The Medium of Exchange, Control Loss and Wealth Effect on Suppliers in Mergers and Acquisitions

Abstract

I examine the corporate control implications of the financing decision in mergers for bidder suppliers. Specifically, I hypothesize that reallocation of control rights from bidder management to target management and block-holders through stock financing in mergers, especially non-diversifying ones, has negative value implications for bidder suppliers due to the nature of incomplete contracting. Because future contingencies are hard to predict, intense trading relationships between the bidder and its suppliers are often governed by implicit agreements. Since the ability of management to deliver on implicit agreements with suppliers is closely related to their controlling power, corporate decisions that dilute managerial power such as stock financing in M&A transactions will have an adverse impact on the firm's suppliers. To the extent that bidder suppliers cannot influence the choice of target, the target ownership structure and the medium of exchange in mergers, the financing decision of bidder would constitute an exogenous shock to bidder suppliers, and provides an ideal setting to examine value implications on bidder suppliers of corporate control changes in the bidder. In support, I find that bidder suppliers affected by non-diversifying mergers suffer strong negative announcement returns of -1.04% in stock offers, but not in cash offers. Moreover, the announcement returns of bidder suppliers become more negative with larger control rights transfer to target management and institutional block-holders in stock offers. Bidder suppliers, however, can rely on higher percentage of sales to the bidder to mitigate the adverse impact of stock financing. In contrast, these effects are not observed for bidder suppliers affected by stock financing under diversifying mergers. These findings remain robust to controlling for the use of over-valued equity using the bidder's accruals and run-up in stock price. Furthermore, bidder suppliers face lower retention likelihood, albeit weakly, when stock financing is used over cash financing under circumstances where there is control rights transfer to target block-holders. Lastly, under non-diversifying mergers, bidder suppliers affected by stock financing and are dismissed experience worse performance post-merger.