Liquidity Mergers

We study the interplay between corporate liquidity and asset reallocation opportunities. Our model shows that financially distressed firms are acquired by liquid firms in their industries even when there are no operational synergies associated with the merger. We call these transactions "liquidity mergers," since their main purpose is to reallocate liquidity to firms that might be otherwise inefficiently terminated. We show that liquidity mergers are more likely to occur when industry-level asset specificity is high (i.e., industry-specific rents are high) and firm-level asset specificity is low (industry counterparts can efficiently operate distressed firms' assets). We also provide a detailed analysis of firms' liquidity policies as a function of real asset reallocation, examining the trade-offs between cash and lines of credit. The model makes a number of predictions that have not been examined in the literature. Using a large sample of mergers, we verify the model's prediction that liquidity-driven acquisitions are more likely to occur in industries in which assets are industry-specific, but transferable across industry rival firms. We also verify the prediction that firms are more likely to use credit lines (relative to cash) when they operate in industries in which liquidity mergers are more frequent.