Adverse Selection and M&A Design: The Roles of Alliances and IPOs

Abstract

This paper investigates strategic alliances and initial public offerings (IPOs) as factors that potentially mitigate the risk of adverse selection in mergers and acquisitions. It is hypothesized that prior alliances between acquirers and targets as well as IPOs undertaken by targets reduce information asymmetries or lessen their effects by offering targets signaling opportunities. Using data on the types of consideration used in M&A transactions to reflect the allocation of overpayment risk across acquirers and targets, we find that targets' prior alliances with acquirers as well as targets' IPOs reduce the likelihood of using stock, or the amount of stock used, to finance acquisitions of these targets. We also present evidence that alliances and IPOs substitute for one another.