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<P>Corporate Financing Decisions When<BR>Investors Take the Path of Least Resistance<BR>Malcolm Baker<BR>Harvard Business School and NBER<BR>Joshua Coval<BR>Harvard Business School and NBER<BR>Jeremy C. Stein<BR>Harvard Economics Department and NBER<BR>First draft: August 2004<BR>This draft: April 2005</P>
<P><BR>We argue that inertial behavior on the part of investors can have significant consequences for<BR>corporate financial policy. One implication of investor inertia is that it improves the terms for<BR>the acquiring firm in a stock-for-stock merger, since acquirer shares are placed in the hands of<BR>investors, who, independent of their beliefs, do not resell these shares on the open market. In the<BR>presence of a downward-sloping demand curve, this leads to a reduction in price pressure, and<BR>hence to cheaper equity financing. We develop a simple model to illustrate this idea, and present<BR>supporting empirical evidence. Both individual and institutional investors tend to hang on to<BR>shares granted them in mergers, with this tendency being much stronger for individuals.<BR>Consistent with the model and with this cross-sectional pattern in inertia, acquirers targeting<BR>firms with high institutional ownership experience more negative announcement effects and<BR>greater announcement volume. Moreover, the results are strongest when the overlap in target<BR>and acquirer institutional ownership<BR></P>