9384 .0388
(.19) (.01) (.30) (.24) (.05)
Credit Watch implication 9.1276 9.2285 9.6567
(.01) (.02) (.02)
Number of grades of debt
rating change 1.7911 1.7121
(.66) (.62)
Change in debt ratio .0265 .0323 .0311
(.31) (.32) (.61)
Cash flow/total asset .0391 .0402
(.38) (.49)
Tobins q .9815 1.0003
(.28) (.29)
Business relatedness of bid-
der and target .0051 .0062
(.52) (.57)
Target management attitude .0233 .0265
(.19) (.15)
Target market value/bidder
market value .0121 .0899
(.10) (.13)
Adjusted R2 .18 .01 .19 .21 .05
Note.The dependent variable is the 2-day (t p 1 to 0) cumulative abnormal return at the announcement
of an acquisition. The independent variables include: (1) a dummy variable for whether the bidding firm is
added to the Credit Watch list and whether the implication is positive or negative, (2) the number of grades
of the change if a bond is upgraded or downgraded (if downgraded, the number has a negative sign), (3) the
change in the bidders long-term debt ratio from year t 1 to year t 1 (t is the announcement year), (4) the
bidders q ratio at year t 1 , (5) the bidders cash flow-total assets ratio at year t 1 , (6) a dummy equal to
one if the bidder and target operate in a related business, and zero otherwise, (7) a dummy equal to one if
target management opposed to the offer and zero otherwise (including if target managements attitude is
undisclosed at the time of announcement), (8) the ratio of target-to-bidder market values at year t 1. p-values
for the coefficients are in parentheses.
* A dummy variable takes the value of one if the firm is not listed on Credit Watch and zero if the firm
is listed with a negative implication.
A dummy variable equal to one if the firm is added to the Credit Watch list with a positive implication
and zero if the firm is added with a negative implication.
ative and significant at the .12 level. When the Credit Watch implication is
taken into account, however, leverage change is not important at all. These
results suggest that change in leverage is not an important determinant of
abnormal returns to bidders shareholders after accounting for the influence
of rating changes. It conforms to the expectation that debt rating changes are
a better proxy to test the benefit of debt theory than changes in debt ratio.
Prior research indicates that the relative size of the underlying assets in-
volved in a corporate acquisition may affect the returns to the buyer (Asquith,
Bruner, and Mullins 1983; Bruner 1988). In general, the acquisition of a small
firm does not have the same financial impact as the purchase of a large firm.
The regression analysis finds that the size variable is positive and significant
at the .04 level in the cash group. The positive sign indicates that the bidders
returns increase with the size of the target. Interestingly, however, the size
variable is negative in the stock group although its explanatory power is at
best marginal, which indicates that small targets are associated with larger
returns to bidders.14 One possible explanation for this finding is that small
target firms may be better merged into the acquiring firms business in strategic
acquisitions that are likely to use stock payment. But further research is needed
to fully explain the relationship between the size of target and the bidders
return.
Another interesting result is found when investigating the relatedness of
business between bidding firms and target firms. This dummy variable, in-
dicating whether the bidder and target are in related businesses or not, is not
statistically significant in cash acquisitions but significant in stock acquisitions.
This result supports the argument that stock acquisitions create new wealth
from operating synergies and is consistent with studies by Kaplan and Weis-
bach (1992), Healy, Palepu, and Ruback (1997), and Maquieira, Megginson,
and Nail (1998), which predict that real operating synergies will be created
only in nonconglomerate acquisitions.
Although the coefficient is not statistically significant at conventional levels,
the target managements attitude variable exhibits a negative sign for both
cash and stock acquisition groups. This sign suggests that friendly transactions
generally create more takeover gains than hostile transactions for bidding
firms, which may imply that bidders have to pay less for targets in friendly
deals.15 The bidders debt ratio before the acquisition, q ratio, and target
managements attitude are not significant; none have p-values that approach
.10.
An additional variable that merits our attention is the impact of the societal
environment at the time of acquisition. Acquisition wealth effect may be
14. Asquith, Bruner, and Mullins (1987) also find a positive relation for cash mergers and a
negative relation for stock mergers.
15. As Huang and Walkling (1987) note, however, the target managements attitude about
the offer is not disclosed in the initial announcement in many cases. In addition, it involves the
truncation effect: anticipated target-management resistance could cause abandonment of low-
valued acquisition attempts before their announcements.
sensitive to the changing legal and economic environment. Recently, our

environment has been changing at a rapid pace. In the 1980s, we witnessed
the development of better takeover defense strategies and innovative financing
methods, as well as a change in governmental attitude to takeovers. Moreover,
the 198596 time period covered in this study encompasses three distinct
episodes in capital market history: (1) a very expansive and turbulent mergers
and acquisitions environment (198589), (2) a recession (199092), and (3)
the beginnings of current expansion (199296).16 To examine whether this
studys results depend on characteristics of the sampling period, the sample
is divided into three subsamples for these three periods in order to run the
same regressions on these subsamples. However, the results (not reported here)
indicate that the subsample partitioning does not essentially alter the results
reported here.
VI. Summary
Earlier research has shown that abnormal returns to acquiring firms share-
holders vary systematically by method of payment. Among many arguments
documented in the literature to explain this phenomenon, academic research
indicates that two of them have more explanatory power than the rest. One
is the signaling role of payment methods. The payment method in acquisitions
conveys the bidders assessment of the true value of combined entitys assets,
coupled with its belief about the true value of assets in place. Bidders would
finance acquisitions in cash (stock) if they assess that assets are undervalued
(overvalued). The other argument is the benefit of debt theory. Increased debt
caused by cash payment reduces the agency costs of free cash flow by reducing
the cash flow available for spending at the discretion of managers. This benefit
is especially stronger for firms with low growth opportunities, unused bor-
rowing power, and large free cash flow because they are more likely to incur
agency costs by undertaking low-benefit, or even value-destroying, acquisi-
tions. Although these two theories are logically sound and have been widely
cited, convincing empirical verification has been lacking, particularly for sig-
naling theory, primarily because of the difficulty of finding reliable proxies
to measure the information asymmetry.
I propose a new empirical approach to test these two hypotheses using
Standard and Poors debt rating reviews/changes as a proxy to measure the
signaling effect and the leverage change effect. When an acquisition is deemed
to cause a significant change in the combined entitys future cash flows and/
or financial leverage, rating agencies alter the acquisition participating firms
debt rating and release a short comment to justify their decision. The comment
reveals specifically whether the rating change is caused by a change in financial
leverage or by a change in expected operating performance caused by the
acquisition.
16. I appreciate the anonymous referee for suggesting this idea.
When cash bidders are divided into two groups depending on whether the
firms debt is downgraded or remains unchanged, the downgraded group
experiences a significantly larger 2-day (t p 1 to 0) abnormal return than
the unchanged group. The larger returns to the downgraded bidders support
the benefit of debt theory. Also, this result runs counter to the signaling
theorys prediction because the bidders rating would remain unchanged or
be upgraded if the synergy effect of the acquisition offset increased financial
risk. To provide additional evidence supporting the benefit of debt theory,
this study investigates the prediction that the benefit of debt is stronger for
bidders with free cash flow. I find a significantly larger return for the cash
bidder group with free cash flow (defined as high cash flow and q ratio below
one) than for the cash bidder group without free cash flow.
When returns to stock-financed bidders is examined and grouped according
to debt rating change (upgraded group, unchanged group, and downgraded
group), the results contrast sharply with the ones of cash-financed bidders. A
significantly positive abnormal return occurs for the upgraded group, whereas
the corresponding abnormal return for the downgraded group is the most
negative and significant. The positive returns for the upgraded group and the
negative returns for the downgraded group can only be explained by the
synergy effect as the Standard and Poors comments reveal.
These results strongly imply that cash acquisitions and stock acquisitions
are two distinct types of takeovers and their sources of value creation are
different. Cash payment is used in hostile financial takeovers, whereas stock
payment is used in friendly strategic takeovers. Overall, this study does not
find convincing evidence that cash is likely to be used for good acquisitions.
While some bidders use stock to pursue a genuinely profitable strategic ac-
quisition, because there are more bidders who pursue unprofitable acquisitions,
firms that offer stock for an acquisition will suffer a stock price decrease at
announcement.
References
Asquith, P.; Bruner, R.; and Mullins, F. 1983. The gains to bidding firms from merger. Journal
of Financial Economics 11 (April): 12140.
Asquith, P.; Bruner, R.; and Mullins, F. 1987. Merger returns and the form of financing. Un-
published manuscript. Cambridge, Mass.: Harvard Business School.
Asquith, P., and Kim, E. 1982. The impact of merger bids on the participating firms security
holders. Journal of Finance 37 (December): 120928.
Berkovitch, E., and Narayanan, M. 1990. Competition and the medium of exchange in takeovers.
Review of Financial Studies 3 (Summer): 15374.
Brown, D., and Ryngaert, M. 1991. The mode of acquisition in takeovers: Taxes and asymmetric
information. Journal of Finance 46 (June): 65369.
Brown, S., and Warner, J. 1985. Using daily stock returns: The case of event studies. Journal
of Financial Economics 14 (March): 332.
Bruner, R. 1988. The use of excess cash and debt capacity as a motive for merger. Journal of
Financial and Quantitative Analysis 23 (June): 119217.
Chung, K., and Pruitt, S. 1994. A simple approximation of Tobins q. Financial Management
23 (Autumn): 7074.
Dennis, D., and McConnell, J. 1986. Corporate mergers and security returns. Journal of Financial
Economics 16 (June): 14387.
Dodd, P., and Ruback, R. 1977. Tender offers and stockholder wealth. Journal of Financial
Economics 5 (December): 35173.
Eckbo, E. 1983. Horizontal mergers, collusion and stockholder wealth. Journal of Financial
Economics 11 (April): 24173.
Eckbo, E.; Giammarino, R.; and Heinkel, R. 1990. Asymmetric information and the medium of
exchange in takeovers: Theory and evidence. Review of Financial Studies 3 (Winter): 65175.
Ederington, L.; Yawitz, J.; and Roberts, B. 1987. The informational content of bond ratings.
Journal of Financial Research 10 (Fall): 21126.
Egar, C. 1983. An empirical test of the redistribution effect in pure exchange mergers. Journal
of Financial and Quantitative Analysis 18 (December): 54773.
Fishman, M. 1989. Preemptive bidding and the role of the medium of exchange in acquisitions.
Journal of Finance 44 (March): 4158.
Franks, R.; Harris, R.; and Mayer, C. 1988. Means of payment in takeovers: Results for the
United Kingdom and the United States. In A. Auerback (ed.), Economic Effects of Mergers
and Acquisitions. Chicago: University of Chicago Press.
Galai, D., and Masulis, R. 1976. The option pricing model and the risk factor of stock. Journal
of Financial Economics 3 (April): 5382.
Gilson, R.; Scholes, M.; and Wolfson, M. 1988. Taxation and the dynamics of corporate control:
The uncertain case for tax-motivated acquisition. In J. C. Coffer, L. Lowenstein, and S. Rose-
Ackerman (eds.), Knights, Raiders, and Targets. New York: Oxford University Press.
Griffin, P., and Sanvicente, A. 1982. Common stock returns and rating changes: A methodological
comparison. Journal of Finance 37 (March): 10319.
Hand, J.; Holthausen, R.; and Leftwich, R. 1992. The effect of bond rating agency announcements
on bond and stock prices. Journal of Finance 47 (June): 73352.
Hansen R. 1987. A theory for the choice of exchange medium in mergers and acquisitions.
Journal of Business 60 (January): 7595.
Harford, J. 1999. Corporate cash reserves and acquisitions. Journal of Finance 54 (December):
196997.
Harris, M., and Raviv, A. 1990. Capital structure and the informational role of debt. Journal of
Finance 45 (June): 32150.
Healy, P.; Palepu, K.; and Ruback, R. 1997. Which takeovers are profitable? Strategic or financial.
Sloan Management Review 38 (Summer): 4557.
Higgins, R., and Schall, L. 1975. Corporate bankruptcy and conglomerate merger. Journal of
Finance 30 (March): 93113.
Holthausen, R., and Leftwich, R. 1986. The effect of bond rating changes on common stock
prices. Journal of Financial Economics 17 (September): 5789.
Hsueh, L., and Kidwell, D. 1988. Bond ratings: Are two better than one? Financial Management
17 (Spring): 4653.
Huang, Y., and Walkling, R. 1987. Target abnormal returns associated with acquisition an-
nouncements: Payment, acquisition form, and managerial resistance. Journal of Financial
Economics 19 (December): 32950.
Jarrell, G., and Bradley, M. 1980. The economic effects of federal and state regulations of cash
tender offers. Journal of Law and Economics 23 (October): 371408.
Jensen, M. 1986. Agency costs of free cash flow, corporate finance and takeovers. American
Economic Review 76 (May): 32329.
Jensen, M. 1988. Takeovers: Their causes and consequences. Journal of Economic Perspectives
2 (Winter): 2148.
Jung, K., Kim, Y. C., and Stulz, R. 1996. Timing, investment opportunities, managerial discretion,
and the security issue decision. Journal of Financial Economics 42 (October): 15985.
Kaplan, S., and Weisbach, M. S. 1992. The success of acquisitions: Evidence from divestitures.
Journal of Finance 47 (March): 10738.
Kim, E. H., and McConnell, J. 1977. Corporate mergers and co-insurance of corporate debt.
Journal of Finance 32 (May): 34965.
Lang, L.; Stulz, R.; and Walkling, R. 1989. Managerial performance, Tobins q, and the gains
from successful tender offers. Journal of Financial Economics 24 (September): 13754.
Lehn, K., and Poulsen, A. 1989. Free cash flow and stockholder gains in going private transactions.
Journal of Finance 44 (July): 77188.
Lewellen, W. 1971. Pure financial rationale for conglomerate merger. Journal of Finance 26
(May): 52137.
Lindenberg, E., and Ross, S. 1981. Tobins q ratio and industrial organization. Journal of Business
54 (January): 132.
Maloney, M.; McCormick, R.; and Mitchell, M. 1993. Managerial decision making and capital
structure. Journal of Business 66 (April): 189217.
Maquieira, C.; Megginson, W. L.; and Nail, L. 1998. Wealth creation versus wealth redistribution
in pure stock-for-stock mergers. Journal of Financial Economics 48 (April): 333.
Martin, K. J. 1996. Motives underlying the payment method in corporate acquisitions. Journal
of Finance 51 (July): 122746.
Martin, K. J., and McConnell, J. 1991. Corporate performance, corporate takeovers, and man-
agement turnover. Journal of Finance 46 (July): 67187.
Morck, R.; Shleifer, A.; and Vishny, R. W. 1988. Characteristics of hostile and friendly takeover
targets. In A. J. Auerbach (ed.), Corporate Takeovers: Causes and Consequences. Chicago:
University of Chicago Press.
Myers, S., and Majluf, N. 1984. Corporate financing and investment decisions when firms have
information that investors do not have. Journal of Financial Economics 13 (June): 187221.
Schleifer, A. and Vishny, R. W. 1986. Large shareholders and corporate control. Journal of
Political Economy 95 (June): 46188.
Settle, J.; Petry, G.; and Hsia, C. 1984. Synergy, diversification, and incentive effects of corporate
merger on bondholder wealth. Journal of Financial Research 12 (Winter): 32939.
Smith, R., and Kim, J. 1994. The combined effects of free cash flow and financial slack on
bidder and target stock return. Journal of Business 67 (April): 281310.
Stillman, R. 1983. Examining antitrust policy toward horizontal mergers. Journal of Financial
Economics 11 (April): 22540.
Stulz, R. 1990. Managerial discretion and optimal financing policies. Journal of Financial Eco-
nomics 26 (July): 228.
Travlos, N. 1987. Corporate takeover bids, methods of payment, and bidding firms stock returns.
Journal of Finance 42 (September): 94364.
Wansley, J.; Lane, W.; and Yang, H. 1983. Abnormal returns to acquiring firms by type of
acquisition and method payment. Financial Management 12 (Autumn): 1622.
Wansley, J.; Lane, W.; and Yang, H. 1987. Gains to bidder firms in cash and securities transactions.
Financial Review 22 (November): 40314.
Warga, A., and Welch, I. 1993. Bondholder losses in leveraged buyouts. Review of Financial
Studies 6 (Winter): 95982.

Jurnal Temu 5 Asing

Încărcat de

Informații document

Drepturi de autor

Formate disponibile

Partajați acest document

Partajați sau inserați document

Opțiuni de partajare

Vi se pare util acest document?

Este necorespunzător acest conținut?

Drepturi de autor:

Formate disponibile

Jurnal Temu 5 Asing

Încărcat de

Drepturi de autor:

Formate disponibile

Larger Return to Cash Acquisitions: Signaling Effect or Leverage Effect?

Author(s): KenC. Yook

Larger Return to Cash Acquisitions:

I. Introduction This article investigates

* I would like to thank William Hudson for providing the Stan-

(Journal of Business, 2003, vol. 76, no. 3)

II. Sources of Wealth Effect

A. The Signaling Theory

B. The Benefit of Debt Theory

cover for the debt obligations. If operating performance is improved and/or

III. Empirical Design

policy than previously anticipated, as evidenced by the increased level of debt

TABLE 1 Sample Summary

TABLE 2 Two-Day (t p 1 to 0) Cumulative Median Abnormal Returns for

squares regression of each firms returns on the CRSP value-weighted index

TABLE 3 Two-Day (t p 1 to 0) Cumulative Median Abnormal Returns for

TABLE 4 Two-Day (t p 1 to 0) Cumulative Median Abnormal Returns for

$3.2 billion stock swap, Columbias subordinated debenture was upgraded

TABLE 5 Cross-Sectional Regressions of Effect of Credit Watch Implications on

sensitive to the changing legal and economic environment. Recently, our

16. I appreciate the anonymous referee for suggesting this idea.

S-ar putea să vă placă și