Jensen, Myers-Majluf, Free Cash Flow and the Returns to Bidders

Previous research has shown that returns to bidders are significantly negative for stock acquisitions and insignificant although slightly positive for cash acquisitions. Two theories (Jensen and Myers-Majluf) would predict positive returns to bidders in cash acquisitions which use up excess cash flow and slack. This paper investigates bidder returns using these theories and the Lang, Stulz, and Walkling proxy for free cash flow. It finds that cash bidders that have low q and sizable free cash flow and that reinvest a high percentage of this free cash flow have significant positive returns as Jensen's theory predicts. It finds no evidence supporting the Myers- Majluf theory. Cash bidders without Lang, Stulz, and Walkling free cash flow have returns that are negative and essentially indistinguishable from those of stock bidders