Strategic underleveraging and acquisitions

Funding Information: We would like to thank Anup Basnet, Gonul Colak, Douglas Cumming, Alexandre Garel, Peter Nyberg, Dimitris Petmezas and Milos Vulonovic as well as the editor and two anonymous referees for valuable comments. Publisher Copyright: © 2022 The AuthorsTThis paper investigates the Morellec and Zhdanov (2008) (MZ) prediction that firms strategically underleverage to win takeover contests. We document support for several specific MZ model predictions: pre-bid underleveraging increases with bidding competition, synergies offered by targets, investment type, industry concentration, and with firms actively adjusting their capital structure in advance of bidding. An empirically verified financial frictions explanation does not fully account for these patterns. Taken together, we find consistent evidence that strategic underleveraging conditional on the acquisition outlook is an important determinant of capital structure dynamics.Peer reviewe