Alexandros P. Prezas

Operating Performance and Free Cash Flow of Asset Buyers

We examine a sample of 552 firms that announce asset purchases. We find that the announcement period returns are negatively related to the amount of free cash flow for buyers with fewer growth opportunities. Compared to the year prior to the purchase, the mean long-run operating performance of asset buyers worsens in each of the three years following the transaction. Operating performance changes are negatively related to the amount of free cash flow, and the relationship is stronger for buyers with fewer growth opportunities. We also find that buyer firms experience a decline in the return on assets and asset turnover ratios. These findings are consistent with Jensen’s (1986) free cash flow theory.

Effects of Depreciation and Corporate Taxes on Asset Life Under Debt-Equity Financing

Under debt-equity financing, the optimal life of an asset increases with the amount of riskless debt used. Also, higher depreciation increases (does not affect) optimal life if asset book value is positive (zero) upon termination. Further, the optimal life of an asset fully depreciated before termination increases with the corporate tax rate. The optimal life of all asset not fully depreciated before disposal, however, decreases with a higher corporate tax rate if salvage value is less than book value upon termination. This latter result may be reversed only if, upon termination, salvage value exceeds asset book value. Finally, the Tax Reform Act of 1986 (TRA) has an ambiguous effect on optimal asset life if book value is positive upon termination; otherwise, TRA reduces optimal asset life.

Corporate Downsizing and CEO Compensation

Our study examines CEO compensation for firms that announce layoffs during the 1993–2001 period. We find that overall there is a large increase in CEO equity-based compensation in the year prior to and the year of the downsizing. Our sample of downsizing firms has small improvements in operating performance following the announcement. However, these performance improvements manifest themselves in the low but not the high equity-based compensation firms. We find that the announcement period returns are higher for downsizing firms that are larger, hire a new CEO in the year prior to the downsizing, have higher leverage, and better operating performance.