Firms have a choice: grow through internal investment, or grow through acquisition. While internal growth takes time, an acquisition provides cash flows immediately, as the acquirer benefits from the investments of previous owners. The opportunity to grow internally affects the price of an acquisition as it is a fall-back option for the acquirer should negotiations break down. Thus, internal growth opportunities speed up acquisitions when integration costs are significant or synergies not too great. Because investors do not have full information about the time a firm requires to grow internally, acquirers earn positive returns before announcement of an acquisition, and there are negative stock price reactions to acquisition announcements for a wide range of parameter values. This research provides novel predictions about how pre-announcement price run-up and negative announcement returns relate to high integration costs and low synergies from acquisition, without requiring learning about these variables. The model also predicts that buyer-initiated acquisitions result in more pronounced negative acquirer announcement returns than seller-initiated acquisitions.
