Acquisition Financing: A Study of American Companies' Choice of Acquisition Financing in Relation to Capital Structure Theory, and Derived Market Reaction

Abstract

The aim of this thesis is to investigate how the general capital structure theory coincides with American companies’ choice of acquisition financing and with the derived market reaction. We take a point of departure in a hypothetico-deductive methodology by presenting a range of hypotheses based on capital structure theory. Quantitative empirical data of 350 US acquisitions between 2012-2021 are used to create a scenario in which theoretical falsification is sought. Multiple metrics are presented to create the base for analysing the choice of acquisition financing in relation to the hypotheses. The market reaction of the acquisition announcement is analysed by applying the event-study methodology. Statistically, ttests and probit regressions are applied to strengthen the validity and reliability. Firstly, our analysis of Modigliani & Miller showed evidence of exposure to other market imperfections than tax, and how low interest rate environments decrease the tax shield’s value-add resulting in the use of other financing methods than debt. Further observations suggested the prevalence of favouritism towards a rebalancing financing method, thereby supporting the trade-off theory. Evidence also indicated the presence of the pecking-order theory financing hierarchy. In addition, observations regarding stock price movements prior to announcement backs the market-timing hypothesis. Despite evidence in favour of the capital structure theories, all theories were exposed to contradicting results, thereby implying that neither a complete acceptance nor rejection of the hypotheses, except the rejection of Modigliani & Miller, could be made. Our analysis of the observed market reactions arguably showed support of the trade-off theory since using a rebalancing financing method positively affected the market reaction. Further evidence showed debt as having the most positive and generalisable effect on the market reaction, thereby underpinning Modigliani & Miller. Observations both in favour and against the pecking-order theory and the free cash flow hypothesis were presented. In a similar fashion as for the analysis of acquisition financing, a complete acceptance nor rejection of the hypotheses was not possible due to both contradicting and supporting evidence