Why are Cash-Rich Firms More Likely to Pay for Acquisitions with Stock?

Abstract

We examine why cash-rich firms prefer to use stock to make acquisitions. Consistent with prior literature, we find that cash-rich firms are more likely to attempt acquisitions than other firms. However, cash-rich acquirers are more likely to employ stock as the method of payment. We investigate this finding further and show that cash-rich firms use overvalued equity to make acquisitions. Moreover, there is no evidence that firms waste excess cash on acquisitions; cash-rich firms that pay with cash actually acquire undervalued firms. Finally, in the post-acquisition period, cash-rich firms that acquire with stock are at least as likely to maintain high levels of excess cash as non-bidder cash-rich firms.