Sending Signals: The Meaning of Equity vs.Cash

Ulrich Hege, Professor of Finance and Stefano Lovo, Professor of Finance - April 15th, 2009
financial data - sending signals

Key Ideas

• When acompany transfers or sells just a portion of its assets, market response is verypositive when the assets are paid for in equity, and decidedly less so whenthey are paid for in cash.

• Incases of mergers or acquisitions, the opposite is true.

• Market reactions vary depending on who defines how the transaction will be paid for and the information thus revealed.

Ulrich Hege ©HEC Paris

Doctor of Economics from Princeton, Ulrich Hege is Director and Professor of TSE (Toulouse School of Economics) since January 2016. Prior to joining TSE, he was Professor of (...)

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Stefano Lovo  ©HEC Paris

Stefano Lovo has been a professor of finance at HEC Paris since 2000. He holds a PhD from the Catholic University of Louvain.  His research focuses on information economics (...)

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Markets are the settings for all types of financial transactions, so considering them closely makes it possible to better understand prominent business deals. Ulrige Hege and Stefano Lovo’s study on the impact of acquisitions on the stock share value of both buyer and seller has generated insight as to how market value is created. They have focused on the currency used for transactions— cash vs. equity—and on the type of acquisition— complete vs. partial (like a business unit).


When it comes to acquiring a company, in part or in full, buyers can pay in cash or in equity. According to Hege and Lovo, approximately half of today’s acquisitions are paid for with equity. Companies being purchased are sometimes so big that it would be impossible to pay cash without creating an explosive level of net debt. Buyers therefore pay for the company by issuing shares and thus avoid upsetting their financial balance. But there is another reason for paying with equity. Financial theory shows that the method of payment chosen sends useful information to the market and enables the initiator of the transaction to maximize value.


Numerous empirical studies evaluate the market impact of the payment method used (cash vs. equity) for full-company acquisitions. Research results (see table) consistently demonstrate the following:

•The market reacts positively to the seller, regardless of the method of payment.

•The market reacts positively to the buyer when the transaction is conducted in cash, but negatively when the purchase is made with equity. In fact, payment choices reveal private information that the market uses to assess share value. When buyers consider their stock to be overvalued, they prefer to pay with equity. They should therefore pay cash to win the trust of investors.


No matter what the type of acquisition (partial or full), both buyers and sellers possess only asymmetrical information. Sellers have information about the value of what they are selling, while buyers are knowledgeable about potential synergies from the acquisition. Still, the researchers have found that when acquisitions are only partial, the market reacts differently to the two means of payment. In this case, assets purchased with equity present greater relative gains than those paid for with cash (see table).

graph article 8 lovo hege eng


According to the researchers, market reactions to partial vs. full acquisitions vary depending on which of the two parties (buyer or seller) initiates the transaction, and on the signals this choice sends.

• Full acquisitions: The buyer must make a formal offer, which requires shareholder approval. It is therefore the buyer who makes the final offer and at this point proposes a cash or equity payment. The means of payment sends a signal to the market.

• Partial acquisitions: In this case, shareholder approval is not required. The seller conducts an auction, which forces potential buyers to release information. In the second case, the seller’s acceptance or refusal of payment in equity sends a signal to the market about the quality of the transaction. A seller that accepts to be paid in equity sends a positive signal, whereas a preference for a cash payment indicates doubts about the soundness of the transaction. Indeed, sellers that believe that the assets transferred will create value for the buyer prefer to be paid in equity, as this means of payment implies retaining shares in the buyer’s company.

Based on an interview with Ulrich Hege and Stefano Lovo, and on the article, “Equity or Cash? The Signal Sent by the Way You Pay” by Ulrich Hege, Stefano Lovo, Myron B. Slovin, and Marie E. Sushka , visiting professors at HEC Paris ( Harvard Business Review , May 2009).



This is the first research to distinguish between partial and full acquisitions. Business people, and corporate bankers in particular, should pay attention to the difference in market reactions to sales of entire companies as opposed to portions of company assets. Awareness of this phenomenon will enable them to adjust acquisition strategies in ways that increase value for both buyers and sellers. 


According to Hege, Lovo, Slovin, and Sushka, it is not necessary to regulate the asset transfer market because it works relatively effectively, benefiting from the competition that sellers spur among potential buyers. This market plays a vital role because it ensures the effective allotment of productive assets and enables sellers with financial difficulties to rebalance their financial structures. Allowing companies to choose their payment method (in other words, abstaining from creating regulations that promote one means of payment over the other) is the best way to enable the market to fulfil its role as an information collection point. Still, when it comes to large scale transactions (i.e., over 20%of the global value of a buyer’s company), reinforcing shareholder rights to control could help reduce principal-agent problems. 


Hege, Lovo, Slovin, and Sushka studied a sample of acquisition transactions having taken place between 1989 and 2002, investigating their impact on the stock value of the companies involved. Data sources include Factiva (formerly Dow Jones News Retrieval Service), LexisNexis, and Edgar, the SEC, The Wall Street Journal, and Standard and Poor’s.