Capital Structure and Corporate Financing Decisions: Theory, Evidence, and Practice

P1: TIX/XYZ P2: ABC

JWBT436-c24 JWBT436-Baker March 4, 2011 8:2 Printer Name: Hamilton

434 Special Topics

investors than equity financing because the profits mainly accrue to the current

shareholders. In contrast, in issuing new equity the new shareholders share the

losses in case the takeover does not generate the expected cash inflows (Schlinge-

mann 2004).

As Exhibit 24.4 shows, the empirical evidence is generally consistent with these

predictions. First, in line with the agency costs of free cash flow hypothesis, Mar-

tynova and Renneboog (2009) document that debt-financed cash payments result

in significantly higher announcement returns for the bidder than those financed

with internally generated funds. Second, Bharadwaj and Shivdasani (2003) report

that acquirers’ returns are positively related to the fraction of the deal value that

is financed with bank debt. Thus, in addition to the monitoring function of the

capital market, banks also perform an important certification and monitoring role

for acquirers. Finally, Martynova and Renneboog (2009) find that equity financing

is associated with negative bidder returns irrespective of the method of payment.

Hence, sufficient empirical evidence exists to conclude that in takeovers, debt

financing is more value enhancing than equity financing.

Sequence of Financing and Acquisition Decisions

With respect to sequential financing and M&A decisions, bidder gains at the time

of the takeover announcement are positively related to the amount of cash that

was raised through ...