reasons.Thefirstislimitedaccesstocapitalmarketsandthe
resultingcapital-rationingconstraint.Smallfirmsandprivate
businessesoftenhavetorejectgoodinvestmentsbecausethey
areunableto raisecapitalata reasonable price.Theother
reason was put forth by Myers and Majluf (1984), who
argued that managers know more than investors about
prospective projects.
13 Consequently,newequitymayhavetobeissuedatless
thantruevaluetofinancetheseprojects,leadingtothegood
projects beingrejected. It maytherefore make sense fora
companywithexcesscashandnoinvestmentopportunitiesto
take over a cash-poor firm with good investment
opportunities, or vice versa. The additional value of
combiningthesetwofirmsisthepresentvalueoftheprojects
thatwouldnothavebeenundertakenifthefirmshadstayed
apart, but cannowbe taken becauseof theavailability of
cash.
Cashslackcanbeapotentrationaleforpubliclytradedfirms
thathaveeasyaccesstocapitaland/orlargecashbalancesand
want to acquire small, private firms that have capital
constraints. It may also explain whyacquisition strategies
concentratingonbuyingsmaller,privatefirmshaveworked
fairly well in practice. Blockbuster (video rental),
Browning-Ferris Industries (waste disposal), and Service
Corporation International (funeral homes) are good examples.
ILLUSTRATION 15.4: Valuing Cash Slack in a Merger
Thevalueofcashslackinamergeriseasytocompute.Inits
simplestvariant,wewouldcomputethenetpresentvaluesof
theprojectsthatthecash-poorfirmwouldbeforcedtoreject
becauseofitscashconstraintandaddittothevalueofthe