The Combined Effects of Free Cash Flow and Financial Slack on Bidder and Target Stock Returns

Joohyun Kim

216 citations0/0 files storedThe Journal of Business

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Corporate Finance and Governance Financial Markets and Investment Strategies Financial Reporting and Valuation Research

Abstract

This article examines the extent to which takeovers mitigate the underinvestment problem of S. C. Myers and N. S. Majluf (1984) and the free-cash-flow problem of M. C. Jansen (1986). Using accounting data, bidders are classified as 'high free cash flow,' 'slack poor,' or 'other.' Bidder, target, and total returns are highest for acquisitions that combine slack-poor and free-cash-flow firms. The widely cited negative returns of bidders are concentrated among combinations where bidders and targets are similarly classified. Cross-sectionally, bidder returns are more positive when associated with capital structure and liquid asset changes that mitigate bidder slack or free-cash-flow problems. Copyright 1994 by University of Chicago Press.

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References

1984Corporate financing and investment decisions when firms have information that investors do not have 1986Agency Costs of Free Cash Flow, Corporate Finance, and Takeovers 1990Do Managerial Objectives Drive Bad Acquisitions?1988Synergistic gains from corporate acquisitions and their division between the stockholders of target and acquiring firms 1987Corporate Takeover Bids, Methods of Payment, and Bidding Firms' Stock Returns 1989Free Cash Flow and Stockholder Gains in Going Private Transactions 1991A test of the free cash flow hypothesis 1989Managerial performance, Tobin's Q, and the gains from successful tender offers

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