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Corporate Bankruptcy and Conglomerate Merger
... This is necessary because the question whether one firm behaves more risk averse than another often depends on the risk type (Miller & Bromiley, 1990). Thus, in the following, we briefly define and explain the most prominently discussed risk types, i.e., variability risk and vulnerability risk (D'Aveni & Ilinitch, 1992;Higgins & Schall, 1975;McConaughy, Matthews, & Fialko, 2001). ...
... Vulnerability risk is defined as the default probability or bankruptcy risk (Higgins & Schall, 1975;March & Shapira, 1987). Whereas variability risk is of particular importance for shareholders, vulnerability risk is the main focus of all other stakeholders (Marchisio, Mazzola, Sciascia, Miles, & Astrachan, 2010). ...
... Finance scholars have traditionally applied the concepts of variability risk and vulnerability risk only to economic wealth, i.e., the risk of losing money (Higgins & Schall, 1975). However, family firm scholars stress that business-owning families derive not only economic but also non-economic wealth from the respective family firm. ...
This chapter reviews prior, so far inconclusive, research on the risk behavior of family firms. On the one hand, scholars assume risk-averse behavior of family firms based on agency theory and wealth concentration arguments. On the other hand, scholars predict that family firms are willing to take substantial financial risks to preserve their SEW. By integrating finance, management, and entrepreneurship literature, we show that different underlying definitions of “risk” are key for a better understanding of family firms’ risk behavior and subsequent strategic decisions. We provide a conceptual model, highlight gaps in the existing literature, and propose fruitful areas for further research.
... Sobre ambas fuentes de financiamiento, el directivo preferirá financiar la inversiones de la empresa a través de los recursos generados internamente, debido a que el uso de éstos no presentan costos de selección adversa (Myers, 1984 Entonces, el problema radica en elegir, una vez agotados los recursos internos, cuál debe ser la siguiente fuente de financiamiento que se debe tomar y hasta qué punto, para luego dar paso a la siguiente fuente de financiamiento. En este sentido, Lemmon & Zender (2004) 87 proponen lo se conoce como la teoría del pecking order "extendida", en la que toman en cuenta la "capacidad de endeudamiento" que tiene cada empresa y señalan que, luego de utilizar los recursos generados internamente, el directivo prefiere el uso de deuda hasta llegar a esta "capacidad de endeudamiento máximo", que supone el límite superior para el uso de deuda y de ahí en adelante se financiaría a través de emisión de acciones ( 86 Helwege & Liang, (1996), encuentran que la probabilidad de obtener fondos externos no está relacionada con un déficit en los fondos generados internamente, lo cual contradice las predicciones de la teoría del pecking order. Sin embargo, de acuerdo con las predicciones del pecking order, encuentran que las empresas con un superávit de tesorería evitan financiamiento externo. ...
... 714.4. La validez y utilidad de la teoría del trade--offInvestigadores comoHiggins & Schall (1975) y Haugen & Senbet (1978, 1988), entre otros, señalan que los costos directos de dificultades financieras son insignificantes y por lo tanto, la teoría del trade--off no es correcta. Por el contrario, Baxter (1967), Stiglitz (1969), Kraus & Litzenberger (1973), Scott (1976), Kim (1978), Marsh (1982), Altman (1984), Hovakimian, Opler, & Titman (2001), Titman & Wessels (1988) y Fischer, Heinkel & Zechner (1989), Opler & Titman (2001), entre otros, señalan que los costos directos de dificultades financieras sí son70 ...
... Cross industry M&A deals diversify the market and expand the customer base of the firms, create a market oriented environment. According to Higgins and Schall (1975), the bankruptcy cost decreases in the cross industry M&A deals due to diverse markets and imperfect correlated cash flows. Mai, Meng and Ye (2017:292) found that high growth rate of GDP per capita and market oriented environment increase the firm's speed of adjustment toward target capital structure. ...
... Along the same lines, the SOA of same industry and cross industry M&A deals may differ from each other. According to the literature, cross industry M&A deals widen the target market, may create imperfectly correlated cash flows, which will reduce bankruptcy costs and will help in making changes in the capital structure (Higgins and Schall, 1975;Ghosh and Jain, 2000). According to Mai et al. (2017), firms having a market orientation environment and surrounded with better economic conditions move faster toward the target capital structure. ...
Purpose-In this study, the speed of adjustment (SOA) toward target capital structure is investigated in cross border and cross industry mergers and acquisitions (M&A). Methodology-As a measure of capital structure both book leverage (BLEV) and market leverage (MLEV) ratios are used in the analysis. The sample consists of 6,520 M&A deals for the period of 2000-2016. Findings-The findings show that for both the BLEV and MLEV, the cross border M&A deals move faster toward the target capital structure compared to non-cross border M&A deals. While the SOA rate for the same and cross industry M&A cases does not show too much difference for BLEV and MLEV. Conclusion-Overall the firms adjust to their target capital structure in maximum three years following the M&A
... By contrast, strategic management research allows for the possibility of (capital) market imperfections such as shareholder-manager conflicts, taxes, bankruptcy costs, and information asymmetries (Aron, 1988;Higgins and Schall, 1975;Jensen and Meckling, 1976). Accordingly, diversified firms can internalize market transactions and force market pressure onto competitors (e.g. through "market power" and "multi-point competition"). ...
... Finally, financial synergies provide diversified firms with better or cheaper access to capital, particularly during economic downturns (Kuppuswamy and Villalonga, 2016). Businesses can benefit from lower external financing cost, lower deadweight costs (e.g. by avoiding adverse selection, stakeholder defection, forgone business, or investment distortions when the firm is in financial distress), the tax shield of higher debt levels, and internal capital markets (Hadlock et al., 2001;Hann et al., 2013;Higgins and Schall, 1975). These opportunities are greatest if the businesses in the portfolio have only weakly correlated cash flows. ...
While the diversification–performance link is well covered in strategy research, we know much less about the link between firm diversification and risk. This article draws from modern portfolio theory and corporate diversification theory to derive a comprehensive set of hypotheses on the impact of related and unrelated diversification on the systematic risk, total risk, and bankruptcy risk of a firm. Based on a large international sample, we find the portfolio effect to be more important than previously thought, while synergy effects appear to be largely counterbalanced by the direct and indirect costs of diversification. Specifically, we find that systematic risk is not reduced by corporate diversification, while bankruptcy risk is significantly lower in diversified firms, possibly leading to conflicts between shareholders and other stakeholder groups.
... However, these high ratings' deals tend to create new injections of cash flow and wealth via cash flow operating efficiencies leading to new loans from bondholders. Then, bondholder reassurance of making gains must come from mere redistributions of shareholder wealth, whereby an increase in bond prices coincides with an offsetting reduction in share prices, thus guaranteeing the right to wealth redistribution (Levy and Samat, 1970;Higgins and Schall, 1975;Galai and Masulis, 1976;Berger and Ofek, 1995). ...
... Moreover, unrelated acquisitions often improve income stability by spreading financial risk across industries with different market conditions. This should reduce the probability of bankruptcy for the combined firm (Higgins and Shall, 1975). Nonetheless, since to some degree related acquisitions can provide such financial-based synergies as well, the common view is that related acquisitions should outperform unrelated acquisitions in the long-term (Seth, 1990a;Singh and Montgomery, 1987). ...
... Bondholders, however, only gain indirectly, from a merger, through a potential risk reduction (Levy and Sarnat 1970). Theoretically this occurs when two merging firms have imperfectly correlated cash flows; the "diversification" of cash flows means that each firm coinsures the whole (Higgins and Schall 1975;Levy and Sarnat 1970;Lewellen 1971). However, risk reduction can also occur in other, less obvious, ways; for instance, Renneboog et al. (2017) show that in cross border M&As bondholders respond positively when they gain exposure to a legal system with greater creditor protections. ...
We study the bond price reaction of a merged firms peers, in order to better understand how the market responds to a restructuring. We argue that a merger announcement may signal the possibility of a merger wave to the industry, and in doing so, increase the conditional probability that peer firms might themselves be acquired in the future. However, while peer firm equity holders expect a direct benefit from a potential acquisition—in the form of a price premium—peer firm bond holders can only expect an indirect benefit—in the form of a risk reduction. Consistent with these hypotheses, we show that price reactions are stronger for firms that have a higher unconditional probability of being acquired ex-ante. In addition, we document that, cross-sectionally, the abnormal returns we observe from peer bondholders are concentrated among firms that have the highest expected risk reduction benefit from a potential acquisition. In order to distinguish a potential reduction in risk as the explicit return driver, we show that abnormal bond returns within firm (between different bond issues) are also concentrated among issues that have the highest expected risk reduction benefit.
... Several studies [55][56][57][58] argue that in case capital markets are not efficient, there may be financial motives for unrelated firm expansion, that is, the product diversification can be an element of risk reducing strategies. Firms can allocate their activities across industries with opposite market risks to reduce the exposure of their core business. ...
Multiproduct firms often diversify into technologically related activities to exploit efficiencies of joint production; however, unrelated products in the company's portfolio provide access to distinct markets and can help to avoid industry-specific shocks. Yet, the underlying mechanisms of related and unrelated diversification are still poorly understood. Here we investigate diversification decisions of firms in periods when corporations' markets are hit by a demand shocks. In these times, cost efficiency considerations might drive firms to reduce costs by narrowing product portfolios and focusing on combinations of technologically related products, in which economies of scope and mutual capabilities can be exploited. To test this hypothesis, we consider two measures of demand shocks, decreasing sales volumes on the product market and increasing import competition; and analyze their association with changes of product portfolios of Hungarian firms in the 2003-2012 period. We find that production has become more coherent in terms of technological relatedness after firms were exposed to demand shocks. Evidence suggests related adjustment of firm production after demand shocks such that products unrelated to firms' core product are dropped from the portfolio but related products are added.
... Even if the firm does not use the enhanced debt capacity, it can gain from lower interest rates if it can prepay without penalty or otherwise renegotiate terms of the pre-merger debt (Lee 1977). Value effects of mergers would also depend on the quantum of bankruptcy costs, the likelihood of bankruptcy, and the market's valuation of risky cash-flows (Higgins and Schall 1975). Another advantage of diversifying mergers is that costs of the bankruptcy process may enjoy scale economies (Scott 1977). ...
Prior review papers on corporate diversification have mostly explored the diversification-performance linkage but not the effects of diversification on various financing aspects of firms. By addressing this gap in the extant literature, our review aims to support entrepreneurs/managers in decision-making related to diversification, organizational form, and structuring. For investors, it highlights potential risks that diversification could expose them to. To this end, we propose an integrated framework that considers both conglomerates and business groups (BG) as diversifying organizational forms. We find that diversification impacts financing through two channels: financial synergies and internal capital markets (ICM). Broadly, financial synergies reduce the probability of default on a firm’s debt, thereby increasing its capital-raising ability. However, diversification can also lead to risk contamination and loss of limited liability benefits. ICMs relax financial constraints, facilitate propping of distressed business lines, and provide resilience during economic downturns. Unlike conglomerates, BG affiliated firms are often controlled through pyramidal structures. Pyramidal structures create divergences between control rights and cash-flow rights, thereby enabling expropriation of minority shareholders. However, such structures can also facilitate financing of growth opportunities from within the group. Finally, we propose certain avenues for future research.
... In enterprise risk management, risk is defined as any event or action that may adversely affect an organization's ability to achieve its objectives and execute its strategies [1], where two types of risk have been among the most studied: variability risk and vulnerability risk [2]. Variability risk is the difference between the actual and expected returns on an investment [3][4][5] and vulnerability risk includes default and bankruptcy risks [6,7]. In particular, variability risk management involves optimizing portfolios to allocate capital in a way that reduces the exposure of assets to risk [8,9]. ...
Because electricity retailers must ensure that energy supply matches end-user demand,
electricity that is not traded through bilateral contracts is typically traded in power exchanges which are subject to great price volatility. In Colombia, the spot price is a reflection of climate variability because approximately 70% of the country’s electricity is generated by large hydropower stations.
In this study, we forecast 2018's prices and calculated its corresponding purchase margins using the 2015 to 2017 bilateral contract prices for electricity plus power exchange price information and climate information. Our forecasts included climate uncertainty and evaluated two multi-period portfolio methods for deciding among three purchasing strategies: bilateral contracts in the regulated market, bilateral contracts in the non-regulated markets, and purchases in the power exchange.
The results indicate that retailers should follow a middle course that is neither conservative nor risky. Creation of portfolios independent of the multi-period method can balance purchases through bilateral contracts and in the power exchange in a way that considers climatic uncertainty. This type of balanced portfolio could control medium-term risks of price volatility and result in good levels of purchase margins.
... In the present-day environment the financial forecasting at the level of the company, i.e., at the micro level, presumes an application of the well-known techniques described in the relevant references on the financial accounting analysis, financial analysis, and financial management (Block, 1999;Brealey, Mayers & Allien, 2017;Brigham & Houston, 2015;Helfert, 2001;Higgins, 1975;McLaney, 1992;Lee,2020;Penman, 2010;Subramanyam & Venkatachalam, 2007;Van Horne,1989, et al.) such as budgeting, percentage of revenues technique, and so-called economic-mathematical technique incorporating mathematical processing methods of time, space and time-spatial aggregate. The budgeting, percentage of revenues technique are utilized as short-term financial forecasting instruments, the economic-mathematical technique is treated as the instrument for the middle-term and longterm financial forecasting. ...
Research background: In the present-day global economic environment overcoming financial difficulties and enhance of financial position is an important goal of the anti-crisis financial management of almost any company. This goal is certain to be reached by using target financial forecasting at the company level.
Purpose of the article: The paper considers conceptual aspects of the target financial forecasting at the company level, as a new instrument of anticrisis financial management for a company to overcome its financial difficulties and enhance its financial position within a time-period of practically any length.
Methods: The methodology of the research, the results being presented in the paper, is based on the concept of the financial ratio analysis, the concept of the company cash flows, and the concept of the balanced scorecard (in terms of its financial score).
Findings & Value added: It is depicted that the procedure of the target financial forecasting comprises an appropriate information-accounting support, a target financial forecasting of the company financial position, a target forecasting of the company’s cash flows, a development of the specific events (managements’ decisions) aimed at overcoming the company’s financial difficulties and enhancing its financial position. The author has stated that in the present-day environment the target financial forecasting is an effective instrument of the financial forecasting that enables to set up the base for overcoming the company’s financial difficulties and strengthening its financial position.
... In synergistic M&As, both bondholders and shareholders win because firm value can increase by achieving economies of scale and scope and by improving management efficiency (Jensen and Ruback 1983;Koerniadi et al. 2015). Debtholders can still gain in nonsynergistic M&As, however, if the M&As reduce cash flow volatility and thereby default risk (Lewellen 1971;Higgins and Schall 1975). Our results that acquirers have lower cost of debt compared with non-acquirers suggest that bondholders perceive M&As as a risk-decreasing investment activity, which is further confirmed by our findings that acquirers have lower information risk and default risk. ...
A large body of literature has examined the effect of mergers and acquisitions (M&As) on firm valuation, and generally find that M&As reduce acquirers’ shareholder value. However, relatively little is known about the effect of M&As on the pricing of corporate debt by debtholders, especially for firms in less developed countries. Using a sample of Chinese listed firms with outstanding bonds from 2007 to 2020, we find that the cost of debt is lower for acquirers than for non-acquirers, and that the effect of acquisitions in reducing cost of debt is more pronounced for firms from provinces with less developed markets, for private firms, and for firms undertaking cross-province acquisitions. Our results are robust to a series of robustness checks that address various endogenous concerns, including the use of a matched-sample approach, the use of the Heckman two-stage model, change analysis, control for acquirers’ pre-acquisition bond yield spread, and exclusion of acquisitions of publicly listed targets. Our analyses of provincial institutional factors show that the relationship between M&As and cost of debt is moderated by government relations to market, private economy development, and the development of market intermediaries and legal environment. We further document that acquirers have lower default risk during the post-acquisition period because of a coinsurance effect, and that acquirers attract more analyst following and investors after acquisitions. Overall, our results indicate that acquisitions can reduce cost of debt through reducing firms’ default risk and information risk, and that institutional factors matter for the effect of M&As on the cost of debt. Free access provided by Elsevier (before December 17, 2021): https://authors.elsevier.com/c/1d~ZD3mS~2SOmB
... Previous studies have shown that firms can promote innovation ability through M&A (Bena & Li, 2014), which means that M&A may increase the number of patent applications. On the other hand, M&A may lead to firm distress (Higgins & Schall, 1975). Hence, M&A activity may cause observable heterogeneity. ...
This paper investigates how imitative innovation affects firms’ financial distress risk and how executive foreign experience moderates this relationship. Using the 2008–2017 patent application data for Chinese listed firms, we find robust evidence that imitative innovation increases firms’ financial distress risk and that executives’ foreign experience can mitigate this adverse impact. Additional tests reveal that firms conduct imitative innovation to gain competitive advantage, but this also tightens their financial constraints, leading to greater financial distress risk. Overall, our results highlight the dark side of imitative innovation and the value of executives’ foreign experience for firms operating in emerging markets that rely on imitative innovation.
... Study reveals that corporate management strongly involved diversification activities and many scholars established this fact. Diversification advances debt capacity, reduce the chances of bankruptcy by introducing new products/markets (Higgins & Schall, 2016) and improves asset placement and productivity. A diversified firm can move funds from a cash surplus unit to a deficit unit without taxes or transaction costs. ...
Diversification is a strategic method that investors use to optimize risk of portfolio. It is an opportunity by which investors move from micro-firm into macro-firm. The investors’ aim is to make an optimal choice that leads to minimization of risk and maximization of return, but the methods that lead to these objectives are not easily achieved. The purpose of this paper is to propose a method to minimize risk of portfolio. Firstly, this paper investigates the risk reduction strength of each asset and secondly, it explores the impact of each asset in minimizing risk of portfolio. The assets allocations divulge by Black Litterman model are used to estimate risk of both portfolios and assets. We explore DataStream (Yahoo finance) of Gold, Oil and Natural gas which spans from January, 2010 to September, 2016. It is observed that investing on Gold minimizes higher risk and achieve more benefits than other assets in the portfolio. In view of these facts, it means diversifying in gold acts as hedge/safe haven for investors during economic crisis.
... Second, our results help us to understand the wealth effect of mergers on shareholders and debt holders. Higgins and Schall (1975) argue that diversifying mergers may benefit existing debt holders at the expense of equity holders because coinsurance makes the existing debt less risky. With the exception of Billett et al. (2004), empirical studies generally find no evidence for a merger-triggered wealth transfer from equity holders to bond holders. ...
We exploit cross-sectional variation in the predictable changes in asset volatility following corporate acquisitions to identify the effect of business risk on capital structure. We find that postmerger changes in leverage and cash holdings are strongly predicted by expected asset volatility changes estimated using premerger information. These capital structure adjustments are partly achieved through the choice of payment method. Our findings provide direct evidence for the coinsurance effect of mergers on debt capacity. More broadly, they suggest that firm risk is a first-order determinant of leverage, consistent with the tradeoff theory of capital structure. Our coefficient estimates imply that a one-standard deviation decline in a firm’s asset volatility corresponds to a 7.5-percentage point increase in leverage.
This paper was accepted by Renee Adams, finance.
... This financial synergy through mergers and acquisitions can help to lower the cost of capital and therefore, increase company value. In unrelated acquisition, the acquirer can acquire another company with un-related cash flows and thereby reduce risk by diversifying their financials (Schall & Higgins, 1975). Mewes (2015) also suggests smaller companies generally have to pay a premium when borrowing money relative to larger companies however, when two mid-sized companies merge, they can lower their combined cost of capital more than they could individually. ...
This paper aims to shed light on whether the Merger & Acquisition (M&A) among several cases create values for Vietnam small and medium enterprises (SMEs). Using 48 months of actual data to compare the pre- and post- merger performance, the study evaluates the impacts of the M&A on business performance collected from HOSE stock exchange website. The result shows that out of 11 chosen key performance indicators (KPIs) and those selected firms only we have 2 KPIs with better results while 6 KPIs do not change and 3 KPIs are even worse after the M&A. In addition, the finding indicated that very few actions were implemented and hence unsurprisingly, the M&A outcomes did not really match with firms’ original expectations. From the theory and the actual results of the analysis, the study provides a number of practical areas that companies should focus on to increase the chance of success for their M&A.
... Findings from the theoretical literature suggest that bondholders should experience significant wealth effects in M&As. Levy and Sarnat (1970), Lewellen (1971), and Higgins and Schall (1975) argue that the coinsurance effect of M&As may increase bondholder wealth. For instance, if acquirer and target firms have imperfectly correlated cash flows, it will reduce a firm's default risk which will benefit risky debt. ...
The coinsurance and wealth transfer hypotheses are both used to explain the wealth effect of acquirer and target bondholders during mergers and acquisitions (M&As). Hindered by a paucity of high-quality bond data, to date there is at best only limited and mixed evidence. Using bond transaction data from TRACE, we investigate daily bond market reactions to M&A announcements. Consistent with the wealth transfer hypothesis, we find new evidence that acquiring (target) firm bondholders experience negative (positive) and statistically significant abnormal returns. Moreover, investors of speculative-grade bonds experience more negative (positive) returns for the acquirer (target) than investment grades. In addition, larger deals and cash payment method worsen acquirer bondholders’ losses and reduce target bondholders’ gains. Target (acquirer) bonds experience more positive (negative) returns when the acquirer (target) is a public firm and when the target’s credit rating is below the acquirer’s. Lastly, consistent with a loss (gain) to acquiring (target) firm bondholders in the initial market reactions, acquirer (target) bonds are more likely to have their credit rating downgraded (upgraded) following the announcement of a merger or acquisition.
... Coinsurance arises anytime less-than-perfectly correlated projects are combined. This idea was first proposed by Lewellen (1971), extended by Higgins and Schall (1975) and Galai and Masulis (1976), and has been repeatedly considered in the financial literature, both empirically and theoretically. 5 We build on this work to examine how coinsurance interacts with the potential misvaluation of debt claims even when agents are risk neutral. ...
This article introduces the impact of debt misvaluation on merger and acquisition activity. We show the potential for debt misvaluation to help explain the shifting dominance of financial acquirers (private equity firms) relative to strategic acquirers (operating companies). Fundamental differences in governance and project coinsurance between the two types of acquirer would interact with debt misvaluation, resulting in variation in how assets are owned that depends on debt market conditions. We find support for our theory in merger data using a novel measure of debt misvaluation.
... Early studies (Lewellen 1971, Higgins and Schall 1975, Gallai and Masulis 1976 have shown that if capital markets are not efficient, there may be financial motives for unrelated firm expansion, that is, the product diversification can be an element of risk reducing strategies. The firms can allocate their activities among industries with opposite market risks to reduce the exposure of their core business. ...
How does technological relatedness influence the portfolio of multi-product firms hit by external shocks? To answer this question, we look at the effect of product-specific demand shocks on product portfolios of Hungarian firms in the 2005-2012 period. We find that production have become more cohesive in terms of technological relatedness if firms were exposed to demand shocks. Evidence suggests that firms in crisis drop or downsize additional products not related to their core product and concentrate resources on related products. JEL: C23, D22, D24, L25
... TOTAL_PAYOUT is the ratio of total payouts to lagged book value of assets, where total payouts are the sum of cash dividends and share repurchases based on the definition in Fama and French (2001), who define repurchases as net repurchases, that is, after removing from share purchases the effect of shares issued for employee stock option programs, to fund acquisitions, and for other corporate purposes. creation or a wealth redistribution between bondholders and shareholders (e.g., Galai and Masulis (1976), Higgins and Schall (1975), Kim and McConnell (1977), and Rubinstein (1973)). The theoretical paper by Leland (2007) proposes that under certain conditions the coinsurance effect may create value for both bondholders and shareholders. ...
We examine how organizational form affects corporate payouts. Conglomerates pay out more than pure plays in both cash dividends and total payouts (cash dividends plus share repurchases). Furthermore, their payouts are more sensitive to cash flows compared to pure-play firms. The sensitivity of payouts to cash flow increases as the cross-segment correlation in a conglomerate decreases. Corporate payouts increase after mergers and acquisitions (M&As), especially among M&As in which acquirers and targets are less correlated. These results suggest that the coinsurance among different divisions of a conglomerate allows them to pay out more cash flow to their shareholders than pure-play firms.
... Higgins y Schall, 1975;Haugen y Senbet, 1978 y 1988. ...
This article summarizes the most important theories on the creation of a company's capital structure in chronological order. We analyze the most representational studies and their results on the incidence that these theories have on the creation of a company's capital structure by using a behavioral analysis of different variables that are representative of these theories. Additionally, we review other representative characteristics in this context such as institutional factors and where companies are located. It also offers a general idea of the state of the art regarding the creation of company's financial structure.
... Lewellen (1971) concludes that the increased debt capacity of the resulting firm, in combination with the effect of tax deductible interest payments (tax advantage), motivate shareholder wealth maximizing firms to engage in mergers. Higgins and Schall (1975) and Galai and Masulis (1976) later extend this co-insurance hypothesis and demonstrate, theoretically, that the co-insurance effect leads to an increase in the market value of the merging firms' debt and a concomitant decrease in the market value of their equity. If diversification results in the co-insurance effect, lenders or bondholders are likely to reward it by accepting lower debt yields resulting in lower borrowing costs to the firm. ...
We find that firm value is reduced via industrial diversification and this reduction in value depends upon a firm’s technology intensity. We consider that asymmetric information problems are more severe in technology intensive industries and find that high tech industry firms present distinctly larger value reduction when compared to low tech industry firms. The negative valuation effect is greater for firms that have a relatively larger amount of intangible assets and greater R&D capital. We determine that our findings are robust to different estimation methods and alternative excess value measures.
... According to co-insurance theory, global diversification through foreign acquisitions may induce uncorrelated cash-flow streams arising from operating in different countries (Lewellen, 1971). These stable cash flows may minimise firms' earnings volatility, which, in turn, reduce their financial distress risk and financial constraints (Higgins & Schall, 1975). Hann et al. (2013) confirm that the co-insurance effect of diversification mitigates firms both default and systematic risk. ...
This paper examines how deviation from firms' target leverage influences their decisions on undertaking foreign acquisitions. Using a sample of 5746 completed bids by UK acquirers from 1987 to 2012, we observe that over-deviated firms are more likely to acquire foreign targets. Consistent with co-insurance theory, we find that over-deviated firms engage in foreign acquisition deals to relieve their financial constraints and to mitigate their financial distress risk. We also note that foreign acquisitions enhance over-deviated firms' value and performance, measured by Tobin's q and return on assets (ROA) respectively. These findings support the view that over-deviated firms pursue the most value-enhancing acquisitions. Overall, this paper suggests that co-insurance effects, value creation and performance improvements are the main incentives for over-deviated firms' involvement in foreign acquisitions.
... Financial synergies on the other hand usually arise from diversifying deals (Martynova and Renneboog, 2006). A decreased probability of bankruptcy, more stable cash flows and easier access to capital are different forms of financial synergies (Higgins and Schall, 1975;Lewellen, 1971;Stein, 1997). Typically researchers use event studies to measure the impact of corporate transactions on either short-or long-term shareholder value, where the former measures initial market reaction, that is, changes in share price over a short time period around the announcement of a deal (usually one month prior to and one month after transaction announcement), while the latter analyzes relative returns over a longer period, often one, two or three years after the transaction announcement. ...
In this paper we investigate the main features of the domestic and cross-border corporate acquisitions involving 38 European countries in the period 2003-2010. The analysis is based on characteristics of takeover transactions such as type of transaction, payment method, legal status of the target firm, activity relatedness, amongst other factors. In addition, we investigate the short-term wealth effects of 2,821 European mergers and acquisitions initiated by large and medium-sized European firms. We find that, upon announcement, domestic acquiring firms earn higher abnormal returns than cross-border bidders. Domestic bidders’ outperformance holds even when controlling for different bid and firm characteristics such as method of payment, type of transaction, public status of the target firm, and activity relatedness of the target and the bidder. We find larger short-term wealth effect of foreign firms bidding on Continental European targets than those of foreign firms attempting to acquire firms in the UK/Ireland. Our analysis shows that cross-border bidding firms tend to experience lower announcement returns when targets are located in countries with stronger investor protection mechanisms, suggesting that acquirers must compensate target firm shareholders (that is, pay higher premiums) if the quality of the corporate governance is reduced.
... Prior studies suggest that M&As may increase bondholder wealth through the coinsurance effect, since the likelihood of default decreases when the assets and liabilities of two firms are combined through M&A as compared to the likelihood of default in individual firms (see, e.g., Levy and Sarnat (1970), Lewellen (1971), and Higgins and Schall (1975)). The coinsurance argument implies that diversifying M&As are beneficial to bondholders, since existing risky debt is spread across the new firm's operations whose cash flows are imperfectly correlated. ...
I empirically investigate the relation between CEO inside debt holdings and mergers and acquisitions (M&As) and find evidence consistent with the agency theory’s prediction of a negative relation between CEO inside debt holdings and corporate risk taking. Further analysis shows that CEO inside debt holdings are positively correlated with M&A announcement abnormal bond returns and long-term operating performance, but negatively correlated with M&A announcement abnormal stock returns. Finally, I find evidence that acquirers restructure the post-merger composition of CEO compensation that mirrors their capital structure in order to alleviate incentives for wealth transfer from shareholders to bondholders or vice versa.
We investigate the influence of gender diversity on the acquisition choices of bidding firms and find that firms with greater gender diversity are more likely to acquire nonlisted targets, use cash as the method of payment, and purchase firms in similar industries. Results show that these preferences are significantly influenced by female directors' financial expertise, target industry experience, mergers and acquisitions (M&A) experience, academic and professional qualifications, and networks. The percentage of female directors on boards is positively correlated with the market response to the announcement of acquisition choices preferred by female directors. Furthermore, bidders improve efficiency and accumulate long‐term value gains through the contributions made by their female directors to these acquisition choices.
Firms' cross-regional development is essential for their growth, with communication costs arising from geographic distance becoming a widely discussed factor. However, the causal relationship between geographic proximity and firms' cross-regional development remains inadequately underexplored. By leveraging firm registration data from 2003 to 2014, and exploiting the staggered construction of China's high-speed rail (HSR) as a quasi-natural experiment, this paper studies the effects of falling communication costs on firms' cross-regional development. HSR construction leads to an 8.6% increase in the number of firms' affiliates and a 68.6% rise in the weighted average distance between new affiliates and their headquarters. The effects are more pronounced for firms with higher performance heterogeneity and in cities with limited Internet infrastructure, suggesting that HSR construction can mitigate information asymmetry and improve monitoring. This study provides new micro-evidence for how geographic proximity promotes firms' cross-regional expansion through communication cost channels, offering implications for multiregional firms and policymakers.
This study examines and analyzes diversification and intellectual capital on sustainability performance mediated by financial performance. This research was conducted at Sharia Commercial Banks (BUS) in Indonesia, registered with the Otoritas Jasa Keuangan (OJK) for 2011 - 2018, with a total sample of 10 Islamic banks that meet the criteria according to the sampling method used, namely purposive sampling. The data analysis technique used SEM-PLS with the help of WarpPLS 7.0 software. The results showed that intellectual capital and financial performance had a positive effect on sustainability performance, but diversification was not significant on sustainability performance. Financial performance can mediate the relationship between diversification and intellectual capital on sustainability performance. The VAF method calculates the mediating effect with financial performance results partially mediates because the VAF value is less than 80%.
By providing a solid theoretical basis, this book introduces modern finance to readers, including students in science and technology, who already have a good foundation in quantitative skills. It combines the classical, decision-oriented approach and the traditional organization of corporate finance books with a quantitative approach that is particularly well suited to students with backgrounds in engineering and the natural sciences. This combination makes finance much more transparent and accessible than the definition-theorem-proof pattern that is common in mathematics and financial economics. The book's main emphasis is on investments in real assets and the real options attached to them, but it also includes extensive discussion of topics such as portfolio theory, market efficiency, capital structure and derivatives pricing. Finance equips readers as future managers with the financial literacy necessary either to evaluate investment projects themselves or to engage critically with the analysis of financial managers. Supplementary material is available at www.cambridge.org/wijst.
This study explores the influence of chief executive officer (CEO) overconfidence on acquirer bondholder wealth in mergers from 1994 to 2019. We find that CEO overconfidence benefits acquirer bondholders. Overconfident CEOs are likely to choose targets with lower return correlations rather than targets with lower risk than acquirers. We further show there is a positive wealth effect during announcement periods as well as firm risk reduction and a positive long-run bond market reaction subsequent to merger completion when overconfident acquirers merge with targets that are less correlated. Overall, the coinsurance effect dominates the liquidity effect on overconfident acquirer bondholder wealth during a merger.
El artículo presenta los resultados de un estudio que tiene como propósito conocer la estructura financiera y los factores determinantes para la estructura de capital en las pymes del sector de confecciones localizadas en Valle del Cauca (Colombia). Como marco de referencia, se utilizan los principales aportes de las teorías sobre la estructura de capital y las evidencias empíricas, y como metodología, el análisis económico-financiero y el empleo de un modelo econométrico de datos de panel para el período 2000-2004. Se encuentra una alta y creciente concentración del endeudamiento a corto plazo, especialmente con entidades financieras y proveedores, aunque con algunas diferencias en la financiación de la pequeña y mediana empresa. También se aprecia que la oportunidad de crecimiento, la retención de utilidades, el costo de la deuda, la rentabilidad, la edad y la protección fiscal diferente a la deuda son los factores más influyentes al momento de tomar la decisión de endeudarse a largo plazo. Esos hallazgos impulsan a la indagación detallada de cada uno de los factores pertinentes de la estructura de capital.
We study whether and how banks reuse information across different but related borrowers in financing mergers and acquisitions. We find that stronger prior lending relationships between acquisition loan lenders and acquisition targets are associated with lower spreads and fewer covenant restrictions on acquisition loans. We show that the results are unlikely to be driven by unobservable acquirer, target, or lender characteristics. Consistent with the information asymmetry hypothesis, the effect is stronger when information asymmetry about the target firm is higher. We also find that the result is not driven by the coinsurance effect.
This study examines segment reporting information usefulness after the adoption of IFRS 8 in 18 European Union countries. Specifically, 1) we introduce a new comprehensive measure of segment reporting quality that reflects four different dimensions of segment information, 2) we investigate the impact of segment reporting quality on the cost of equity and debt capital after the adoption of IFRS 8, and 3) we investigate the moderating role of the country-level enforcement system on the association between segment reporting quality and the cost of equity and debt capital after the adoption of IFRS 8. Using a self-constructed segment reporting quality measure and a sample of 884 firm-year observations over the period of 2007 to 2011, we provide evidence that investors and lending institutions find no change in the usefulness of segment reporting after the adoption of IFRS 8. Our study is original in using a comprehensive measure of segment reporting quality. Furthermore, our study is the first to examine the relationship between segment reporting quality and the cost of debt capital after the adoption of IFRS 8 and the moderating role of the country-level enforcement system. Our findings provide useful insights to regulator and accounting standard-setting bodies about segment reporting.
Acquisitions made by distressed firms are economically important. This paper explores the rationale behind such acquisitions in a quasi-natural experiment and identifies the causal link between bankruptcy risk and acquisitions. Upon an exogenous reduction in bankruptcy risk, distressed firms react by cutting 46% of cash spending on acquisitions, announcing fewer deals, and borrowing less for acquisition-related activities. The evidence suggests that distressed firms make acquisitions to diversify bankruptcy risk. These findings demonstrate a new effect of financial distress on firm investment—the pressure to meet debt obligations creates an incentive for firms to diversify through acquisitions.
This paper compares the insolvency risk of financial holding companies' subsidiaries and bank holding companies' subsidiaries in the U.S. The presented findings show that financial holding companies' affiliates tend to engage in more risk-taking behaviour than bank holding companies' affiliates. Our results suggest a diversification discount in the complex structure of the financial holding company at the subsidiary level. The regulator should take into account the increased risk exposure of financial holding companies’ structures to stabilize the banking system.
This study aims to examine and analyze the effect of diversification, corporate governance and intellectual capital on sustainability performance, either directly or indirectly, by involving financial performance as a mediating variable. This study uses secondary data on Islamic Commercial Banks in Indonesia which are registered with the Financial Services Authority from 2011 - 2018, with a sample size of 10 Islamic banks that meet the criteria using the purposive sampling method so that 80 observations are obtained. Data is obtained from annual reports, sustainability reports, and reports on the implementation of good corporate governance. The data analysis technique used SEM-PLS with the help of WarpPLS 7.0 software. The results of the study provide empirical evidence that both the quality and quantity of corporate governance, intellectual capital and financial performance have a positive effect on sustainability performance.
To carry out an evaluation of the impact of the global financial crisis of 2008 on the decision variables of the capital structure of non-financial companies listed on the stock exchange. A panel of non-balanced data was constructed and a population of 5,203 non-financial companies from Brazil, Chile and Mexico over the years 2003 to 2013 was studied through a methodology of random effects. The results show that in periods prior to the financial crisis, the level of debt is mainly explained by variables of demand for funds, with the size of the company. After the crisis, both the demand and the supply of credit are key in the level of debt, highlighting the size of the company, liquidity and operational risk, with the exception of Mexico. In this way, dissimilar effects are observed before and after the financial crisis in the financial structure, which allows us to conclude that the financial crisis of 2008 really affected the financing decisions of the companies in the study. This article contributes updated information to the scarce international literature available that evaluates the effects of a global financial crisis on the financing decisions of Latin American companies.
In this paper, we investigate whether foreign and domestic assets of US firms are financed with borrowed funds (e.g., with short-and long-term debt maturity structures). Our regression analysis documents a positive association between foreign assets and long-term debt, and a negative association between foreign assets and short-term debt. Estimation results show that 1% increase in FAS leads to, on average, a 39 percent increase in leverage, an economically important effect. We also document the opposite relations between long-term (negative relation) and short-term (positive relation) and domestic fixed assets. Further analysis suggests that a one percent increase in domestic assets corresponds to -20.13% decrease in long-term debt, while a 1% increase in domestic assets raises short-term debt by 16.66 percent, on average. We further find that foreign assets are incrementally, positively associated with Tobin’s q, indicating that foreign investment is a successful path to higher equity value, a result inconsistent with Denis et al (2002). In the partition sample, we find that variation in debt affects the pricing of foreign assets. We document that foreign assets of high debt-to-asset ratios are positively related to Tobin’s q, whereas the relation is less positive for medium debt-to-asset ratio firms and insignificant for low debt-to-asset ratios, implying that near-all equity firms do not trade at a discount.
Diversification is a strategic option that investors use to optimize their portfolio. Diversification is investing in many assets for the purpose of minimizing risk or maximizing return of portfolio. It is an opportunity by which investors improve from his micro-firm into macro-firm. The investors’ aim is to make an optimal choice that leads to minimization of risk and maximization of return, but the platform that achieves these objectives is not at the finger tips. The purpose of this study is to propose procedures for constructing optimal portfolio for rational investors. Also, the study demonstrates the benefits of diversification of each asset in portfolio. The assets allocations divulge by Black Litterman model are used to estimate risk of both portfolios and assets. We explore DataStream (Yahoo finance) of Gold, Oil, Silver and Platinum. It is observed that diversifying in Gold minimizes higher risk and achieve more benefits than other assets in the portfolio, which made portfolio1 to be optimal portfolio. In view of these facts, it means diversifying in gold acts as hedge/safe haven for investors during economic recession.
Banks who can influence clients' governance may steer those clients into mergers to reduce the banks' own risk. Empirical evidence based on Japan's mergers and acquisitions (M&As) during the country's 1990s banking crisis indicates that acquirers with stronger bank ties made acquisitions that they would not have normally made. These acquirers lost more shareholder value via mergers than acquirers with weaker bank ties. The banks' risk was reduced, while the banks' shareholders gained significant excess returns from their borrowers' mergers. This paper offers implications for corporate governance of firms with strong bank ties and advances the existing knowledge on business groups.
This paper investigates whether corporate diversification by property type and by geography reduces the costs of debt capital. It employs asset-level information on the portfolios of U.S. REITs to measure diversification and looks at two of their main sources of debt capital: 1,173 commercial mortgages and 952 bank loans. The paper finds that diversification across different property types does indeed dependably reduce the cost of these different types of debt. The effect is about 7 basis points for bank loans if a firm’s property Herfindahl Index is lowered by one standard deviation and this effect gets stronger for REITs with worse financial health – as measured by the interest coverage ratio. The corresponding effect for commercial mortgages is around 22 basis points for collateral diversification by property type. After the crisis, the salience of the collateral asset increases. For diversification across regions, we do not find a consistent relationship between real asset diversification and loan pricing.
Tujuan penelitian ini adalah menguji pengaruh diversifikasi usaha terhadap biaya modal dikaitkan dengan korelasi arus kas antar segmen serta tingkat kendala pendanaan yang dihadapi perusahaan. Model penelitian diuji dengan menggunakan sampel dari seluruh perusahaan di luar sektor keuangan yang terdaftar di Bursa Efek Indonesia periode 2010-2014 dengan metode Feasible Generalized Least Square (FGLS). Hasil penelitian menunjukkan diversifikasi usaha berpengaruh positif terhadap biaya modal secara keseluruhan. Namun, pengujian model secara parsial menunjukkan adanya perbedaan pengaruh diversifikasi terhadap biaya utang dan biaya ekuitas. Di satu sisi diversifikasi usaha menurunkan biaya utang, dan di sisi yang lain juga dapat meningkatkan biaya ekuitas. Temuan yang lain menunjukkan bahwa semakin rendah tingkat korelasi arus kas antar segmen usaha, semakin rendah biaya modal yang ditanggung perusahaan. Tingkat kendala pendanaan juga menunjukkan pengaruh signifikan dalam memoderasi hubungan diversifikasi usaha dengan biaya modal.
The purpose of this chapter is to view the state and prospect of capital budgeting as a field of study. The literature to be considered embraces expositions of the theoretical framework and context of the field, planning models, and empirical surveys. The literature is diverse in emphasis — some say divergent:
Industrial engineers, economists, operations research analysts and finance specialists claim [capital budgeting] as their domain. Each has a unique perspective and point of view, each tends to concentrate attention on a different type of problem because of slightly different goals, each tends to use a different set of tools... The literature has tended to diverge from, rather than converge to, a unified whole. (Thompson, 1976, p. 125)
Progress since this was written in integration of other aspects of corporate planning with capital budgeting, and in enrichment of theoretical models towards reality and empirical tractibility, has been material. This progress is substantially due to increasing technical facility, increasing interdisciplinary collaboration, and growing sophistication in management training and interest.
Purpose
The purpose of this paper is to survey bank credit managers and analysts in Mozambique regarding their attitude toward firm diversification.
Design/methodology/approach
Forty-five credit managers and analysts from 23 banks in Mozambique were surveyed about their views on diversification and diversified firms. Questionnaires were used. Data were analyzed using chi-square test and binomial test.
Findings
Credit analysts and managers in Mozambique have a generally positive attitude toward diversification. This is mainly due to the coinsurance effects and stability of cash flows that diversification could provide. They, however, prefer moderately diversified to highly diversified firms and related to unrelated diversified firms. This is a puzzle, given the expectation that greater unrelated diversification is better able to provide coinsurance.
Practical implications
The study provides information that is useful for understanding the diversification–cost of capital relationship and could help corporate managers in making capital structure decisions.
Originality/value
Previous researchers have not studied the attitude of credit managers/analysts toward diversification in Mozambique using the survey approach. The study contributes to the literature on diversification and access to external finance, the diversification discount and cash holding behavior of firms.
Merger activity amplifies the conflict of interest between a bidder's different classes of security holders. This study examines how equity returns and credit default swap spreads are affected by acquisition-driven changes in firm leverage. We develop an improved proxy for predicted leverage changes which includes transaction financing and find it has a positive relationship with both equity returns and credit spreads. Using data for North American firms that made acquisition announcements between 2008 and 2014, we find that in leverage increasing mergers, bidding firm shareholders gain while bondholders lose. While these results are consistent with the wealth transfer literature we show that it is caused by the change in leverage, not the form of payment or its signaling effect as is commonly documented.
The phenomenon of global warming as changes in the business environment has impacted on the strategic planning processes of Mexican companies in the creation of objectives and methodologies in various fields and sectors, highlighting the importance of adapting to the needs and the limitations that may arise with climate change in the various markets we are focused.
I empirically investigate the relation between CEO inside debt holdings and mergers and acquisitions (M&As) and find evidence consistent with the agency theory’s prediction of a negative relation between CEO inside debt holdings and corporate risk taking. Further analysis shows that CEO inside debt holdings are positively correlated with M&A announcement abnormal bond returns and long-term operating performance, but negatively correlated with M&A announcement abnormal stock returns. Finally, I find evidence that acquirers restructure the post-merger composition of CEO compensation that mirrors their capital structure in order to alleviate incentives for wealth transfer from shareholders to bondholders or vice versa.
A great many people provided comments on early versions of this paper which led to major improvements in the exposition. In addition to the referees, who were most helpful, the author wishes to express his appreciation to Dr. Harry Markowitz of the RAND Corporation, Professor Jack Hirshleifer of the University of California at Los Angeles, and to Professors Yoram Barzel, George Brabb, Bruce Johnson, Walter Oi and R. Haney Scott of the University of Washington.
In Section I of the present paper, it is shown that Proposition I (relationship between income streams) and the irrelevancy of firm-investment diversification hold in the multiperiod case, with risky (as well as riskless) debt and with no assumption regarding which income-stream parameters (e.g. mean an variance) are used by investors in selecting portfolios. That is, no particular valuation equation is assumed. Proposition I is derived first , given homogeneous investor expectations, and then is extended to the case of heterogeneous expectations by adding a further assumption. In Section II, corporate taxes are introduced. Proposition I does not hold in this case. However, a similar proposition is derived and found to imply that diversification should not be a consideration for firm-investment policy even with corporate taxes. In establishing the results of Section I and II, it is assumed that capital markets are competitive with zero transaction costs and that, therefore, "arbitrage" can be performed in the market. In Section III, the arbitrage assumption is briefly examined.
I. Debt versus equity financing, 452: Investor portfolio choice, 454; Fundamental leverage theorem, 456; Leverage as an externality
456; Effect of no default risk: the “homemade leverage theorem,” 457; Corporate management and the capital markets, 458; Corporate
capital budgets as a “public good,” 460. — II. The corporate investor: long-, margin-, and short-risk positions, 462. — Appendix:
option financing, 467.
This paper considers the implications of bankruptcies, take-overs, and divergent expectations for the financial policy of the firm; we argue that, under reasonable assumptions, there is an optimal debt-equity ratio. Previous studies have shown that under very general conditions, if there is no chance of bankruptcy, then financial policy has no effect on the value of the firm; there is no optimal debt-equity ratio. Under certain very restrictive conditions, the no bankruptcy condition may be removed. We show that when these restrictive conditions are not satisfied, and when there is a real possibility of bankruptcy if the firm issues too much debt, the firm's valuation will depend on its debt-equity ratio; the real decisions of the firm (e.g., its investment and choice of technique) cannot be separated from its financial decisions; and the real decisions of the firm may not be productively efficient. Finally, the implications of the possibility of a take-over for the financial policy of the firm are considered.
A Pure Financial Rationale for the Conglomerate Merger: Comment
- Higgins
The Profitability of Conglomerate Investment Mergers: Sources and Prospects
- Alberts W. W.