Do firms have leverage targets? Evidence from acquisitions, forthcoming Journal of Financial Economics

In the context of large acquisitions, we provide evidence on whether firms have target capital structures. We examine how deviations from these targets affect how bidders choose to finance acquisitions, the valuation effects of those decisions, and how bidders adjust their capital structure following the acquisition. We find that when a bidder’s leverage is over its target level, it is less likely to finance the acquisition with debt and more likely to finance the acquisition entirely with equity. Bid announcement returns reveal that movements away from an optimal capital structure reduce firm value. Following cash acquisitions that over-lever the firm, managers actively move the firm back to its target leverage, reversing 75 % of the acquisition’s leverage effect within 5 years. Attempts to mitigate under and overinvestment problems are important determinants of bidders ’ decisions to maintain a target capital structure. Overall, our results are strongly consistent with a model of capital structure that includes a target level and adjustment costs