The risk effects of acquiring distressed firms

Abstract

Existing research shows that bidder default risk increases following acquisitions due to a rise in post-acquisition leverage and managerial risk-taking actions offsetting the potential for asset diversification. This study examines whether the risk effects of acquiring distressed targets are fundamentally different and investigates possible explanations for any dissimilarities. Bidders often acquire relatively smaller distressed targets in domestic and related industries and have a higher initial target stake and more financial flexibility, thereby minimizing risk exposure. Controlling for several characteristics of bidder investment behaviour in both types of deals, however, we find that the increase in bidder default risk is substantially larger when acquiring distressed firms.