Agency Costs in Small Firm Acquisitions

This event study examines small Russell 2000 firms acquired during the two years ending June 30, 2001. This study tests whether bidders highly value sales or assets (the agency hypothesis) or profits/cash flows (the alternative hypothesis). This study finds that independent director majorities or the presence of academic directors on acquirer boards of directors are associated with lower target-firm announcement-period abnormal returns. Acquirer boards with both an independent director majority and at least one director from academia are associated with the lowest target-firm announcement-period abnormal returns of any of the groups examined. Consistent with prior research, diversifying acquisitions are associated with higher target-firm and lower acquirer announcement-period abnormal returns than focusing acquisitions. However, a closer look at diversifying acquisitions suggests that acquirers more highly value smaller, more profitable target firms for use in entering unfamiliar industries. Therefore, a “dip your toe into a different pond theory” might be more appropriate for these types of diversifying acquisitions than either the agency or hubris theories.