Booms, Busts, and Firm Exit: Evidence from M&A Activities Across Business Cycles

Abstract

Our paper investigates a corporation's mergers and acquisitions (M&A) investment decisions across business cycles and their impact on the firm's involuntary exit hazard in a recession. We find that firms that concentrate most of their M&A activities in the good times (economic expansions) exit more often in a subsequent recession than firms that distribute M&A investment decisions to non-expansionary times. The increase in the probability of exit for those firms that make one standard deviation more M&A bids than an average firm in the sample would cause a one notch downgrade in ratings, assuming they are AAA firms. We show that the heightened exit hazard of expansionary bidders in recessions is transmitted through a channel of agency cost of overvalued equity, increased business risk and reduced firm efficiency. Our results suggest that a cleansing effect of recession is at work in the business sector and firms need to examine carefully their investment policies in good times to cushion against involuntary exit in bad times.

Keywords: Recession, Boom, Bust, Firm Exit

JEL Classification: E32, G33, G34