Risk Reduction Through Acquisitions: The Roles of Firm-Specific Investments and Agency Hazards

Abstract

This paper provides a stakeholder-based rationale for firm risk reduction through diversification. While firm-specific investments from stakeholders are often important sources of firm competitive advantage and economic rents, there is a reduced incentive for stakeholders to make these investments due to the risk associated with firm-specific investments. Since the risk associated with firm-specific investments is often related to the total firm risk level, we argue that stakeholders’ difficulties in diversifying the risks associated with their firm-specific investments create incentives for risk management by firms. We test this argument in a diversification setting. Based on a sample of firms’ first acquisition moves, we find that firms are more likely to engage in risk reduction through diversification when high levels of firm-specific assets are important to the firm's operations. Several proxies for stakeholders’ specific investments are found to be significant in explaining cross-sectional variation in the extent of ex ante risk reduction in acquisitions.

Citation

Wang, H. and Reuer, J.J. (2006), "Risk Reduction Through Acquisitions: The Roles of Firm-Specific Investments and Agency Hazards", Cooper, C.L. and Finkelstein, S. (Ed.) Advances in Mergers and Acquisitions (Advances in Mergers and Acquisitions, Vol. 5), Emerald Group Publishing Limited, Leeds, pp. 25-49. https://doi.org/10.1016/S1479-361X(06)05002-2