dividend policy and the method of payment

8/3/2019 Dividend Policy and the Method of Payment

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Dividend Policy and the Method of Paymentin Mergers and Acquisitions

Jin Q Jeon*Dongguk Business School

Dongguk University

3-26 Pil-dong, Chung-gu

Seoul 100-715, KOREA

+822-2260-8884

[email protected]

James A. LigonDepartment of Economics, Finance & Legal Studies

The University of Alabama

P.O. Box 870224

Tuscaloosa, AL 35487-0224

205-348-6313

[email protected]

Charn SoranakomCollege of Management

Mahidol University

69 Vipawadee Rangsit Rd.

Phayathai, Bangkok, 10400 THAILAND

+662-206-2000 Ext. 2105

[email protected]

Last modified: July 2010

* Corresponding Author.


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Dividend Policy and the Method of Payment in Mergers and Acquisitions

ABSTRACT

This study examines how relative differences in dividend policies affect the choice of

payment method in mergers and acquisitions. Using the dividend clientele hypothesis, we

hypothesize that, at the margin, the method of payment is more likely to be stock if the

dividend policies of the two firms involved in a merger or acquisition are quite similar, but

more likely to be cash if the dividend policies are much different. The empirical data support

the relevance of the dividend clientele hypothesis for the method of payment in mergers and

acquisitions. We also find some evidence that in stock-based deals a difference in dividend

policies is negatively correlated with announcement returns.

JEL classification: G32, G34, G35

Keywords: Mergers and Acquisitions; Method of Payment; Dividend Clientele; Dividend

Policies; Announcement Returns


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price movement as the change in dividend policy is more apparent to those investors who

find it less favorable (present stockholders) than to those who find it more favorable."

Baker, Coval, and Stein (2007) show that if the demand curve for the acquirers stock

is downward sloping, then the cost of a stock for stock merger is decreasing in the fraction of

target shareholders who passively accept and retain acquirer shares. Each share retained by a

passive target shareholder is one less share that must be absorbed by market investors with a

lower evaluation of the acquirer. Demand curves for stocks may slope down for a number of

reasons. Miller (1977) suggested the combined effects of differences of opinion and short-

sale constraints. The empirical literature provides clear support for downward-sloping

demand curves (e.g. Harris and Gurel, 1986; Shleifer, 1986; Bagwell, 1992; Hodrick, 1999;

Kaul, Mehrotra, and Morck, 2000; Wurgler and Zhuravskaya, 2002; and Greenwood, 2005).

In the context of mergers, Mitchell, Pulvino, and Stafford (2004) focus on price pressure

around mergers and Baker, et al. (2007) find evidence in support of inertial behavior by

target shareholders and that acquirer returns are lower when inertia is lower.

We argue that if the target firm's dividend policy is very different from the acquiring

firm's, this may serve as a disincentive to a stock based acquisition. If the dividend clientele

hypothesis holds and the dividend policies of the acquirer and the target are materially

different and stock is used in the acquisition, this may cause a change in the shareholder

composition of the targets shareholder base. That is, target shareholders may decide to

rebalance their portfolios. They may decide to sell their position in the target, before the

merger is consummated, or in the survivor firm, after the merger is consummated, if they do

not like the dividend policy of the acquiring firm. In the language of Baker, et al. (2007), a

similarity in dividend policies between the target and the acquirer increases inertia, while a


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management faces the qualitative decision to pay in the form of either stock, cash, or some

mix of the two. The results of our multinomial regressions show that the degree of difference

in dividend policies is significantly higher for pure cash deals than pure stock deals. We

alternatively examine the determinants of the proportion of cash payment used in takeovers

using a two-limit Tobit approach. The results are similar to our discrete analysis showing that

a difference in dividend policies significantly increases the percentage of cash payment. In

addition, consistent with previous studies, we find that several deal, target, and acquirer

characteristics serve as important determinants of the payment choice.

We also examine the relationship between the degree of similarity in dividend

policies and takeover abnormal announcement returns. According to the dividend clientele

hypothesis, target shareholders who do not prefer the dividend policy of the acquiring firm

may sell at any point from the announcement date until after the merger consummation.

However, clienteles preferring the dividend policy of the acquirer would not buy until the

likelihood of merger consummation was high enough and the price drop large enough to

compensate them for the risk of merger failure and the transaction costs of rebalancing.

Target announcement returns will be lower if some dividend related selling occurs at the

announcement date and the effect is not fully transferred by merger arbitragers immediately

to the acquirer. Acquirer announcement returns will be lower if merger arbitragers

immediately transfer, at least partially, the effects of any selling by target shareholders to the

acquirer. Therefore, our second hypothesis states that in stock based acquisitions abnormal

announcement returns of targets, acquirers, or both are lower if the level of difference in

dividend policies is larger.


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To test this hypothesis, we conduct both OLS and a 2-step procedure that controls for

the potential endogeneity of the choice of the payment methods. Our results show that target

cumulative abnormal returns (CARs) at the takeover announcement date for stock deals are

significantly lower when one firm pays a dividend but the other does not and decreases in the

difference in dividend policies between target and acquiring firms when dividend yield is

used to measure the differential in dividend policies. We also find some evidence that

acquirer CARs decrease in the difference in dividend policies. In addition, our results are

largely consistent with adverse selection explanations that announcement returns are lower

for stock based acquisitions because acquirers may use their stock to pay for acquisitions

only when their stock is overvalued (Myers and Majluf, 1984; Travlos, 1987; Amihud, Lev

and Travlos, 1990).

In sum, this study provides a new perspective regarding the takeover method of

payment choice by showing that, in addition to other factors related to traditional

explanations of method of payment, the dividend policies of target and acquiring firms are a

key determinant of the payment choice. The remainder of this paper is organized as follows.

In Section 2, we present the research hypotheses and describe the dependent and test

variables and the testing techniques. Section 3 details the sample selection process and

provides the descriptions of the control variables and the rationales for including them,

including references to relevant literature, and presents the descriptive statistics. Section 4

analyzes the determinants of the payment method. Section 5 analyzes announcement returns,

and Section 6 concludes.


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2. Hypotheses Development, Dependent and Test Variables, and Testing Techniques

2.1. Hypotheses

We construct and test two hypotheses in this study. The first hypothesis states that, if

the dividend policies of the two firms involved in an acquisition are quite similar, it is more

likely that a method of payment for the acquisition is going to be stock, other things equal. A

method of payment is more likely to be cash if the dividend policies are much different, other

things equal. Ceteris paribus, the management should consider using a stock based

acquisition when the dividend policies are similar and use cash when the dividend policies

are fundamentally different.

Our second hypothesis states that for stock based mergers, abnormal stock returns on

the announcement day for the target, the acquirer, or both are lower if the level of difference

in dividend policies is greater. In this case, selling activities by target shareholders who do

not like the change in dividend policy that a successful merger would entail may put

downward pressure on the target stock price. Potential buyers who prefer the new dividend

policy may delay their purchase until the merger has a reasonably high probability of

consummation and they can cover the transaction costs of rebalancing through a temporarily

depressed stock price. These factors may result in a lower announcement return, ceteris

paribus, for targets when the dividend policies of the target and the acquirer differ

substantially. A negative effect of dividend differences on announcement returns for stock

based mergers for acquiring firms is also possible if dividend related effects are anticipated

and arbitraged by the market. Both may experience negative return if any effect is only

partially arbitraged.


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2.2. The Dependent and Test Variables

2.2.1. Dependent Variables : Method of Payment and Announcement Returns

We take both dummy variable and continuous variable approaches to measure the

payment method. First, we categorize deals into three groups in terms of their payment

methods; Cash Only, Mixed Paymentand Stock Only. Cash Only includes deals where at

least 90% of consideration is paid with cash. Stock Only includes deals where at least 90% of

consideration is paid with acquirer stock.2Mixed Paymentincludes deals financed with both

stock and cash. Alternatively, we use a continuous variable, %Cash PMTor%Stock PMT,

which takes on any value between zero and one.

Announcement returns, CARs, are the cumulative abnormal returns over the three-

day window [-1, +1] or five-day window [-2, +2] around the bid announcement using the

firm return minus the CRSP value-weighted market return. We calculate the announcement

returns for both target and acquiring firms.

2.2.2. Measures of a Difference in Dividend Policies

We obtain cash dividends for each acquiring firm and target firm from the

COMPUSTAT database. We collect quarterly dividend data as of the end of the quarter

immediately preceding the quarter when a merger is announced. We then average actual

dividend payments over the last 4 quarters in order to account for seasonality in dividend

payments. For example, if a merger is announced in the second quarter of 2006, we average

quarterly dividends from the second quarter of 2005 to the first quarter of 2006.3

We use three measures of a difference in dividend policies between an acquirer and

2 We use alternative definitions for cash- or stock-based acquisitions and the results are similar to those

presented here.3 In unreported results, we also use the quarterly dividend prior to the announcement date. The results are

similar to those presented here.


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target. First, One is Payeris a dummy variable equal to 1 if one of the two firms involved in

the merger pays any dividend during the last 4 quarters prior to the deal announcement, while

the other does not, and equals 0 otherwise. Dividend policies are significantly different in the

case that only one of the two firms pays a dividend. There is less difference in dividend

policies if both or neither firm pay dividends. We also calculate the absolute value of

differences in the dividend yield between targets and acquirers,Diff.DivYield, and, in order to

ensure that our results are not affected by stock price variation (Grinstein and Michaely,

2005; Li and Zhao, 2008), we also use the absolute value of differences in the dividend to

book value ratio between targets and acquirers,Diff.Div/Book. DivYield is defined as the

ratio of dividends per share to the market price per share and Div/Book is the ratio of the

amount of dividends to the book value of assets.

For example, for a merger between a firm with a dividend yield of 2.0% and a firm

with a dividend yield of 5.0%, the dividend yield difference between the two companies

would be |2.0% - 5.0%| = 3.0%. The closer this number is to zero, the more similar the

dividend policies between the two firms are. For the coefficient on Diff.DivYield to be

meaningful, we add a control variableAcquirer DivYieldto control for the levels of dividend

yields of the acquiring firms. Likewise, we add a control variable Acquirer Div/Bookwhen

Diff.Div/Bookis included as a variable of interest. We do so because a 3% value reported in

Diff.DivYieldmay result, for example, from a 3%-dividend-yield acquirer takes over a non-

dividend-paying firm, or it may result from a non-dividend-paying acquirer buys a 3%-

dividend-yield firm. The impact on the method of payment from these two cases may be

different. Hence, we use the variableAcquirer DivYieldto control for the differences in the

acquirers dividend yields.


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2.3. Testing Techniques

To test the first hypothesis, we adopt the multinomial logit model as well as the two-

limit Tobit model. First, we consider the case where acquirer management faces the

qualitative financing decision. Faccio and Masulis (2005) argue that in many mixed deals,

target shareholders have a choice to receive cash or stock, implying that acquiring firms do

not determine the fraction of cash financing.4

Accordingly, we categorized the sample into

three groups in terms of their payment methods. An indicator variable, MOP, takes a value of

0 for pure cash deals, 1 for mixed deals (whether the mix is acquirer or target determined),

and 2 for pure stock deals. Using MOPas a dependent variable, we estimate the following

multinomial logit regression :

(1)

where P(MOPi=K) is the probability that a deal i will have the Kth

payment method. The

variables of interest are the measures of the degree of similarity in dividend policies, One is

Payer,Diff.DivYield, orDiff.Div/Book. Following previous literature, we include a number of

other control variables including; deal characteristic variables such asDeal Premium, ln(Deal

Value), Related Deal, Hostile, and Tender Offer, acquirer characteristic variables such as

Insider Ownership, Insider Ownership Squared, Leverage, Change in Leverage, PPE/Book,

Market/Book, Cash/Deal Value, andPrereturns, and target characteristic variables including

Relative Size, Insider Ownership, Insider Ownership Squared, Institutional Ownership,

4 The fact that target shareholders have a choice to receive cash or stock should not affect our investigation of

the relationship between method of payment and dividend differences since, in equilibrium, the more similar the

dividend policies of the two firms the more likely stock is the method of payment, ceteris paribus, irrespectiveof whether the choice is made by the acquirer or target shareholders. In our examination of announcement

returns, our key test variable is an interaction term related to stock only acquisitions.


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Leverage, and Market/Book. All the control variables and the rationales for including them

are discussed fully in Section 3.2.

We also examine the effect of a difference in dividend policies on the fraction of cash

financing by adopting the two-limit Tobit model. In this model, the dependent

variable, %Cash PMT, can be thought of as a latent variable that is truncated at both lower

and upper limits, namely at zero and one. %Cash PMTvalues that we actually observe are

bounded between zero and one. Specifically, we estimate the following model :

(2)

wherex is the set of explanatory variables and,

iCashPMT% = 1 if iCashPMT%*1, all cash

iCashPMT% = iCashPMT%*

if 0< iCashPMT%*


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CARs=+1(Stock OnlyMeasures of Dividend Differences) + 2 Measures of

Dividend Differences +3 Stock Only+ 4X+e (3)

Announcement returns, CARs, are measured as the cumulative abnormal returns of

targets and acquirers, respectively, relative to the CRSP value-weighted market index,

computed for the event windows of [-1, +1] and [-2, +2] days around a bid announcement

date. Measures of Dividend Differences refers to the three measures of dividend differences

previously discussed. As discussed in our second hypothesis, we expect the interaction term

of a dividend difference and a stock based acquisition dummy, Stock Only Measures of

Dividend Differences, is negatively correlated with target and/or acquirer announcement

returns. We include several control variables (designated by the vector X) in the

announcement returns regressions; including the acquirers ln (Market Value), Market/Book,

Leverage, and PPE/Bookand the targets Relative Size, Institutional Ownership, Leverage,

Stock Return Volatility, and Market/Book. The control variable descriptions and the

rationales for including them are again provided inSection 3.2.

A potential concern in equation (3), however, is that the payment method, Stock Only,

is an endogenous variable because it is not randomly determined (Faccio and Masulis, 2005).

If the payment method is indeed endogenous, then the interaction term of the payment

method and a difference in dividend policies also becomes an endogenous variable. As a

result, controlling for this endogeneity is integral to estimating the model. In order to control

for the potential endogenous problem in our regressions, we additionally estimate the

following 2-stage least squares (2SLS) equations:

1st

reduced form: %Stock PMT = 1 z1+ 2 z2+ 3X+u


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2nd

reduced form: %Stock PMTMeasures of Dividend Differences= 1z1+ 2 z2+ 3 X+w

Main equation:

CARs=+1P[%Stock PMTMeasures of Dividend Differences] + 2 Measures of

Dividend Differences +3 P[%Stock PMT]+ 4X+e (4)

where P[] refers to the predicted value from the first stage regressions.6

In this model, we have two sets of instrumental variables; one for %Stock PMTand

the other for %Stock PMTMeasures of Dividend Differences. The set of instrumental

variables for%Stock PMTisz1. Since %Stock PMTMeasures of Dividend Differences is an

interaction term, the instrumental variables, z2, arez1Measures of Dividend Differences.

Note that in order to satisfy the over-identification condition, all instrumental variable sets (z1

andz2) and the exogenous variable set,X, must be included in both first and second reduced

forms.7

Instrumental variable sets,z1and z2, are described in Section 3.2.

3. Sample Selection, Control Variable Descriptions, and Summary Statistics

3.1. Sample

Our sample consists of all mergers and acquisitions that were announced from

January 1, 2001 to December 31, 2007, obtained from the Securities Data Corporation (SDC)

Platinum Mergers and Acquisitions database. All mergers and acquisitions must satisfy the

following screening criteria : 1) deal value is greater than one million dollars and is publicly

disclosed, 2) the percentage of shares of the target firm held by an acquirer at announcement

is less than 50%, 3) stock prices are available in the Center for Research in Securities Prices

6 Instead of the discrete variable, Stock Only, we use a continuous variable for stock payment, %Stock PMT,

defined as the percent of stock financing.

7 See Section 6.2 of Wooldridge (2002) for detailed discussion of this model.


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(CRSP) database, 4) Financial data are available in COMPUSTAT for both targets and

acquirers, and 5) insider ownership data are available in the Thomson Financial Network

(TFN) Insider Filing database for both targets and acquirers. The sample restrictions result in

a final sample of 1,022 deal observations.

3.2. Control Variable Descriptions

The literature has suggested that various factors may have some impact on the

outcome of a method of payment in acquisitions. The variables mentioned below will be used

as our control variables for these factors in our payment choice regression models.

3.2.1. Ownership Structure

Managers of an acquiring firm who value control may prefer to use cash as a means

of payment in an acquisition because stock dilutes their ownership in the combined firm

(Amihud, Lev, and Travlos, 1990; Harris and Raviv, 1988; Martin, 1996; Mayer and Walker,

1996; Stulz, 1988; Yook, Gangopadhyay, and McCabe, 1999). Conversely, managers of a

target firm may be interested in retaining control in the combined firm after the merger or

acquisition (Ghosh and Ruland, 1998). Ghosh and Ruland find that the target firms

managerial ownership is an even more important factor than the acquiring firms managerial

ownership in explaining the method of payment in acquisitions. Faccio and Masulis (2005)

indicate the role of managerial ownership may be non-linear and we control for this as well.

Thus, we include the acquiring firm's percentage of insider ownership, Acquirer Insider

Ownership, and the target firm's percentage of insider ownership, Target Insider Ownership,

and their squares in our empirical models. The data on ownership is obtained from the TFN

Insider Filing database. The more stake the management of the acquiring firm has in the

firm, the more likely the acquiring firm will use cash as a means of payment for the


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acquisition. So, we expect the coefficient ofAcquirer Insider Ownership to have a positive

sign. On the contrary, the higher the percentage of target firm's insider ownership, the more

likely the means of payment will be stock. Thus, we expect the coefficient ofTarget Insider

Ownership to have a negative sign.8

Baker, et al. (2007) show that if the proportion of passive shareholders who accept

acquirer stock in a stock for stock deal decreases, acquirer returns to the acquisition decrease.

They find that institutional shareholders are less likely to be passive than individual

shareholders. Accordingly we control for the percentage of institutional target shareholders

using Target Institutional Ownership. The larger this percentage, the less attractive a stock

merger is for the acquirer and hence acquirers would be less likely to use stock and if they do

so the merger is likely to have lower announcement returns.

3.2.2. Relative Cost of Funds

According to Myers (1984) pecking order theory, firms should fund their investment

opportunities from internally generated cash flow whenever feasible. If cash flow is

inadequate, debt should be the next financing option the firms should consider. Equity

financing, being the most expensive, should be considered last, only when the firms have no

other financing option. This implies that if the acquiring firm has a lot of free cash flow, the

firm is more likely to use cash as a means of payment for the acquisition. Martin (1996), and

Mayer and Walker (1996) find acquirers, who have an ample amount of cash on the balance

sheet or who can generate a large amount of free cash flow and have a low level of leverage,

tend to use cash and/or debt to finance their acquisitions. Our variable, Cash/Deal Value,

8 Faccio and Masulis (2005) provide the tradeoff hypothesis between corporate control concerns and

debt constraints. They argue that an acquirers payment decision is influenced by debt capacity and existingleverage and, simultaneously, by insiders desire to maintain their control of firms. We consider leverage below.


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measures the amount of acquirer cash plus marketable securities normalized by the value of

the merger or acquisition.

In the case where the acquirer does not have enough cash, but it is not already highly

leveraged, the acquirer can issue new debt to fund the acquisition. The acquirer can also use

the unused lending capacity from the target firm if the target firm is under-leveraged.

Chaney, Lovata, and Philipich (1991) find that acquiring firms that use cash acquisitions tend

to be highly levered small firms with high return on assets, while acquiring firms that use

stock acquisitions tend to have large asset bases, low leverage, low return on assets, and high

price-earnings ratios. Acquirer Leverage and Target Leverage measure the debt to assets

ratio of acquirers and target firms, respectively. Faccio and Masulis (2005) control for the

borrowing power of the acquirer using a variable related to the collateral capacity of the firm,

which they measure using property, plant, and equipment (PPE) over the book value of total

assets. We also includePPE/Bookto control for the collateral value of the acquiring firms

assets.

Yook (2003) suggests that the leverage effect plays an important role in payment

decisions. An increase in leverage caused by cash payment reduces the free cash flow

problem that self-interested managers invest money on less profitable (or negative NPV)

projects. The benefits of this leverage effect should be stronger when a firm has lower growth

opportunities and large free cash on hand. To address this, we include Change in Leverage,

defined as the change in the acquirers leverage (total liabilities/total assets) from t-2 to t-1

(where t is the deal announcement year).

When the stock price runs up considerably, it makes equity financing relatively less

expensive. Acquirers could take advantage of such an occurrence by using stock as a means


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of payment when their stock prices have gone up prior to the merger or acquisition

announcement. Conventional wisdom suggests that targets would recognize such overvalued

stock offers and refuse them. However, research by Rhodes-Kropf and Viswanathan (2004)

suggests that stock price appreciation of bidders and targets may be positively correlated.

Mutual overvaluation can lead bidders to make, and targets to accept, stock offers

introducing a possible positive correlation between stock price appreciation, merger

frequency, and use of stock as a method of payment. Shleifer and Vishny (2003) construct a

model where mutual overvaluation can also lead to a positive correlation between stock price

performance and the use of stock as a method of payment in acquisitions. We use a 90-

trading-day market-adjusted cumulative return at the 30th

trading day prior to the

announcement date,Prereturns, to measure how much the stock price of each acquiring firm

has run-up. We predict a negative sign on this coefficient. The higher the stock returns prior

to mergers or acquisitions announcements, the higher the likelihood that acquirers will use

stock.

The growth opportunities of acquiring firms also affect the payment choice. An

acquirer with a high growth rate may be able to use their high multiple stock to pay for

acquisitions.Acquirer Market/Bookis defined as the sum of total assets and market value of

equity minus book value of equity divided by total assets. We also include Target

Market/Book. According to Carleton, Guilkey, Harris and Stewart (1983), a high target

market to book ratio represents potentially high capital gains for target shareholders and non-

deductible goodwill for acquirers, hence low market to book ratios of targets are associated

with the use of cash.


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3.2.3. Asymmetric Information

Payment for acquisitions in the form of stock can help alleviate an asymmetric

information problem. Asymmetric information exists in acquisitions because acquirers may

know more about the value of their own firms than do target firms, but may not be able to

derive a correct estimate of the true value of target firms, and vice versa. Hansen (1987)

regards a stock offer as a contingent pricing mechanism. He finds that when target firms

know their values better than acquirers, the acquirers will prefer to use stock, which has

desirable contingent-pricing characteristics, rather than cash. When asymmetric information

exists on both acquirers and target firms sides, a signaling equilibrium develops whereby

targets regard both the method of payment used and the size of the stock offer as signals of

the value of the acquiring firms. However, he finds only minimal supportive evidence.

Fishman (1988) and Eckbo, Giammarino, and Heinkel (1990) also provide adverse selection

based models of the acquirers choice of payment.

When stock is used as a payment in acquisitions, the risks of a miscalculated firm

valuation are shared between acquirers and targets. This type of risk is likely to be small

when an acquirer is a much larger firm than is a target firm. As the target firms size

increases, the risks are larger. Following Martin (1996),Relative Size is our proxy variable

for information asymmetry which measures the relative size of target firm to acquiring firm.

Relative Size is a ratio of targets market value of equity to the sum of targets market value

and acquirers market value as of the year-end prior to the deal announcement.9

The larger

the size of the target firm relative to the acquirer, the higher the risks of valuation

9 In unreported regressions we substitute an alternative relative size measure, which is the ratio of target firms

total assets to the sum of targets total assets and acquirers total assets. The results are essentially unchanged.


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miscalculation and, thus, the higher the probability of a use of stock as a payment

consideration.10

Target Return Volatility, an alternative proxy for information asymmetry that may be

particularly relevant to announcement returns, is the standard deviation of daily stock returns

during the one year prior to the bid announcement date. Officer, Poulsen, and Stegemoller

(2009) find that acquirer announcement returns are greater in stock based acquisitions when

target stock return volatility is greater, which implies that targets market value is difficult to

estimate.

3.2.4. Deal Characteristics and Acquirer Size

We examine several variables that capture deal characteristics. Deal Premium is

defined as an acquirers offer value for the target over the pre-offer market value of the target

minus one. We follow the approach of Officer (2003) to calculate deal premium. Ln(Deal

Value) is the natural logarithm of deal value.Related Dealis a dummy variable equal to 1 if

an acquirer and target share the same primary 2-digit SIC code and 0, otherwise. Hostile is a

dummy variable equal to 1 if deal attitude is hostile and 0 if friendly or unsolicited as

classified by the SDC. Tender Offeris a dummy variable equal to 1 if an acquirer involves a

tender offer as reported in SDC and 0, otherwise.

In the announcement return regressions we include a number of the variables

previously discussed. We also include the natural log of the acquirers market value,

ln(Market Value) in the announcement return regressions. Our control variables in the

10 Mayer and Walker (1996) use both the interaction between earnings predictability and the market to book

ratio of acquirers, and the ratio of market value of equity for target firms to that of acquirers to proxy for theinformation asymmetry. However, they find that these variables have only minimal impact on the method of

payment.


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announcement returns regressions follow previous literature such as Moeller, Schlingemann,

and Stulz (2004) and Officer, Poulsen, and Stegemoller (2009).

3.2.5. Instrumental Variables for Equation (4)

The set of instrumental variables for the percentage stock financing, %Stock PMT, in

the first stage estimation associated with Equation (4) includes two variables. Average

Acquirer Industry %Stock PMTis the acquirer industry-average (based on the 1-digit

acquirer SIC code) proportion of stock financing during the quarter prior to the bid

announcement. Average Target Industry %Stock PMTis the target industry-average %Stock

PMT, computed in the same manner. We construct instrumental variables for an interaction

variable of the proportion of stock financing and our three measures of differences in

dividend policies, %Stock PMTMeasures of Dividend Differences, by interacting the

instrumental variables for%Stock PMTand the measures of differences in dividend policies.

3.3. Descriptive Statistics

[Table 1 about here]

Table 1 presents the summary statistics when deals are classified by the payment

method and dividend policy. There are 379 deals (37.1% of total sample) financed only with

cash, while 271 deals (26.5%) are financed only with stock. The frequency of stock-based

deals is the highest in the year 2001 (87 out of 208 deals), and is then generally decreasing

over the sample years. The average of the cash portion of consideration is about 50%, while

that of the stock portion is about 43%. During the sample period, 355 target and 535

acquiring firms pay dividends. The average quarterly dividend yield of target and acquiring


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firms are 0.802% and 0.956%, respectively.11

The average dividend to book value ratio is

1.233% for targets and 1.555% for acquiring firms. In 303 mergers, only one firm (either a

target or an acquirer) pays a positive dividend during last 4 quarters prior to the deal

agreement. In 312 merger deals, both firms pay dividends, while no firm pays a dividend in

407 deals. The mean and median of the absolute differences in dividend yields,Diff.DivYield,

are 0.404% and 0.077%, respectively, while those ofDiff.Div/Bookare 1.157% and 0.00%,

respectively.

4. Effects of Differences in Dividend Policies on the Payment Method


Table 2 presents the mean and median differences in dividend policies for the three

sub-groups in terms of the payment method. Tests for statistically significant differences

between the Stock Only group and other groups are from t-tests and Wilcoxon rank-sum tests

for each of the three measures of dividend differences: One is Payer, Diff.DivYield, and

Diff.Div/Book. The overall results in Table 2 support the hypothesis that acquirers are more

likely to pay with stock when dividend policies are similar. All 1,022 deals are examined in

Panel A. Thirty-nine percent of the merger deals in the Cash Only group have a single

dividend payer (i.e. are part of the One is Payerclassification). In the Mixed Paymentgroup,

24% of the deals have only one dividend payer. The percentages ofOne is Payer in both

Cash Only and Mixed Paymentgroups are significantly higher than that in the Stock Only

group, 19%. The mean and median Diff.DivYieldof the Cash Only group are 0.495% and

11 Note that this is average quarterly dividend yield. One may calculate annual dividend yield by multiplying by

4.


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0.122%, respectively, which are (weakly) significantly greater than those of the Stock Only

group, 0.391% and 0%. The mean and median ofDiff.Div/Bookare also significantly higher

for the Cash Only group (1.467% and 0.155%, respectively) than for the Stock Only group

(0.472% and 0%). The Mixed Payment group also has greater dividend policy differences

than the Stock Only group, while lower than the Cash Only group (these test results are not

reported). In Panel B, we drop the deals where both targets and acquires do not pay any

dividend in the previous quarters. As a result, the values of the percentage ofOne is Payer,

Diff.DivYieldand Diff.Div/Bookare greater than those in Panel A. However, the results of

univariate tests remain consistent withPanel A.


Table 3 reports estimates of multinomial logit models on the acquirers financing

decisions as a function of the measures for dividend differences and the control variables.

The table makes pair-wise comparisons between three categories of payment methods: Cash

Only, Mixed Paymentand Stock Only. Note that in a multinomial logit analysis, a regression

coefficient indicates the effects on the log-odds between each of the groups and the reference

group. In the first regression, where the reference choice is the Stock Only group, the

coefficients ofOne is Payer,Diff.DivYieldandDiff.Div/Bookare all positive and statistically

significant in the Cash Only group. Thus, if dividend differences between the target and

acquirer are greater, the acquisition is more likely to be financed by cash than stock, which is

consistent with our first hypothesis.

In the second and third regressions, whenDiff.DivYield(Diff.Div/Book) is used as the

independent variable, we control for the DivYield (Div/Book) of acquiring firms. The

negative coefficients onAcquirer DivYieldandAcquirer Div/Booksuggest that the higher the


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acquirers dividend level, the more likely the acquisition is to be stock based. While we had

no prior expectation regarding the sign of this variable, the empirical results are consistent

with the proposition that dividend paying stock is more likely to be used as an acquisition

vehicle.

In each of our regressions, where the dependent variable is Mixed Paymentand the

reference group is Stock Only, the coefficients of our dividend difference measures are

positive but not statistically significant. Also, in the third regression, where the dependent

variable is Cash Only and reference group is Mixed Payment, the coefficients of the dividend

difference measures are positive, but again insignificant. Therefore, the results suggest that

even if the degree of dividend differences leads an acquirer to choose a cash deal rather than

stock deal, it does not significantly affect a choice between mixed payment and stock only or

a cash deal versus a mixed deal.

Note that most of the coefficients of the control variables are signed in accordance

with our expectations and prior literature. We find that tender offers are usually financed

with cash (Jensen and Ruback, 1983). The positive coefficient ofCash/Deal Value implies

that an acquirer maintaining more cash has a greater ability of cash financing and, therefore,

is more likely to use cash as a mean of payment. Consistent with Faccio and Masulis (2005),

the negative coefficient ofPrereturns suggests that when acquirers stock price is overvalued

at the announcement date the acquirer is more likely to use stock financing. Acquirer

Leverage displays a positive sign, which suggests that acquirers may borrow early in

anticipation of future cash acquisitions. The coefficient ofTarget Insider Ownership displays

a significant quadratic relationship, first falling and then rising, implying higher managerial

ownership in target firms at first decreases, but ultimately increases, the likelihood of the


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method of payment being cash. Ghosh and Ruland (1998) have previously documented a

negative relationship (i.e. a positive relationship between target inside ownership and stock

payments).Relative Size is negatively correlated with the probability of cash payment and is

weakly significant, implying a larger target size, which increases the risk of valuation

miscalculation, results in the lower chance of cash financing rather than stock financing. The

results support the asymmetric information hypothesis (Hansen, 1987; Martin, 1996). Target

Institutional Ownership is positively related to the probability of a cash payment, consistent

with the arguments of Baker, et al. (2007). TargetLeverage is negatively related to the

probability of a cash payment.


In Table 4, we alternatively employ a two-limit Tobit approach to examine the effect

of dividend differences on the fraction of cash financing, %Cash PMT. The Q-MLE is used

to maximize a log-likelihood function, in cases where that function is possibly misspecified

due to the specification of the wrong density. The proxies for a difference in dividend

policies (One is Payer, Diff.DivYield and Diff.Div/Book) have positive and significant

coefficients, implying that the proportion of cash financing is increasing in these variables.

The result is consistent with the first hypothesis that with a greater difference in the dividend

policies between an acquirer and target, acquirer management is more likely to choose cash

as the payment form. The effect of the level of the dividend yield or dividend to book ratio of

an acquirer in the second and third regressions is negative and significant, consistent with the

findings in the first regression in Table 3. As expected, other important determinants of the

percentage of cash payment include Deal Premium, Tender Offer, Cash/Deal Value,

Prereturns, Target Insider Ownership, Target Institutional Ownership, and Target Leverage.


26/46


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24.60%, respectively. In contrast, takeovers are possibly wealth destroying for acquiring

firms where average CARs are -1.45% and -1.41% in the three-day and five-day windows,

respectively. The table also shows that the average CARs of the Cash Only group are

significantly higher than the Stock Only group. The average CARs of acquiring firms are

0.41% in the three-day window and 0.57% in the five-day window for a cash deal, while they

have negative values for a stock deal. Also, cash based takeovers are associated with greater

target CARs. As widely documented in the literature, the lower announcement returns

associated with stock deals are consistent with the adverse selection argument initially

suggested by Myers and Majluf (1984). The mergers and acquisitions literature applies the

adverse selection argument to suggest that acquiring firms pay with stock only when their

shares are overvalued (Travlos, 1987; Amihud, Lev and Travlos, 1990).


Table 6 presents the results of OLS regressions that analyze the determinants of

takeover announcement returns for both target and acquiring firms. The variable of interest in

the regressions is the interaction variable of a dummy for a stock deal and the difference in

dividend policies. As discussed above, our second hypothesis states that abnormal

announcement returns are lower for a stock based deal with a greater difference in dividend

policies. Whether this negative announcement effect is greater for target firms or acquiring

firms depends upon whether merger arbitragers anticipate the extent of dividend related

selling and the speed with which they shift its effects to acquirers. In Panel A, consistent with

our hypothesis, the coefficients of the interaction variables between a stock deal dummy and

the degree of the dividend differences are negatively correlated with target returns for all

three measures and are statistically significant when One is PayerandDiff.DivYieldare used


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to measure the dividend differential. In stock based mergers target CARs decrease by, on

average, 2.6% during the three-day window around the deal announcement and 5.9% during

the five-day window if only one firm pays a dividend.12

Also, target CARs drop by 2.9% or

4.5% during the three-day or five-day windows, respectively, when the difference in

dividend yield increases by one unit. In the acquirer CARs regressions in Panel B, the

interaction terms again have negative coefficients for the three measures of dividend

differences but are significant only when One is Payerand Diff.Div/Book(and the latter at

the 10% level) are used as the dividend difference measure. In stock based takeovers, CARs

of acquiring firms decrease by 0.6% (that is, -0.015 + 0.009) or 0.3% during the three-day or

five-day windows, respectively, when only one firm pays a dividend. The evidence suggests

that the market does not fully immediately shift the dividend effect in the acquirer stock price,

but that some arbitrage activity does occur. In both panels, the coefficients of a dummy for a

pure stock deal, Stock Only, are negative and significant at the 1% level in 11 of the 12

specifications (and at the 5% level in the other), supporting the adverse selection hypothesis.

We include several control variables in both the target and acquirer CARs regressions

as suggested by previous literature. Target and acquirer announcement returns are

significantly higher if the ln(Market Value) of an acquirer is larger, while they are lower if

the targetsRelative Size is bigger. The positive coefficient on target Stock Return Volatility

suggests that target firms with greater stock return volatility are more likely to benefit from

takeovers. HigherTarget Institutional Ownership depresses announcement returns for both

targets and acquirers consistent with Baker, et al.s (2007) passive shareholder arguments.

12 Note that the coefficient ofOne is Payeris not statistically different from 0 in both the three-day and five-

day CARs regressions. Therefore, the marginal effect of One is Payer in stock based deals is -0.0261+0=-

0.026.


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Finally, we find that Target Leverage is negatively associated with target announcement

returns.


A potential concern in Table 6 is that a decision on a pure stock payment would not

be randomly assigned, resulting in endogeneity bias. As discussed in Section I.C, we employ

the two-stage least squares (2SLS) approach to control for the endogeneity of payment

decisions in takeovers. Table 7 reports the results of both first and second stage 2SLS

regressions. In Panel A , One is Payeris used for the measure of dividend difference, while

Diff.DivYieldandDiff.Div/Bookare used in Panel B and Panel C, respectively. In the reduced

form regressions in each panel, we estimate the determinants of the endogenous

variables, %Stock PMTand %Stock PMTMeasure of Dividend Differences. In each panel,

the instrumental variables, described in Section 3.2.5, are significantly and positively

correlated with each of the endogenous variables they are intended to instrument, confirming

that there is no weak instrument problem.

The results of 2SLS in Table 7 are generally consistent with our findings from the

OLS regressions in Table 6. In Panel A, the predicted value of the interaction variable

between %Stock and One is Payer is negatively and significantly correlated with target

CARs, confirming that our results in Table 6 are robust after controlling for endogeneity. For

acquiring firms, it is negative and weakly significant when three-day CARs are used, but not

significant when five-day CARs are used. In Panel B Diff.DivYield, is used for the measure

of the dividend differential. Consistent with our previous findings, target CARs are

negatively correlated with the predicted value of the interaction variable, %Stock

Diff.DivYield. The coefficient of the interaction variable, however, is negative but not


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significant for acquirer CARs. In Panel C Diff.Div/Book, is used for the measure of dividend

differential. The effect of the predicted value of %StockDiff.Div/Book is negative but not

significant on both target and acquirer abnormal announcement returns. The results are thus

similar to the OLS results for target CARs but somewhat weaker, in terms of statistical

significance, for acquirer CARs. In addition, the predicted values of the percentage of stock

payment in each panel are negatively correlated with both target and acquirer announcement

returns, consistent with adverse selection explanations.

Overall, the results of the announcement returns analysis support our second

hypothesis. In stock based takeovers, the difference in dividend policies has a negative effect

on target returns, reflecting the possibility of selling activities by target shareholders who will

experience a change in dividend policy from that of the target firm to that of the acquirer.

The effect, however, is less significant in the acquirer CARs regressions, suggesting that the

market does not immediately fully arbitrage the dividend related effect.

6. Conclusions

The dividend clientele hypothesis suggests that shareholders are different in their

preferences for payouts from the firms they invest in. Some shareholders prefer to receive a

regular stream of income in the form of cash dividends, while others may prefer to forgo cash

dividends in order to get a possibly better payout from a firm in the form of capital gains.

Hence, different dividend policies attract different types of shareholders.

Changes in dividend policies resulting from mergers of firms with dissimilar policies

may result in portfolio rebalancing from target shareholders. Shareholders may reduce or

totally liquidate their positions from the firms whose dividend policies have changed in a


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way that is unfavorable to them. In anticipation of such a consequence, acquirers may at the

margin select a method of payment based on how different the dividend policies are between

the acquirers and the target firms.

We offer two hypotheses. First, similar dividend policies between acquirers and

targets increase the likelihood of the use of stock as a method of payment in acquisitions.

Second, in stock based acquisitions abnormal announcement returns are lower if the level of

difference in dividend policies is larger.

Our empirical results generally support the hypothesis that the likelihood of acquirers

using stock as the payment method in takeovers increases with the degree of similarity in

dividend policies. To arrive at this conclusion, first we consider the case where acquirer

management faces the qualitative decision to pay in the form of stock, cash, or a mix of the

two. The results of our multinomial analysis show that the degree of difference in dividend

policies is significantly higher for pure cash deals than pure stock deals. We, then, examine

the determinants of the proportion of cash payment using a two-limit Tobit approach. The

results show that a larger difference in dividend policies significantly increases the

percentage of cash payment. We also find that the higher the dividend on the acquirer stock,

the more likely it is to be used as an acquisition currency.

To test our second hypothesis related to announcement returns, we conduct OLS and

a 2-step procedure in order to control for endogeneity of payment decisions. Our results show

that, for stock deals, target cumulative abnormal returns (CARs) around the takeover

announcement date significantly decrease if only one firm pays a dividend and the other does

not or if the difference in dividend yields between target and acquiring firms becomes larger.

The negative effect for acquirer CARs, however, is only weakly significant and only when


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one firm pays a dividend and the other does not. These results suggest that the market does

not fully immediately incorporate the dividend effect in the acquirer stock price. In addition,

our results are largely consistent with adverse selection explanations of the method of

payment, which suggest that stock based acquisitions produce lower announcement returns

because acquirers may use their stock to pay for acquisitions only when their stocks are

overvalued.

In sum, this study provides a new perspective regarding the takeover method of

payment choice. We show that, in addition to factors related to traditional explanations of

the method of payment, the dividend policies of target and acquiring firms are a key

determinant of the payment choice.


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Table 1. Descriptive Statistics

This table provides summary statistics regarding the method of payment and dividend policies of target andacquiring firms. The sample includes 1,022 merger agreements during the period January, 2001 to December,

2007. Cash Only includes deals where at least 90% of consideration is paid with cash. Stock Only includes deals

where at least 90% of consideration is paid with acquirer stocks. Mixed Paymentincludes deals financed with

both stock and cash. One is Payer,Diff.DivYield and Diff.Div/Book, based on quarterly dividends, are ourmeasures of the degree of difference in dividend policies and are discussed in Section 2.2.

Year 2001 2002 2003 2004 2005 2006 2007 Total

Mean Mean Mean Mean Mean Mean Mean Mean Median

N 208 110 150 149 148 143 114 1,022 [100%]

Payment Method

Cash Only (N) 48 41 50 52 53 76 59 379 [37.1%]

Stock Only (N) 87 33 40 39 29 25 18 271 [26.5%]

Mixed Payment (N) 73 36 60 58 66 42 37 372 [36.4%]

% Cash Financing 34.708 46.248 47.950 48.824 52.799 63.543 64.574 49.937 46.135

% Stock Financing 55.101 45.040 45.578 45.564 40.402 30.090 31.282 42.945 43.725

Target Dividends

Dividend Payer (N) 57 34 54 52 53 56 49 355

DivYield (%) 0.881 0.838 0.812 0.694 0.814 0.849 0.716 0.802 0.570

Div/Book (%) 0.895 0.790 0.269 0.601 1.692 2.623 1.579 1.233 0.270

Acquirer Dividends

Dividend Payer (N) 79 53 75 93 82 90 63 535

DivYield (%) 0.779 0.858 1.576 0.827 0.983 0.878 0.798 0.956 0.652

Div/Book (%) 1.191 1.313 1.163 1.003 2.752 1.735 1.740 1.555 0.569

Dividend Differential

One is Payer (N) 59 27 31 51 49 50 36 303

Both are Payers (N) 57 30 49 47 43 48 38 312

Neither is Payer (N) 92 53 70 51 56 45 40 407

Diff.DivYield (%) 0.195 0.246 0.736 0.264 0.510 0.564 0.348 0.404 0.077

Diff.Div/Book (%) 0.754 0.517 0.563 0.667 1.845 1.796 2.240 1.157 0.000


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Table 2. Univariate Tests

The sample is divided into three groups based on their payment methods. Cash Only includes deals where atleast 90% of the consideration is paid with cash. Stock Only includes deals where at least 90% of the

consideration is paid with acquirer stock. Mixed Payment includes deals financed with both stock and cash.

Tests for statistically significant differences between the Stock Only group and other groups are from t-tests (for

means) and Wilcoxon rank-sum (i.e. Mann-Whitney-Wilcoxon) tests for each of the three measures ofdifferences in dividend policies, One is Payer,Diff.DivYieldandDiff.Div/Book, which are discussed in Section

2.2. The Wilcoxon tests are technically for the equality of the distributions rather than medians per se. The

symbols ***, **, and * represent statistical significance at the 1%, 5%, and 10% level, respectively.

Panel A. Full Sample

Cash Only Mixed Payment Stock Only

N = 1022 379 372 271

Mean Median Mean Median Mean Median

One is Payer (%) 38.522 *** 0 *** 23.656 ** 0 *** 19.188 0

Diff.DivYield (%) 0.495 * 0.122 *** 0.423 0.106 *** 0.391 0

Diff.Div/Book (%) 1.467 *** 0.155 *** 1.341 ** 0.006 *** 0.472 0

Panel B. Subsample (When both targets and acquirers are dividend payers)

Cash Only Mixed Payment Stock Only

N = 588 225 231 132

Mean Median Mean Median Mean Median

One is Payer (%) 64.889 *** 1 *** 40.125 * 0 * 38.393 0

Diff.DivYield (%) 0.966 ** 0.345 ** 0.682 0.326 * 0.602 0.295

Diff.Div/Book (%) 2.242 *** 1.062 *** 1.474 * 0.324 *** 0.662 0.165


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Table 3. Determinants of the Payment Choice

Cash Only includes deals where at least 90% of consideration is paid with cash. Stock Only includes dealswhere at least 90% of consideration is paid with acquirer stock. Mixed Payment includes deals financed with

both stock and cash. Multinomial logit regressions are estimated for the payment method categories. The

measures of differences in dividend policies include One is Payer,Diff.DivYield, andDiff.Div/Book, which are

discussed in Section 2.2. All tests use the QML robust standard errors and z statistics which are reported in brackets. The symbols ***, **, and * represent statistical significance at the 1%, 5%, and 10% level,

respectively. Coefficients onRelative Size have been multiplied by 10,000 for presentation purposes. All of

the control variables are discussed in Section 3.2.

Cash Only Mixed Payment Cash Only

Reference group : Stock Only Stock Only Mixed Payment


One is Payer 0.614**

0.227 0.387

[2.23] [0.96] [1.44]

Diff.DivYield 33.308**

17.753 15.555

[2.15] [1.05] [1.01]

Acquirer DivYield -30.697**

-15.562 -15.135

[-2.05] [-0.95] [-0.96]

Diff.Div/Book 11.042**

10.363 0.679

[2.32] [0.87] [0.23]

Acquirer Div/Book -6.152* 7.635 -1.483

[-1.91] [0.72] [-0.46]

Deal Characteristics

Deal Premium 0.592** 0.538 0.546 0.066 0.042 0.075 0.526** 0.495 0.470

[2.16] [1.25] [1.34] [0.25] [0.16] [0.29] [2.07] [1.35] [1.56]

Ln (Deal Value) -0.296*** 0.249* 0.277* 0.198** 0.216** 0.200** -0.494*** -0.465 -0.477

[-2.89] [1.76] [1.71] [2.13] [2.34] [2.15] [-5.00] [-1.48] [-1.49]

Related Deal -0.112 -0.075 -0.105 0.471** 0.495*** 0.464** -0.583*** -0.570*** -0.569*

[-0.54] [-0.36] [-0.51] [2.58] [2.69] [2.50] [-3.09] [-3.03] [-3.03]

Hostile -0.158 -0.076 -0.131 0.131 0.153 0.105 -0.289 -0.228 -0.236

[-0.18] [-0.09] [-0.15] [0.15] [0.18] [0.12] [-0.45] [-0.35] [-0.36]

Tender Offer 1.752*** 1.706*** 1.712*** 0.346 0.337 0.333 1.406*** 1.369*** 1.378*

[4.96] [4.95] [4.96] [0.96] [0.93] [0.91] [4.13] [4.11] [4.13]

Acquirer Characteristics

Insider Ownership -0.374 -0.478 -0.304 0.173 0.141 0.311 -0.546 -0.620 -0.615

[-0.42] [-0.53] [-0.34] [0.21] [0.18] [0.37] [-0.62] [-0.70] [-0.70]

Insider Ownership

2

-0.010 0.009 -0.060 -0.441 -0.440 -0.510 0.431 0.449 0.449[-0.03] [0.03] [-0.18] [-1.05] [-1.04] [-1.18] [1.13] [1.16] [1.15]

Leverage 1.355*** 1.605*** 1.444*** 0.253 0.391 0.249 1.102** 1.214** 1.194*

[2.71] [3.22] [2.84] [0.52] [0.81] [0.49] [2.13] [2.41] [2.35]

Leverage -1.082 -1.258 -1.290 -1.456 -1.626 -1.708 0.374 0.368 0.418

[-1.08] [-1.23] [-1.26] [-1.43] [-1.58] [-1.58] [0.41] [0.41] [0.46]

PPE/Book 0.544 0.362 0.213 0.693** 0.613** 0.449 -0.149 -0.251 -0.236

[1.59] [1.07] [0.62] [2.26] [2.03] [1.49] [-0.53] [-0.90] [-0.84]


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Market/Book -0.029 -0.032 -0.056 0.069 0.068 0.046 -0.098 -0.100 -0.102

[-0.31] [-0.34] [-0.58] [0.74] [0.72] [0.47] [-1.20] [-1.24] [-1.22]

Cash/Deal value 0.022** 0.022** 0.020** 0.002 0.002 0.000 0.020 0.020 0.020

[2.14] [2.19] [2.14] [0.11] [0.09] [0.00] [1.15] [1.17] [1.15]

Prereturns -1.502***

-1.587***

-1.535***

-0.582 -0.629 -0.580 -0.920**

-0.958**

-0.955*

[-2.59] [-2.73] [-2.70] [-1.04] [-1.12] [-1.03] [-2.04] [-2.11] [-2.09]

Target Characteristics

Relative Size -0.923*

-0.895*

-0.858*

-0.615***

-0.611***

-0.606***

-0.308 -0.284 -0.252

[-1.69] [-1.69] [-1.66] [-2.70] [-2.72] [-2.71] [-0.55] [-0.52] [-0.48]

Insider Ownership -4.121**

-0.004**

-0.005***

1.939 1.938 2.026 2.182 2.089 2.081

[-2.58] [-2.55] [-2.60] [1.22] [1.21] [1.26] [1.48] [1.43] [1.43]

Insider Ownership2

4.769***

0.047***

0.049***

-2.182 -2.227 -2.384 -2.587 -2.508 -2.507

[2.69] [2.72] [-2.81] [-1.27] [-1.29] [-1.37] [-1.55] [-1.53] [-1.53]

Institutional Ownership 2.835***

2.631***

2.658***

0.314 0.241 0.232 2.522***

2.390***

2.426*

[5.49] [5.14] [5.17] [0.66] [0.51] [0.48] [5.34] [5.17] [5.23]

Leverage -1.886

***

-1.630

***

-1.610

***

0.501 0.585 0.611 -2.388

***

-2.215

***

-2.221

*

[-3.97] [-3.55] [-3.50] [1.20] [1.38] [1.37] [-5.17] [-5.01] [-5.07]

Market/Book 0.059 0.038 0.037 -0.173 -0.180 -0.188 0.232*

0.219*

0.225*

[0.63] [0.44] [0.44] [-1.54] [-1.62] [-1.60] [1.84] [1.81] [1.83]

Intercept 4.033** -3.205* -3.769** -4.553*** -4.890*** -4.568*** 8.586*** 8.095*** 8.336*

[2.24] [-1.79] [-2.10] [-2.73] [-2.95] [-2.72] [5.02] [4.81] [4.97]

No. observations 1,022 1,022 1,022

Wald test 199.34 201.64 201.64

P-value 0.000 0.000 0.000

Pseudo R2 0.1449 0.1443 0.1443


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38

Table 4. Determinants of the Proportion of Cash Payment

Two-limit Tobit regressions are estimated where the dependent variable is the proportion of cash

payment, %Cash PMT. The measures of differences in dividend policies include One is Payer,Diff.DivYield, andDiff.Div/Book, which are discussed in Section 2.2. All tests use the QML robust standard

errors and t statistics which are reported in brackets. The symbols ***, **, and * represent statistical

significance at the 1%, 5%, and 10% level, respectively. Coefficients onRelative Size have been multipliedby 10,000 for presentation purposes. All of the control variables are discussed in Section 3.2.

Dependent variable: %Cash PMT


One is Payer 0.298 [3.29]***

Diff.DivYield 13.432 [2.32]**

Acquirer DivYield -11.387 [-2.11]**

Diff.Div/Book 1.668 [2.70]***

Acquirer Div/Book -1.221 [-2.48]**

Deal Characteristics

Deal Premium 0.212 [2.01]** 0.232 [2.19]** 0.230 [2.16]**

ln (Deal Value) 0.115 [1.97]** 0.056 [1.45] 0.049 [1.50]

Related Deal -0.006 [-0.08] -0.028 [-0.35] -0.041 [-0.50]

Hostile -0.332 [-1.10] -0.318 [-1.04] -0.319 [-1.04]

Tender Offer 0.874 [6.37]*** 0.876 [6.36]*** 0.878 [6.36]***


Insider Ownership -0.212 [-0.58] -0.319 [-0.87] -0.268 [-0.73]

Insider Ownership2 -0.029 [-0.16] 0.024 [0.13] 0.007 [0.04]

Leverage 0.714 [3.45]*** 0.820 [3.97]*** 0.794 [3.81]***

Leverage -0.427 [-1.00] -0.492 [-1.14] -0.440 [-1.03]

PPE/Book 0.053 [0.45] 0.078 [0.65] 0.089 [0.74]

Market/Book -0.038 [-1.10] -0.037 [-1.07] -0.039 [-1.12]Cash/Deal value 0.008 [3.03]*** 0.009 [3.08]*** 0.009 [3.11]***

Prereturns -0.679 [-3.13]*** -0.701 [-3.22]*** -0.690 [-3.16]***


Relative Size -0.144 [-1.18] -0.157 [-1.27] -0.151 [-1.23]

Insider Ownership -1.557 [-2.53]** -0.016 [-2.59]*** -0.016 [-2.61]***

Insider Ownership2 1.723 [2.55]** 0.171 [2.53]** 0.175 [2.59]***

Institutional Ownership 1.112 [5.62]*** 1.168 [5.87]*** 1.172 [5.90]***

Leverage -0.727 [-3.96]*** -0.758 [-4.12]*** -0.757 [-4.10]***

Market/Book 0.047 [1.32] 0.051 [1.42] 0.051 [1.42]

Intercept 1.896 [2.76]*** 1.833 [2.64]*** 1.902 [2.75]***

No. observations 1,022 1,022 1,022

Wald test 199.99 193.44 190.29

P-value 0.000 0.000 0.000

Pseudo R2 0.145 0.100 0.099


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39

Table 5. Univariate Tests for Announcement Returns

Announcement returns are measured as the cumulative abnormal returns (CARs) relative to the CRSP

value-weighted market index over three day [-1, 1] and five day [-2, 2] horizons. The sample is divided intothree groups based on the method of payment. Tests for statistically significant differences are from t-tests

between the Stock Only group and other groups. The symbols ***, **, and * represent statistical

significance at the 1%, 5%, and 10% level, respectively.

Cash Only Mixed Payment Stock Only Overall

Acquirer CARs (%) [-1, 1] 0.41 *** -2.08 ** -3.06 -1.45

[-2, 2] 0.57 *** -1.74 *** -3.59 -1.41

Target CARs (%) [-1, 1] 30.71 *** 19.93 19.46 23.81

[-2, 2] 31.37 *** 20.86 20.25 24.60


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40

Table 6. Determinants of Announcement Returns

This table reports the results of OLS regressions that test the determinants of takeover announcement returns, definedas the cumulative abnormal returns (CARs) over the three-day [-1, +1] and five-day [-2, +2] windows. The dependentvariable in Panel A is target CARs, while it is acquirer CARs in Panel B. The measures of differences in dividend

policies include One is Payer,Diff.DivYield, andDiff.Div/Book, which are discussed in Section 2.2. The t-statistics arebased on White robust standard errors. The symbols ***, **, and * represent statistical significance at the 1%, 5%, and

10% level, respectively. Coefficients onRelative Size have been multiplied by 10,000 for presentation purposes. Allof the control variables are discussed in Section 3.2.

Panel A. Target Announcement Returns

Dependent Variables Target CAR [-1,1] Target CAR [-2,2]


Stock OnlyOne is Payer -0.026** -0.059**

[-2.27] [-2.16]

One is Payer -0.011 -0.003[-0.51] [-0.12]

Stock OnlyDiff.DivYield -0.029** -0.045**

[-2.02] [-2.35]

Diff.DivYield -0.242

-0.322[-0.84] [-1.08]

Stock OnlyDiff.Div/Book -0.079 -0.509

[-1.08] [-0.85]

Diff.Div/Book -0.049 -0.041

[-0.52] [-0.44]

Stock Only -0.058*** -0.059*** -0.059*** -0.059*** -0.060*** -0.062***

[-3.55] [-3.70] [-3.71] [-3.50] [-3.73] [-3.85]

Acquirer Characteristicsln(Market Value) 0.019*** 0.019*** 0.019*** 0.021*** 0.021*** 0.021***

[4.08] [3.82] [3.85] [4.35] [4.20] [4.22]

Market/Book 0.008 0.008 0.008 0.007 0.007 0.007

[1.25] [1.25] [1.27] [1.15] [1.13] [1.13]

Leverage -0.071 -0.073* -0.072* -0.086* -0.086* -0.086*

[-1.64] [-1.67] [-1.65] [-1.96] [-1.95] [-1.94]

PPE/Book -0.018 -0.020 -0.019 -0.018 -0.018 -0.018

[-0.96] [-1.06] [-1.02] [-0.92] [-0.94] [-0.95]

Target CharacteristicsRelative Size -0.044*** -0.043*** -0.043*** -0.044*** -0.044*** -0.045***

[-3.19] [-3.12] [-3.14] [-3.16] [-3.15] [-3.23]

Institutional Ownership -0.120*** -0.123*** -0.122*** -0.136*** -0.138*** -0.137***

[-3.50] [-3.60] [-3.57] [-3.92] [-4.00] [-3.96]

Leverage -0.140*** -0.137*** -0.138*** -0.134*** -0.133*** -0.134***

[-4.14] [-4.10] [-4.12] [-3.95] [-3.96] [-3.99]

Stock Return Volatility 0.150*** 0.146*** 0.146*** 0.149*** 0.147*** 0.148***

[4.55] [4.51] [4.52] [4.56] [4.57] [4.59]

Market/Book -0.009 -0.009 -0.009 -0.007 -0.007 -0.007

[-1.47] [-1.50] [-1.49] [-1.15] [-1.16] [-1.15]Intercept 0.258*** 0.263*** 0.261*** 0.264*** 0.268*** 0.267***

[5.87] [5.87] [5.90] [5.77] [5.74] [5.80]

No. observations 1,022 1,022 1,022 1,022 1,022 1,022

F test 8.34 11.57 8.42 8.95 12.37 9.11P-value 0.000 0.000 0.000 0.000 0.000 0.000Adj. R2 0.117 0.116 0.116 0.123 0.123 0.228


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41

Panel B. Acquirer Announcement Returns

Dependent Variables Acquirer CAR [-1,1] Acquirer CAR [-2,2]


Stock OnlyOne is Payer -0.015** -0.019 *

[-2.23] [-1.68]

One is Payer 0.009 *** 0.016 **

[2.66] [2.20]

Stock OnlyDiff.DivYield -0.113 -0.168

[-0.98] [-1.51]

Diff.DivYield 0.126 0.041

[1.22] [0.43]

Stock OnlyDiff.Div/Book -0.008* -0.237 *

[-1.73] [-1.81]

Diff.Div/Book 0.060 0.045

[1.70] * [1.32]

Stock Only -0.015 ** -0.020 *** -0.019 *** -0.024 *** -0.029 *** -0.029 ***

[-2.41] [-3.53] [-3.30] [-3.64] [-4.67] [-4.59]


ln(Market Value) 0.002 * 0.003 ** 0.003 * 0.002 0.003 * 0.003 *

[1.74] [1.97] [1.90] [1.07] [1.83] [1.73]

Market/Book -0.003 -0.004 -0.004 * -0.005 ** -0.005 ** -0.005 **

[-1.46] [-1.63] [-1.78] [-2.07] [-2.21] [-2.36]

Leverage 0.009 0.010 0.009 0.007 0.008 0.007

[0.65] [0.71] [0.62] [0.47] [0.55] [0.46]

PPE/Book 0.009 * 0.011 * 0.010 * 0.012 * 0.014 ** 0.012 *

[1.88] [1.93] [1.70] [1.77] [2.13] [1.91]


Relative Size -0.011 ** -0.013 *** -0.013 *** -0.010 * -0.012 ** -0.012 **

[-2.54] [-3.07] [-3.00] [-1.91] [-2.23] [-2.28]

Institutional Ownership -0.016 ** -0.015 ** -0.016 ** -0.020 * -0.019 * -0.019 *

[1.98] [-2.47] [-2.49] [-1.81] [-1.75] [-1.73]

Leverage 0.010 0.006 0.007 0.010 0.007 0.008

[0.96] [0.60] [0.65] [0.92] [0.67] [0.70]

Stock Return Volatility 0.011 * 0.014 ** 0.013 * 0.006 0.008 * 0.008

[1.77] [2.34] [1.68] [1.24] [1.86] [1.45]

Market/Book 0.002 0.003 0.003 0.003 0.003 0.003

[0.96] [1.15] [1.14] [1.38] [1.58] [1.57]

Intercept -0.035 * -0.041 ** -0.038 ** -0.026 -0.031 * -0.028

[-1.90] [-2.21] [-2.11] [-1.42] [-1.67] [-1.56]

No. observations 1,022 1,022 1,022 1,022 1,022 1,022

F test 5.57 5.95 4.92 4.96 4.34 4.09

P-value 0.000 0.000 0.000 0.000 0.000 0.000

Adj. R2 0.056 0.051 0.049 0.063 0.059 0.059


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42

Table 7. Two-Stage Analysis of Announcement Returns

This table reports the results of two-stage least squares (2SLS) regressions that test the determinants of takeover announcement returns

of both target and acquiring firms. The two-step approach when the interaction term is an endogenous variable is discussed in Section2.3. In Panel A, One is Payeris used as the measure of dividend differential, whileDiff.DivYieldandDiff.Div/Bookare used in Panel

B and Panel C, respectively. These measures are discussed in Section 2.2. The t-statistics based on robust standard errors are reported

in parentheses below coefficient values. The symbols ***, **, and * represent statistical significance at the 1%, 5%, and 10% level,

respectively. Coefficients onRelative Size have been multiplied by 10,000 for presentation purposes. All of the control variables arediscussed in Section 3.2.

Panel A. One is Payeras a Measure of Dividend Differential

1st stage regressions 2nd stage regressions

%Stock* Target CARs Acquirer CARsDependent Variables %Stock One is Payer [-1,1] [-2,2] [-1,1] [-2,2]


%StockOne is Payer -0.012** -0.033* -0.008* -0.007

[-2.02] [-1.78] [-1.88] [-1.65]

%Stock -0.133*** -0.138*** -0.060*** -0.070***

[-3.20] [-3.26] [-3.96] [-4.45]One is Payer (1) -0.062* -0.084*** -0.020 -0.020 0.005 0.002

[-1.71] [-3.35] [-0.57] [-0.59] [0.53] [0.19]

Acquirer Characteristicsln(Market Value) -0.038*** -0.018*** 0.015*** 0.017*** 0.000 0.000

[-5.42] [-4.41] [3.00] [3.34] [0.12] [-0.09]

Market/Book -0.001 0.004 0.009 0.008 -0.003 -0.004*

[-0.13] [0.76] [1.46] [1.31] [-1.28] [-1.82]Leverage -0.014 0.010 -0.064 -0.080* 0.011 0.010

[-0.25] [0.43] [-1.49] [-1.83] [0.78] [0.65]

PPE/Book -0.040 -0.011 -0.026 -0.025 0.005 0.008

[-1.30] [-0.65] [-1.36] [-1.29] [0.85] [1.18]Target Characteristics

Relative Size 0.135*** 0.042*** -0.025* -0.026* -0.002 -0.001

[5.72] [3.25] [-1.67] [-1.68] [-0.45] [-0.14]Institutional Ownership -0.029 0.044* -0.129

*** -0.146*** -0.023** -0.026**

[-0.62] [1.68] [-3.71] [-4.17] [-2.18] [-2.39]Leverage 0.147*** 0.064*** -0.113*** -0.108*** 0.021* 0.023*

[3.00] [2.70] [-3.27] [-3.12] [1.93] [1.92]

Stock Return Volatility -0.159*** -0.014 0.135*** 0.134*** 0.003 -0.002[-3.25] [-0.59] [3.98] [3.99] [0.29] [-0.22]

Market/Book 0.024*** -0.001 -0.008 -0.006 0.003 0.004

[3.18] [-0.17] [-1.25] [-0.93] [1.18] [1.53]

Instrumental VariablesAverage Acquirer 0.502*** 0.004

Industry %Stock (2) [5.69] [0.40]

Average Target 0.499*** -0.028**Industry %Stock (3) [5.66] [-2.19]

(1) (2) -0.016 0.447***[-0.10] [3.40]

(1) (3) 0.073 0.672***

[0.50] [5.87]Intercept 0.260*** 0.082** 0.326*** 0.334*** -0.001 0.010

[3.62] [2.56] [6.52] [6.47] [-0.04] [0.53]

No. observations 1,022 1,022 1,022 1,022 1,022 1,022

F test 88.34 29.29 8.50 9.13 5.80 5.52

P-value 0.000 0.000 0.000 0.000 0.000 0.000Adj. R2 0.372 0.561 11.890 12.420 0.069 0.071


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43

Panel B.Diff.DivYieldas a Measure of Dividend Differential


%Stock* Target CARs Acquirer CARs

Dependent Variables %Stock Diff.DivYield [-1,1] [-2,2] [-1,1] [-2,2]

Dividends Differences

%StockDiff.DivYield -0.327** -0.260** -0.007 -0.016

[-2.31] [-2.08] [-1.32] [-1.07]

%Stock -0.129*** -0.130*** -0.062*** -0.071***

[-3.42] [-3.40] [-4.94] [-5.47]

Diff.DivYield (1) -0.514 -0.157*** -0.126 -0.205 0.092 -0.024

[-0.69] [-4.58] [-0.36] [-0.56] [0.90] [-0.21]


ln(Market Value) -0.041*** 0.000** 0.014*** 0.015*** 0.001 0.000

[-6.03] [-2.15] [2.71] [3.06] [0.29] [-0.02]

Market/Book -0.001 0.000 0.009 0.008 -0.003 -0.004*

[-0.11] [1.11] [1.45] [1.32] [-1.27] [-1.81]

Leverage -0.019 -0.001 -0.069 -0.082* 0.012 0.010

[-0.32] [-0.63] [-1.59] [-1.86] [0.84] [0.71]

PPE/Book -0.044 0.000 -0.030 -0.028 0.006 0.008

[-1.45] [0.10] [-1.53] [-1.40] [1.01] [1.30]


Relative Size 0.140*** 0.001*** -0.023 -0.024 -0.003 -0.001

[5.80] [2.72] [-1.57] [-1.61] [-0.52] [-0.16]

Institutional Ownership -0.035*** -0.001 -0.133*** -0.148*** -0.022** -0.026**

[-2.75] [-1.32] [-3.84] [-4.24] [-2.12] [-2.36]

Leverage 0.154*** 0.000 -0.110*** -0.106*** 0.020* 0.022*

[3.12] [-0.41] [-3.18] [-3.05] [1.85] [1.90]

Stock Return Volatility -0.171*** 0.000 0.129*** 0.130*** 0.004 -0.001

[-3.56] [-0.18] [3.82] [3.90] [0.42] [-0.15]

Market/Book 0.024*** 0.000 -0.008 -0.007 0.003 0.004

[3.08] [-0.69] [-1.33] [-1.01] [1.25] [1.59]

Instrumental Variables

Average Acquirer 0.516*** -0.001

Industry %Stock (2) [6.80] [-0.61]

Average Target 0.511*** -0.001

Industry %Stock (3) [6.78] [-1.48]

(1) (2) -2.623 0.466**

[-0.98] [2.56]

(1) (3) 2.525 1.044***

[1.02] [3.18]

Intercept 0.266*** 0.002** 0.333*** 0.338*** -0.002 0.009

[3.71] [2.54] [6.51] [6.42] [-0.12] [0.46]

No. observations 1,022 1,022 1,022 1,022 1,022 1,022

F test 84.17 19.74 9.02 9.70 6.48 5.57

P-value 0.000 0.000 0.000 0.000 0.000 0.000

Adj. R2 0.371 0.857 0.118 0.125 0.069 0.070


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Panel C.Diff.Div/Bookas a Measure of Dividend Differential


%Stock* Target CARs Acquirer CARs

Dependent Variables %Stock Diff.Div/Book [-1,1] [-2,2] [-1,1] [-2,2]Dividend Differential

%StockDiff.Div/Book -0.365 -0.286 -0.001 -0.006

[-1.40] [-1.22] [-1.01] [-1.35]

%Stock -0.128*** -0.130*** -0.061*** -0.070***

[-3.42] [-3.42] [-4.79] [-5.34]

Diff.Div/Book (1) 0.015 0.028 0.020 0.016 0.033 0.003

[0.05] [0.28] [0.07] [0.06] [0.50] [0.04]


ln(Market Value) -0.041*** 0.000*** 0.014*** 0.016*** 0.000 0.000

[-5.96] [-2.62] [2.76] [3.11] [0.25] [-0.04]

Market/Book 0.000 0.000 0.009 0.009 -0.003 -0.004*

[0.06] [-0.90] [1.51] [1.37] [-1.35] [-1.86]

Leverage -0.017 -0.002 -0.068 -0.082* 0.011 0.010

[-0.30] [-1.10] [-1.55] [-1.83] [0.79] [0.66]

PPE/Book -0.042 0.000 -0.028 -0.027 0.005 0.008

[-1.33] [-0.25] [-1.43] [-1.33] [0.90] [1.21]


Relative Size 0.139*** 0.002*** -0.023 -0.024 -0.002 -0.001

[5.84] [3.33] [-1.55] [-1.59] [-0.50] [-0.17]

Institutional Ownership -0.033 0.000 -0.132*** -0.147*** -0.022** -0.026**

[-0.72] [-0.08] [-3.82] [-4.22] [-2.14] [-2.36]

Leverage 0.153*** 0.003** -0.110*** -0.106*** 0.020* 0.022*

[3.11] [2.08] [-3.18] [-3.05] [1.88] [1.91]

Stock Return Volatility -0.169*** -0.002** 0.129*** 0.130*** 0.004 -0.001

[-3.51] [-2.05] [3.83] [3.91] [0.40] [-0.15]Market/Book 0.024*** 0.000 -0.008 -0.007 0.003 0.004

[3.07] [-0.45] [-1.34] [-1.01] [1.24] [1.59]

Instrumental Variables

Average Acquirer 0.542*** 0.006**

Industry %Stock (2) [6.62] [2.01]

Average Target 0.490*** -0.005*

Industry %Stock (3) [5.96] [-1.78]

(1) (2) -3.144 0.226***

[-1.24] [2.67]

(1) (3) 2.488 1.016***

[1.08] [3.63]

Intercept 0.255*** 0.003 0.330*** 0.334*** -0.001 0.010

[3.59] [1.10] [6.50] [6.42] [-0.05] [0.50]

No. observations 1,022 1,022 1,022 1,022 1,022 1,022

F test 88.41 106.26 8.60 9.27 5.61 5.26

P-value 0.000 0.000 0.000 0.000 0.000 0.000

Adj. R2 0.372 0.819 0.119 0.124 0.068 0.070

dividend policy and the method of payment

Documents