Cash Acquirers: Can Free Cash Flow, Debt and Institutional Ownership Explain Long Run Performance?

Abstract

Purpose - This paper investigates the Jensen's free cash flow (FCF) hypothesis in the context of UK cash acquisitions. Under this hypothesis, financial slack induces mangers to acquire targets for cash if such behaviour generates either pecuniary or non-pecuniary rewards for them, giving rise to a potential agency problem around cash takeovers. We argue that the stronger position of shareholders, as opposed to firm managers, in the UK should help in constraining such potential agency problems around such mergers. Compared to the USA, position, this should make the FCF hypothesis less relevant in the UK. Design/methodology/approach - This paper uses short-run announcement period returns and long-run calendar-time returns in testing our hypotheses. Findings - This paper shows that low leverage and high FCF may be advantageous provided shareholder monitoring is adequate. By analysing both announcement period and long-term returns, we show that acquirers with high levels of FCF are superior performers, and that any long-run under-performance of cash acquirers appears to be associated with low cash resources and low institutional ownership. Research limitations/implications - Inevitably, long-run returns measurement is contentious, although we present results from alternative models to mitigate this. Limitations are necessarily imposed by the sample size, meaning that multi-way partitioning of the data is not feasible. Practical implications - The practical implications are that the UK regulatory and institutional ownership regime may actually protect the interests of shareholders and mitigate agency problems. Originality/value - As far as we are aware, this is the first paper to systematically test FCF, leverage and institutional ownership effects in the context of UK cash acquisitions.