How Do Firms Price Optimal Capital Structure? Evidence from Mergers and Acquisitions

Finance

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Abstract

This study examines how capital structure considerations affect acquisition pricing. Over-levered bidders pay higher premiums in leverage rebalancing deals and create leverage slack, while under-levered acquirers are not equally incentivized to lever up towards target leverage; rather they offer higher premiums using overvalued equity as they consider the market timing opportunity more valuable than leverage rebalancing. This asymmetry is more pronounced for financially constrained firms with non-rated debt. Over-levered acquirers also pay higher premiums for potential debt capacity improvement. Rebalancing and debt capacity improvement are value-enhancing for over-levered acquirers only when the option to borrow is exercised in the long-run.