Equity overvaluation, financing, and M&A payment method: Evidence from Japan

Based on debt capacity theory and pecking order theory, this paper examines the effect of equity overvaluation on the choice of payment method in mergers and acquisitions (M&A) in the Japanese market. Using a sample of 2,180 M&A deals from 2006 to 2023, our analysis shows that equity overvaluation significantly increases the use of cash payments. Path analysis provides further evidence that debt financing is an important mechanism through which equity overvaluation affects cash payment. In subsequent analyses, we demonstrate that for companies with substantial internal funds or greater financing capabilities, the impact of equity overvaluation is diminished. In contrast to previous studies suggesting that equity overvaluation is associated with the use of stock payments, we find that Japanese firms use overvalued equity to enhance their debt capacity and thus choose cash payments. This study contributes to the literature on M&A payment methods by highlighting the unique financing behavior of Japanese firms and has important policy implications for the development of the M&A market.