Distressed acquirers and the bright side of financial distress

Extant literature states that managers who fear the consequences of financial distress may inhibit investments in profitable opportunities. Here, we posit that the career and reputational damages that distress and potential default cause are large enough to align the interests of managers and shareholders thus improving investment decisions. We find that financially distressed firms see a 3.5% higher market reaction to the announcement of acquisitions than non-distressed firms. This effect is stronger for poorly governed firms, consistent with the hypothesis that the large reputational cost of failure incentivizes managers to act in the best interest of their firm.

Automated summary

The study suggests that financial distress may affect managers' investment decisions, and financially distressed companies tend to have higher market reactions to acquisition announcements. This effect is more significant in poorly governed firms.