Leverage Deficit and The Acquirer’s Company Value in Normal Economics

In acquisitions, a leverage deficit tends to happen as firms underleverage for financial flexibility and higher financial synergy post-acquisition. Overleveraging is also common when debt utilization in leverage buyouts exceeds historical debt capacity. The acquirer’s company value could be proxied by its abnormal return, a product of surplus returns compared to its historical tendencies. This abnormal return, however, could perform outlandishly in periods of economic downturns, as investors place greater value on good news in dire times. This paper examines the interplay between leverage deficit and company value while analyzing the dynamics of acquisitions in normal economics. A two-step multivariate regression is conducted, using samples in the Jakarta Composite Index from 2010 through 2019. The first step consists of finding the target leverage equation, followed by examining the relationship between leverage deficit and cumulative abnormal return. The results of this study illustrate that the positive spectrum of leverage deficit has a positive impact on the value of the company in the context of acquisitions. Previous research suggests that abnormal return is positively correlated to zero deficit, as the achievement of optimal capital structure creates maximum value and minimal agency cost. However, a zero-deficit resulting from an overleveraged scenario is better appreciated, as debt reduction allows higher financial flexibility for future investments. On the other hand, underleveraged companies must increase their debt composition to reduce the deficit, reducing shareholder claims to net cash in a bankruptcy-prone environment.