Abstract

We examine whether the M&A decisions of zero-leverage (ZL) firms may not be optimal (value-maximizing) as their choices of targets may be limited for maintaining zero leverage, by comparing their short-term announcement returns and long-term post-acquisition firm performance with leverage firms. Our main findings are as follows: debt-free companies tend to acquire targets with low or zero leverage; zero-leverage acquirers underperform non-ZL acquirers around event announcement and the result is robust to using the matched sample and controlling for bidder management quality, governance quality, and bidder, target and deal characteristics; compared to levered buyers, zero-debt buyers display significantly lower long-term post-acquisition operating performance as well as lower post-acquisition stock return performance, and the difference in the long-term operating performance between zero-leverage and leverage bidders is robust to the methodology and benchmark used. Overall, our results show that unlevered firms underperform levered firms during and after the M&A activities. Our results suggest that M&A decisions of zero-leverage acquirers may not be value maximizing since they tend to draw on a limited pool of targets given their preference to maintain zero leverage.