Capital Structure and Control Transactions Job Market Paper

In this paper I propose a model for two bidding firms competing to acquire a target. I show how the capital structures of the bidders determine the equilibrium outcome of the takeover contest. Notably, I demonstrate that there exists an asymmetric equilibrium with endogenous leverage, bankruptcy, and takeover terms. The model generates a number of predictions consistent with empirical evidence and provides grounds for further empirical research. In particular, the model predicts that the leverage of the winning bidder is below the industry average. Also, the winner of the takeover contest is expected to lever up after the takeover consummation. The model also shows the potential to reconcile traditional contingent claims capital structure models with empirical evidence. Finally, the model relates the degree of leverage asymmetry to industry characteristics. Preliminary empirical analysis supports the predictions of the model.