Explaining returns to cash bids : Tests of the free - cash - flow and market imperfections hypotheses

Cash takeover bids financed from internally generated cash reserves could be a function of capital market imperfections (Myers and Majluf 1984) or symptomatic of “free-cash-flow” problems (Jensen 1986, 1988). We find that bids financed from cash reserves outperform those that use debt financing. Further, ‘free cash flow’ firms outperform ‘non-free cash flow’ firms. The majority of cash bids are made by ‘non-free cash flow’ firms, and the profile of the typical ‘free cash flow’ cash bidder is consistent with firms that hold high levels of cash due to capital market imperfections. Our evidence supports the market imperfections theory of investment financing. * University of Sydney # University of Stirling † University of Western Australia Corresponding Author: R.J.Limmack Dept of Accounting, Finance and Law University of Stirling Scotland FK9 4LA Email: [email protected]