Wealth Effects from Acquiring Bankrupt Firms

Acquisitions of bankrupt firms can be beneficial because the bankrupt targets may be more receptive to acquisition offers for the purpose of survival, courts can override any resistance that may occur, information on the target is disclosed within the formal reorganization plan, acquirers can accrue tax benefits, and acquirers may assume favorable debt contracts. However, two disadvantages of acquiring a bankrupt firm are higher costs of completing the conversion and the high degree of uncertainty about the target's future cash flows. Results of our analysis suggest that firms announcing acquisitions of bankrupt targets experience favorable wealth effects. Thus, the market appears to anticipate that the present value of future cash flows derived from the target will exceed the cost of the acquisition. Our analysis also found that acquisitions of bankrupt firms yield more favorable wealth effects than acquisitions of healthy firms. The acquisitions of bankrupt firms were especially well received by the market when the acquirer was the sole bidder and when the target's business was closely related to that of the acquirer.