Caveat Emptor as an Obstacle to Business Transfers: Effect of Product Line Exceptions on Acquisitions, Entry, and Exit

Author(s) Information
Natarajan Balasubramanian, Whitman School, Syracuse University
Jagadeesh Sivadasan, University of Michigan
Wenjian Xu, Shanghai Jiao Tong University



Journal 
Strategic Management Journal

Summary
Making acquisitions costlier (by making acquirers liable for the target firm's liabilities) will not only deter acquisitions but also increase business closures and deter business entry.

Research Questions
How will making acquirers liable for the target firm's product line liabilities affect business acquisitions, closures and entry?

What We Know
Many recent studies have highlighted the importance of business exit through acquisitions.  In parallel, a large literature has studied barriers that impede acquisitions.  However, whether obstacles to acquisitions affect the important strategic choices of entry and exit remains understudied.

Novel Findings
We find that after adoption of the PLE, on average, the probability of a manufacturing establishment being acquired decreases relative to non-manufacturing establishments. Concomitantly, exits through closure increase and establishment entry decreases. Further analysis shows that these effects are larger in industries where it is harder to redeploy capital, consistent with the ability to sell the business as a whole (rather than as individual assets) being a relatively more important component of firm value in these industries. We also find that these effects appear to be larger for smaller entrants, consistent with their lower ability to reduce liability exposure for potential buyers. Further, consistent with the extent of liabilities only becoming apparent over time, we find a difference over the life cycle with regard to exit via a business transfer. Specifically, older manufacturing establishments are less likely to be acquired after adoption of the PLE (in line with the average effect), but younger manufacturing establishments (which likely have lower risk of having accumulated liabilities) are more likely to be acquired.

Full Citation
Balasubramanian, N, Sivadasan J. & Xu, W. Caveat Emptor as an Obstacle to Business Transfers: Effect of Product Line Exceptions on Acquisitions, Entry, and Exit. Forthcoming at the Strategic Management Journal

Abstract 
Being able to sell a business not only allows a firm to exit an industry, but is also a motivation for entrepreneurial entry. Therefore, factors that make acquisitions less desirable for potential acquirers could not only affect the rate of acquisitions, but also entry and exit. We test this in the context of judicial adoptions of product line exceptions, which increased acquirer exposure to potential accumulated liabilities. We find that after adoption, and relative to non-manufacturing establishments, acquisitions of manufacturing establishments decrease, while exits through closure increase. Relative entry of manufacturing establishments declines. These effects are higher in industries where resalability of physical capital is lower and for smaller entrants. Interestingly, while the likelihood of acquisitions declines for older establishments, it increases for younger ones.