Means of payment and timing of mergers and acquisitions in a dynamic economy

This paper studies the interaction between takeover activity, means of payment (cash versus stock), and premiums in a dynamic real-options model. The timing of takeovers and the equilibrium bids in contests with multiple bidders are driven by three factors: synergies of the bidder with the target, cash constraints of the bidder, and cash constraints of its competitors. The model produces many testable hypotheses, both novel and consistent with existing studies. First, contests in stock extract more surplus from the bidder, so higher-synergy bidders benefit from approaching targets when they are smaller and acquiring them in cash. This self-selection by bidder quality can explain higher takeover premiums in cash versus stock deals in the sample of takeovers. Second, cash constraints need not have a monotonic effect on incentives of bidders to approach the target. Finally, high deal activity can be caused by shocks not only to valuations but also to cash constraints.