I study the announcement effects of all acquisitions in the recent telecom wave on both the acquirers and their industry competitors. I find evidence of negative rival returns (−0.55%, t-stat=2.47) by focusing on non-horizontal acquisitions where rivals are less susceptible to experience positive returns due to increased market power or expectation that some will become future targets themselves. I find that this effect is worse for closer rivals defined as having similar size and being in the same primary service area as the acquirer. Competitor returns are positively correlated with those of the acquirers suggesting that the negative impact experienced by competitors is driven by acquisitions in which the acquirer itself is earning negative abnormal returns. Results are broadly consistent with the Competitive Advantage Hypothesis that posits acquisitions are a means of corporate restructuring in a changing environment, awarding the acquirer a competitive edge and thereby making these acquisitions costly for their non-merging competitors.

Some acquisitions can be viewed as the quickest means to obtain a scarce resource required for restructuring in response to an economic shock. Such acquisitions can give the acquirer a competitive edge and hurt its competitors. In this paper, I first show that if a firm will be adversely affected by a competitor’s acquisition, then it can rationally “overpay” for the target to avoid this outcome within a value-maximizing framework due to industry equilibrium effects. Next, I show that depending on the level of anticipation by the market, the magnitude of the cost of losing, and the competition between bidders, an acquirer can earn negative payoffs at the announcement of such an acquisition. Even though the merger is the best decision given the circumstances, negative returns incorporate the understanding that the target is a necessary resource to survive in this changing environment, losing it to a rival is costly, and there is a positive probability that the bidder may not win or win by paying more than the synergy value of the target. Finally, I extend the model to include 2 targets that become available sequentially to multiple bidders and show that when there are alternatives available for the target’s resources, overbidding subsides.

This paper examines how industry structure affects corporate investment patterns. Real options theory shows that deferring irreversible investment in the face of uncertainty is valuable. Theory also shows that the value of waiting to invest falls if investment opportunities are contestable. Consistent with these theories, we find that firms in monopolistic industries exhibit lower investment-q; sensitivity and are slower to invest than firms in competitive industries. However, we find that investment-q; sensitivity and investment speed are highest in oligopolistic industries, suggesting that the value of investing strategically can outweigh the value of waiting. Indeed, oligopolistic industries experience less entry and more exit than other industries.

Investment patterns often associated with agency and information problems can emerge as rational responses to product–market rivalry. We illustrate this result when industry players make simultaneous or sequential investment decisions in the face of two negative externalities. One externality arises when all competing firms invest, thus eroding the gains to investment accruing to any one firm. Another externality arises when some firms do not invest and lose out to rivals who do invest. The value of investment therefore depends on the investment’s intrinsic merits and the actions of all competitors. Our analysis can rationalize investment patterns that might appear suboptimal when such externalities are ignored. For instance, our simultaneous model can justify investment levels that might otherwise be interpreted as under- or over-investment. Our sequential model shows that value-maximizing firms might optimally herd in their investment decisions. We present evidence supporting key aspects of both the simultaneous and sequential models.

We study whether shocks to the supply of capital affect bond covenant structures using the collapse of Drexel Burnham Lambert, Inc. and the subsequent regulatory changes as an exogenous contraction in the supply of speculative-grade credit around 1989. We find that speculative-grade firms increase their covenant use significantly more than the investment-grade firms in the post-1989 period. This result is robust to using alternative control groups such as using only the BBB-rated firms, unrated firms, and employing matched sample analysis. Consistent with a supply effect, the increase in covenant use is higher for firms with high costs of switching to alternative sources of funds and high dependence on external finance. Overall, our results suggest that shifts in credit supply affect not only the debt amounts but also the bond covenant structures. Even contracting terms of firms with access to public debt markets are not immune to fluctuations in the supply of capital.

We investigate the effect of creditor rights on the probability of becoming a takeover target by constructing firm-level bond covenant indices. Our primary result is that the more restrictive covenants a firm has, the more likely it is to become the target of an acquisition. This finding is robust to the exclusion of merger-related event-risk covenants which have the opposite impact and appear to reduce takeover likelihood. Furthermore, this effect is not driven by financially distressed firms and rather contained in small, profitable, financially healthy firms with high growth opportunities and low cash holdings. We also find that a higher target covenant index leads to a significant decrease (increase) in target (acquirer) abnormal returns around acquisition announcements and tilts merger gains towards the acquirer, suggesting the presence of a ‘covenant discount’ for potential target firms. Overall, our results are consistent with covenants creating key frictions, and in turn, making firms viable targets for acquirers with possibly deep pockets.