Real and Financial Decisions in Mergers

28 Pages Posted: 4 Nov 2001

See all articles by Murray Brown

Murray Brown

SUNY at Buffalo, College of Arts & Sciences, Department of Economics

Shin-Hwan Chiang

York University - Department of Economics

Multiple version iconThere are 2 versions of this paper

Date Written: October 2001

Abstract

Both real and financial variables are integrated into a model of oligopolistic firms that allows for mergers. Limited liability provides the basis for financing mergers by means of debt. This shifts risk to credit holders in bad states of nature. In general, it is found that when the credit market clears, the cost of credit to the firm increases with the amount of debt issued. Moreover, if all agents are risk neutral no debt is issued; the merger is financed only by equity. But allowing the merged firm to be risk averse does yield nonnegative debt, depending on its cost and its strategic effect. Simulations of a special form of the general model help explain the change in capital structure from the high debt-equity ratios in the 1980's and the low debt-equity ratios associated with mergers in the 1990's. These explanations make explicit the role played by changes in risk aversion as a result of the increased institutional presence in the 1990's equity market, the increase in product market volatility, and the increase in competition. We also indicate what did not contribute to the change in the capital structure in the two decades.

Keywords: Capital Structure; Large Shareholder; Risk Aversion; Risk Shifting; Merger

JEL Classification: G32, D8, L1

Suggested Citation

Brown, Murray and Chiang, Shin-Hwan, Real and Financial Decisions in Mergers (October 2001). Available at SSRN: https://ssrn.com/abstract=288679 or http://dx.doi.org/10.2139/ssrn.288679

Murray Brown

SUNY at Buffalo, College of Arts & Sciences, Department of Economics ( email )

Fronczak Hall
Buffalo, NY 14260
United States
716-838-1941 (Phone)
716-645-2127 (Fax)

Shin-Hwan Chiang (Contact Author)

York University - Department of Economics ( email )

4700 Keele St.
Toronto, Ontario M3J 1P3
Canada
416-736-5083 (Phone)

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