Corporate mergers and the impact if pre-merger variance, leverage and maturity of bonds on wealth transfers

Abstract

This paper addresses several hypotheses concerning wealth transfers among bondholders and stockholders in two firms which merge. In so doing, several refinements relative to the previous research in this area are introduced. We find evidence which supports the presence of diversification effects (coinsurance) to some bondholders, incentive effects (risk increases) to other bondholders, and wealth transfers between stockholders and bondholders. This study examines the impact of 49 industrial mergers between 1970 through 1984 on the returns to bondholders and stockholders of the merging firms. Results indicate that bondholders of the acquired firm group gain significantly in the announcement month, suggesting a diversification effect for acquired firm bondholders. Acquiring firm bondholders suffer significant losses in the pre-announcement month supporting the incentive effects hypothesis for the acquiring firm bondholders. Further analysis indicates that abnormal returns to bondholders are greater for firms with high variance and high leverage pre-merger. We do not find any direct evidence that differences in maturity of merging firms’ bonds have a significant impact on merger-related bondholder returns. We find evidence of wealth transfers between stockholders and bondholders of merging firms and some support for the theory that bondholder returns are negatively related to the pre-merger correlation between cash flows of the merging firms. In total, the empirical findings enable more definitive conclusions regarding the wealth effects of mergers on important classes of claimholders of merging firms, and buttress the theoretical developments relating to wealth transfers among those claimholders.