Why are distressed firms acquisitive?

Acquisitions made by distressed firms are economically important. This paper explores the rationale behind such acquisitions in a quasi-natural experiment and identifies the causal link between bankruptcy risk and acquisitions. Upon an exogenous reduction in bankruptcy risk, distressed firms react by cutting 46% of cash spending on acquisitions, announcing fewer deals, and borrowing less for acquisition-related activities. The evidence suggests that distressed firms make acquisitions to diversify bankruptcy risk. These findings demonstrate a new effect of financial distress on firm investment—the pressure to meet debt obligations creates an incentive for firms to diversify through acquisitions.