This paper presents a general model of strategic behavior of (regulated and non-regulated) firms in M&A. The focus of the paper is on regulated firms (mostly monopolies). For such firms, the model shows that managers, acting on behalf of shareholders, make their strategic decisions on debt issuing and investment, in anticipation of both the decisions of the regulatory body and the responses of financial markets. These decisions are aimed at influencing the probability that an acquisition occurs, as well as the price the potential bidder will have to pay. However, such decisions are also made with a view to influence the regulatory policies (maximum price or rate of return permitted), thereby mitigating the probability that, in the regulatory game, the regulator adopts an opportunistic behavior.
Most managerial decisions impact on the firms’ preferred capital structure.
Likewise, one can think of mergers and acquisitions as also having an impact on
the financial decisions of target firms. This is clearly the case when managers of
firms targeted by a hostile attempt of takeover increase leverage with the only
objective of deterring the impending threat—a type of commitment similar to many
others studied in Industrial Organization literature, specially the use of debt as
a commitment device, which was examined in an oligopoly setting by Brander and
Lewis (1986).
Approaching M&A from the viewpoint of financial policies of firms calls for
recognizing (and benefiting from) the contribution of two strands of literature:
Industrial Economics and Financial Theory—an approach that is becoming popular
among researchers (see for example, Showalter, 1999; Dasgupta and Titman,
1998 or more recently Riordan, 2003).Surprisingly, research has ignored the case of firms subject to economic
regulation. It is here, that drawing on the contribution of Industrial Economics
and Financial Theory is likely to be most insightful as most models in the Economics
of Regulation are extensions of other models derived in Industrial Organization
literature, and financial features of regulation are less developed in that former
field (even in the more rigorous and sophisticated works as, for example, Laffontand Tirole, 1993)1. Yet, those financial aspects are crucial in the “regulatory game”,
where the financial strategies used by the managers of the regulated firm play
a fundamental role not only in that game, but also in potential M&As (when
allowed by the regulator and/or the government).
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