Corporate Financing Decisions When Investors Take the Path of Least Resistance / Malcolm Baker, Joshua Coval, Jeremy C. Stein.

By:

Baker, Malcolm

Contributor(s):

Material type: Text

TextSeries: Working Paper Series (National Bureau of Economic Research) ; no. w10998.Publication details: Cambridge, Mass. National Bureau of Economic Research 2004.Description: 1 online resource: illustrations (black and white)Subject(s):

G32 - Financing Policy • Financial Risk and Risk Management • Capital and Ownership Structure • Value of Firms • Goodwill
G34 - Mergers • Acquisitions • Restructuring • Corporate Governance

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Abstract: We explore the consequences for corporate financial policy that arise when investors exhibit inertial behavior. One implication of investor inertia is that, all else equal, a firm pursuing a strategy of equity-financed growth will prefer a stock-for-stock merger to greenfield investment financed with an SEO. With a merger, acquirer stock is placed in the hands of investors, who, because of inertia, do not resell it all on the open market. If there is downward-sloping demand for acquirer shares, this leads to less price pressure than an SEO, and cheaper equity financing as a result. We develop a simple model to illustrate this idea, and present supporting empirical evidence. Both individual and institutional investors tend to hang on to shares granted them in mergers, with this tendency being much stronger for individuals. Consistent with the model and with this cross-sectional pattern in inertia, acquirers targeting firms with high institutional ownership experience more negative announcement effects and greater announcement volume. Moreover, the results are strongest when the overlap in target and acquirer institutional ownership is low and when the demand curve for the acquirer's shares appears to be steep.

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Holdings
Item type	Home library	Collection	Call number	Status	Date due	Barcode	Item holds
Working Paper	Biblioteca Digital	Colección NBER	nber w10998 (Browse shelf(Opens below))	Not For Loan

Total holds: 0

December 2004.

We explore the consequences for corporate financial policy that arise when investors exhibit inertial behavior. One implication of investor inertia is that, all else equal, a firm pursuing a strategy of equity-financed growth will prefer a stock-for-stock merger to greenfield investment financed with an SEO. With a merger, acquirer stock is placed in the hands of investors, who, because of inertia, do not resell it all on the open market. If there is downward-sloping demand for acquirer shares, this leads to less price pressure than an SEO, and cheaper equity financing as a result. We develop a simple model to illustrate this idea, and present supporting empirical evidence. Both individual and institutional investors tend to hang on to shares granted them in mergers, with this tendency being much stronger for individuals. Consistent with the model and with this cross-sectional pattern in inertia, acquirers targeting firms with high institutional ownership experience more negative announcement effects and greater announcement volume. Moreover, the results are strongest when the overlap in target and acquirer institutional ownership is low and when the demand curve for the acquirer's shares appears to be steep.