Why Do Firms Pay Cash in Acquisitions? Evidence from a Demand Perspective

I study the means of payment in acquisitions from a demand perspective. I propose that the decision to pay cash is positively related to the prevailing investor cash demand. To test this prediction, I construct a new measure of investor cash preferences using mutual fund flows (“cash popularity”). I show that the choice of cash offers is significantly affected by the cash popularity in the market. One standard deviation increase in cash popularity raises the probability of cash offers from 38% to 53%. When cash is very popular, cash mergers strengthen the bargaining power of the bidder. This effect is stronger in the cases where the target stock displays high idiosyncratic volatility and low institutional ownership. The use of cash when cash is popular also increases the probability of success of the deal. Overall, the evidence supports a cash demand explanation on the choice of payment methods in mergers and acquisitions.