TY - JOUR
T1 - Growth options, risk dynamics, and cost of capital
T2 - Evidence from U.S. corporate control transactions
AU - Coy, Jeffrey M.
AU - Garcia-Feijoo, Luis
N1 - Funding Information:
We thank Jeff Madura, Ariel Viale, and two anonymous referees for insightful suggestions. We also appreciate helpful comments from participants at the Southern Finance Association (2013), Eastern Finance Association (2014), and Financial Management Association (2014) annual meetings. All errors are our own.
Publisher Copyright:
© 2020 Board of Trustees of the University of Illinois
PY - 2022/5
Y1 - 2022/5
N2 - We provide empirical evidence on recent models on the evolution of systematic risk around growth option exercise related to takeover announcements. Consistent with theory, the risk differential between the merging firms influences the evolution of bidder systematic risk. We find that the cost of capital decreases (increases) when the growth option's underlying assets (i.e., the target firm) are less (more) risky than the bidder's assets in place. Furthermore, the impact on the cost of capital is larger, the bigger the difference between the pre-transaction risk of the bidder and the target. Firm characteristics such as the relative size of the firms and information asymmetry affecting the bidder also impact risk dynamics. Our findings help clarify conflicting predictions in the finance literature, thus allowing for more informed capital structure decisions by financial managers when considering growth option exercise.
AB - We provide empirical evidence on recent models on the evolution of systematic risk around growth option exercise related to takeover announcements. Consistent with theory, the risk differential between the merging firms influences the evolution of bidder systematic risk. We find that the cost of capital decreases (increases) when the growth option's underlying assets (i.e., the target firm) are less (more) risky than the bidder's assets in place. Furthermore, the impact on the cost of capital is larger, the bigger the difference between the pre-transaction risk of the bidder and the target. Firm characteristics such as the relative size of the firms and information asymmetry affecting the bidder also impact risk dynamics. Our findings help clarify conflicting predictions in the finance literature, thus allowing for more informed capital structure decisions by financial managers when considering growth option exercise.
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U2 - 10.1016/j.qref.2020.10.010
DO - 10.1016/j.qref.2020.10.010
M3 - Article
AN - SCOPUS:85095600473
SN - 1062-9769
VL - 84
SP - 562
EP - 576
JO - Quarterly Review of Economics and Finance
JF - Quarterly Review of Economics and Finance
ER -