Overlapping insiders and the method of payment in acquisitions: New tests and evidence on adverse selection

Journal: British Accounting Review

Synopsis: Why do stock-financed acquisitions underperform cash-financed ones? What effect does information asymmetry between the transacting parties have on the payment method in acquisitions? Using a novel information proxy of deals with overlapping insiders on both sides, the researchers try to unravel these questions in this paper.

Specifically, they find that (1) stock-financed acquisitions underperform cash-financed ones only when insiders are non-overlapping between acquiring and target firms, (2) deals in which acquiring and target firms share overlapping insiders have a significantly higher propensity of getting financed with stock relative to those with non-overlapping insiders, and (3) the effect of overlapping insiders on the propensity of stock financing weakens when acquiring and target firms share the same industry (i.e., in the presence of other channels of information asymmetry reduction).

Their results indicate that (1) the difference between the performance of cash-financed and that of stock-financed acquisitions is attributable primarily to the adverse selection effects of stock issues, and (2) the effect of a particular channel of information asymmetry reduction on the payment method is greatest in the absence of other channels.