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Acquisition Mode and Financing in Takeovers

In this paper, I explore how the acquisition mode and capital structure of the acquiring firm are determined when there is asymmetric information about the type of manager of the acquiring firm. Under nonbootstrap acquisition, an increase in the leverage ratio reduces the capital cost by mitigating the asymmetric information problem between the manager and outside investors. By contrast, under bootstrap acquisition, a decrease in the leverage ratio reduces the capital cost. In addition, the acquisition mode and capital structure also have an effect on the takeover bid price by affecting the free-riding behavior of the atomistic shareholders of the target firm. Given the trade-off between these effects, the manager of the acquiring firm designs the acquisition mode and capital structure to alleviate the conflict of interest between the manager and outside investors in the acquiring firm. The analysis yields implications for the pattern of takeover activity of both publicly traded and private equity firms as determined by their acquisition mode and capital structure.