“How Do Regulatory Costs Affect M&A Decisions and Outcomes”
by Barış İnce
In this paper, I look into the relation between fixed regulatory costs and M&A decisions. Regulations introduce significant fixed costs, and add to operating leverage. Regulatory operating leverage, introduced by Ince and Ozsoylev (2018), quantifies the ratio of fixed regulatory costs within a firm’s cost structure. I document that regulatory operating leverage increases implied cost of equity, and decreases operating margin, hence decreases a firm’s value. Economies of scale decrease exposure to regulatory fixed costs, therefore large firms are less exposed to the negative value implications of regulatory operating leverage. This creates a motive for large firms with high regulatory operating leverage to acquire other firms in the same industry that are exposed to similar regulations. Since regulatory operating leverage is constraining for small firms, it increases the likelihood of a small firm being a target. Moreover, as the merger results in a decline in the acquirer’s regulatory operating leverage, it is value increasing.