Capital Structure Theory Of M & A Financial Means

　　 (1) MM theorem and its extension

Modigliani and Miller (1958) proposed the theory of irrelevance of capital structure or the theory of investment cash flow. The theory points out that the value of a company is only related to the company's assets and its investment decisions. It depends on the basic profitability of enterprises (investment cash flow) and risk: the adjustment of capital structure will not change the average capital cost and enterprise value of an enterprise. The significance of the MM theorem for the financial means of M & A activities is that the different financial methods of M & A will not affect the value of the acquiring company.

Miller (1977) extends the MM theorem and proposes the tradeoff (trade-off) theory of the tax shield and the bankruptcy cost (tax shield and bankrupt cost). This theory holds that debt has the tax shield function of increasing enterprise value and bankruptcy cost which is not conducive to enterprise value. When the marginal tax shield profit of debt is greater than its marginal bankruptcy cost, debt financing should be selected to increase enterprise value; on the contrary, debt financing should be abandoned to avoid adverse changes in enterprise value. According to the theory of tax and bankruptcy cost, when the marginal tax shield revenue of debt issuance is greater than its marginal bankruptcy cost, the buyout enterprise should choose the debt financing way to implement M & A transactions, such as the bond payment or the lever purchase method.

　　 (two) agency cost (agency cost)

Agency cost originates from conflict of interest. The model of agency cost indicates that capital structure depends on agency cost. The early pioneers in the field of agency cost research are Jensen&Meckling (1976) and earlier Fama and Miller (1972). Jensen&Meckling (1976) regards the enterprise as a contractual nexus, and distinguishes two types of conflicts of interests: one is the conflict between shareholders and managers; the other is the clash between shareholders and creditors. (nexus)

1. conflict of interests between shareholders and managers

The conflict of interests between shareholders and managers stems from the fact that managers hold less than 100% of residual residual claim, while managers bear all the costs of operating activities, but they can not grab all the proceeds of business activities. This will lead to less effort by managers to manage the resources of enterprises or to transfer the resources of enterprises to their own interests. The failure rate of such management behavior will decrease as the manager's share increases. Jensen&Meckling further believes that debt financing will increase the share of managers (assuming managers invest in enterprises as a constant), thereby alleviating the value loss caused by conflicts of interests between managers and shareholders.

Jensen (1986a), when studying the agency cost of free cash flow, points out that the existence of debt will require enterprises to pay cash, and ultimately reduce the free cash flow that managers can get, thereby limiting the managers' pursuit of maximizing their own interests which are not conducive to the interests of shareholders. Jensen (1986b) further believes that higher debt levels will motivate management to work more efficiently. Grossman and Hart (1982) believes that the enterprise bankruptcy mechanism will constrain the moral hazard behavior of the management authorities, and encourage the management to carry out highly efficient investment activities to avoid the loss of agency caused by liquidation (poor financial condition).

From the perspective of shareholder manager agency cost theory, debt financing helps to inhibit the moral hazard tendency of managers' management behavior, and reduces their corresponding agency costs, so as to improve the management efficiency of managers.

2. conflict of interests between shareholders and creditors

The conflict of interests between shareholders and creditors stems from the fact that debt contracts encourage shareholders to make sub optimal (suboptimal) investment decisions. Because only limited liability, shareholders will transfer investment risk to creditors. As a result, shareholders will benefit from going for broke: for example, invest in high-risk projects, even if they are less valuable. Black-Scholes (1973) uses the option (option) tool to analyze corporate debt. It believes that debt financing and its implied option nature will encourage shareholders to sacrifice the interests of creditors at the expense of maximizing their own value, and ultimately lead to a reduction in the overall value of the company. This effect is called asset substitution effect. In addition, when keen creditors see see through shareholders shifting their risks, they will demand a higher premium (or ultimately supervised by shareholders), thereby increasing the capital cost of debt and reducing the overall value of the enterprise.

From the analysis of Jensen and Meckling, we can see that on the one hand, debt financing helps to alleviate conflicts of interests between shareholders and managers, thereby reducing agency loss of management behavior; on the other hand, debt financing will induce shareholders' risky behavior to produce asset substitution effect.

The revelation of Jensen and Meckling (1976)'s agency cost theory is that when the marginal revenue of debt financing is greater than its marginal cost, the buyout enterprise should choose the debt financing mode (debt payment method and leveraged buyout) to increase the value of the enterprise; otherwise, the buyout enterprise should abandon the debt financing way to avoid the reduction of the enterprise value.

　 (three) asymmetric information (asymmetric information)

In the information structure of enterprise knowledge, there is information asymmetry between internal Insider (outside) or external investors (external investors). Insiders have private information about the characteristics of income streams or investment opportunities. The theory of capital structure under asymmetric information has two main viewpoints: one is signal theory (signal). The research in this field starts with the work of Ross (1977) and Leland&Pyle (1977); another view is that capital structure can be designed to alleviate the inefficiency of enterprise investment decisions caused by asymmetric information, which is derived from Myers and Majluf (1984) and Myers (1984) research results.

Ross (1977) proposed the theory of signal incentive, which is determined by capital structure. The theory holds that enterprise management can transfer information about profitability and risk by changing the capital structure, and capital structure can be used as a signal to convey insider's private information. In the Ross model, the external investors of the enterprise regard the higher debt level as the signal of the high quality or better prospect of the enterprise. Leland and Pyle (1977) considers that the increase of corporate leverage will allow managers to retain a larger proportion of risk rights through the study of managerial risk aversion. Based on risk aversion, larger share of benefits will reduce managers' welfare; but for managers with higher quality projects, the benefits decrease is lower. Therefore, managers of high quality enterprises will transmit signals containing this fact (high quality) by having more balanced debts.

Myers and Majluf (1984) found that if investors had less information about the value of assets than insiders, the rights and interests would be mispriced by the market. The underestimation of equity price (underprice) will enable new shareholders to capture the net present value (NPV) of new new projects, resulting in net loss of existing shareholders. In this case, even if the net present value is positive, the investment project will be rejected by the existing shareholders. Enterprises can only avoid these underinvestment (underinvestment) by issuing new securities which are not seriously underestimated by the market. Therefore, internal funds or riskless debt or even less risky debt are better than equity financing. Myers (1984) called the "pecking order" of the new project financing.

Hansen (1987) thinks that the choice of payment method reveals the future investment opportunity or cash flow situation through the investigation of the signal function of M & a payment method. Using cash indicates that the existing assets of the acquirer can generate larger cash flow; the acquirer has the ability to make full use of the investment opportunities of the target enterprise or the merger and acquisition. Cash acquisition may also reflect the secret information of the acquirer about the profitability of the purchase. Therefore, using cash is a good (good) signal.

The main theoretical points of capital structure under asymmetric information can be summarized as follows: financing for new projects, issuing debt is a signal of higher quality. Or there is a "rank order" of financing: internal financing is superior to (no or low risk) debt financing, and debt financing is better than equity financing. The inspiration given by these theories is that the acquisition of enterprises should first choose the way of cash payment, followed by bond payment (or leveraged buyout), and the last is stock payment.