The effect of taxes on the structure of corporate acquisitions

Abstract

This study investigates tax and non-tax determinants of corporate acquisition structure. In contrast to previous research, this study analyzes acquisitions from an investment financing perspective and investigates the tax implications of transaction structure for all three contracting parties--acquiring firm, target firm and target firm shareholders. Results indicate that the probability of an equity-financed tax-free transaction structure is an increasing function of the acquiring firm's likelihood of tax exhaustion. The probability of a debt-financed taxable transaction is a decreasing function of the percentage of the acquiring firm's value represented by growth opportunities (market to book ratio), and an increasing function of acquiring firm leverage and size. The results provide mixed support for the notion that target firm tax attributes and potential target firm shareholder capital gains tax liabilities influence acquisition structure. The Tax Reform Act of 1986 was expected to increase the likelihood that corporate acquisitions would be completed as tax-free transactions. Evidence in this study fails to support the conclusion that TRA86 impacted the way in which corporate acquisitions are consummated in the aggregate. Furthermore, results indicate that TRA86 did not modify the impact, on acquisition structure, of target firm tax attributes or shareholder capital gains tax liabilities. Overall, this study provides new evidence that tax and non-tax characteristics of acquiring firms are important determinants of the structure of corporate acquisitions.