Fire Sale Acquisitions: Myth vs. Reality

Abstract

A consequence attributed to economic crises is that firms could be forced to sell at deep discounts, or fire sale prices. In addition to the wealth transfer from the shareholders of the selling firms to that of the acquiring firms, the economy may also lose when bargain hunting acquirers may not be the ones that could provide the best utilization of the assets. The purpose of our study is to provide empirical evidence to support or reject these conjectures. Specifically, we calculate and compare prices at which companies are sold under normal and recessionary periods for selling firms that are and are not under pressure or in weakened bargaining positions. We find the existence of fire sale discounts depends critically on the reference price used in calculating deal premiums (discounts). Using the stock price near the announcement date as a reference point, instead of a discount, we find distressed firms in crisis periods received a 26% higher offer premium than distressed firms in normal economic periods. When compared to non distressed firms, distressed firms received a 31% higher premium in crisis periods. Decomposing the discounts in transaction prices, we find economic crises brought an average premium of 19% to all target firms. Acquirer announcement return results show that the market reacts negatively for all acquisitions, including those involving distressed firms and/or economic crises. Long term return results also show negative acquirer performance for all acquisitions not taking place during a crisis period. Combining all results, we find that on average, fire sale acquisitions related to firm distress do not exist and that stock prices near the announcement date are relatively efficient, even for distressed firms, although the absolute price levels may be too low in crisis periods. Thus, the notion of fire sale discounts may have to rely on a behavioral explanation.

Keywords: Fire sale, mergers and acquisitions, financial crisis, firm distress, behavioral corporate finance

JEL Classification: G34