Do Capital Structure Adjustments by Takeover Targets Influence Acquisition Gains?
Existing theoretical models predict that takeover targets optimally increase debt and repurchase equity around takeover attempts. Ultimately, these leverage shifts should benefit target shareholders and enhance bargaining power in negotiations with acquiring firms. We show that target firms indeed issue higher levels of debt, and simultaneously repurchase more equity, relative to a set of matched firms, during the period from one year prior to takeover announcement through completion. We find that bank debt is the primary source of these debt increases. Lastly, we find evidence consistent with the expectation of improved bargaining power for target equityholders with target debt issuances. We document that compared to debt issued by non-target firms, announcements of debt issuances by takeover targets are associated with additional positive abnormal returns to target stockholders. Additionally, at least some of these target equity gains appear to come at the expense of bidder shareholders. These impacts on target and bidder abnormal returns are more significant for debt issuances occurring in the periods immediately preceding and following takeover announcement, as well as for issuances of bank debt. Debt issuances occurring after takeover announcement appear to reverse initially lower (higher) abnormal returns experienced by targets (bidders) upon takeover announcement itself, and further increase the likelihood of positive adjustments to acquisition premiums offered by the bidders to the targets.