Debt Financing and Collateral: The Role of Fair-Value Adjustments

Using a large hand-collected sample of business combination disclosures provided by non-financial US acquirers, we investigate whether fair-value adjustments (FVAs) of targets’ assets allow acquirers to increase their debt capacity. We find that the average corporate acquirer reports an economically significant increase of 46% (187%) in the value of target’s fixed assets (total assets less cash). We also document that FVAs are associated with a substantial increase in the debt issuance of the combined entity during the three-year period after the acquisition. This additional debt is issued at lower interest rates, has longer maturities, and is more likely to be secured. The increase in new debt issuance during the post-acquisition period is associated with FVAs on tangible assets and positive FVAs, suggesting that the reporting of previously unrecognized asset values increases the value of the collateral on acquirers’ balance sheet. Our findings indicate that asset fair value measurement increases debt capacity and improves credit terms, consistent with lenders fixating on balance sheet values when establishing borrowers’ collateralizable asset base.