Document Type

Article

Article Version

Post-print

Publication Date

7-2021

Abstract

Purpose: This paper examines the relation between takeover likelihood and the documented underperformance of distressed company stocks while exploring two competing hypotheses. The failure risk explanation predicts lower returns to distressed firms with high probability of being acquired because the acquisition reduces risk and investors' required return. Conversely, the agency conflicts explanation predicts lower returns when acquisition is unlikely.

Design/methodology/approach: The likelihood of receiving a takeover bid is estimated, and portfolio tests explore the underperformance of distressed company stocks relative to non-distressed stocks across varying levels of takeover likelihood. Predictive regressions subsequently examine the relation between distress, takeover exposure and future firm operating performance including how the relation is affected by state anti-takeover laws.

Findings: Distressed stocks underperform non-distressed company stocks by economically and statistically significant margins when takeover likelihood is low, yet there is no evidence of underperformance among distressed stocks with moderate or high takeover exposure. Consistent with agency conflicts playing a key role, distressed firms that are disciplined by takeover threats invest more, use more leverage and experience higher future profitability. State-level anti-takeover legislation limits this disciplinary effect, however.

Originality/value: The results show that the well-documented distress anomaly is driven by a subset of distressed firms whose managers face limited pressure from the external takeover market. The evidence casts doubt on the failure risk explanation and suggests that agency conflicts play a key role.

Comments

Copyright © 2021, Emerald Publishing Limited. This AAM is provided for your own personal use only. It may not be used for resale, reprinting, systematic distribution, emailing, or for any other commercial purpose without the permission of the publisher.

Publication Title

Managerial Finance

Published Citation

Kozlowski, S.E. and Puleo, M.R. (2021), "Financial distress, corporate takeovers and the distress anomaly", Managerial Finance, Vol. 47 No. 8, pp. 1168-1193. https://doi.org/10.1108/MF-12-2019-0621

DOI

10.1108/MF-12-2019-0621

Peer Reviewed

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