Restaurant firms extensively expand through acquisitions. While acquisitions can be an efficient business strategy, the extant literature presented evidence showing that acquisitions can be value–increasing or –decreasing investments. However, why acquisitions increase or decrease firm value is not clear. Corporate finance and franchising theories collectively suggest that the value of acquisitions may depend on firms’ free cash flow capacities, growth opportunities, and organizational forms. The purpose of this study is to examine the concurrent effects of free cash flows, growth opportunities, and franchising on restaurant firms’ returns from acquisitions. The results showed that firms with high-free cash flows gain lower returns compared to firms with low-free cash flows, suggesting that acquisitions reduce underinvestment problems but also increase overinvestment problems. Franchising firms also gain lower returns compared to non-franchising firms; however, the availability of free cash flows exacerbates overinvestment problems in franchising firms. Theoretical and practical implications are discussed.

Introduction

Expansion through acquisitions has been a profound method for corporations because it provides acquiring firms an opportunity to grow without losing momentum in margins. Acquisitions also have potential benefits to improve earnings, reduce costs, achieve greater market shares, and increase shareholders’ wealth (Kim and Zheng, 2014; Chatfield et al., 2011; Dogru, 2017). However, acquisitions are often associated with valuation concerns (i.e., liquid and/or fixed assets, etc.) and shareholders’ reactions to price movements before, during, and after the acquisitions both in the short and long-run. Within this context, the neoclassical theory of acquisitions postulates that companies, acting in the best interest of shareholders, acquire another company only if the acquisition increases their value (Rosen, 2006). Empirical evidence, however, indicates that shareholders may not always enjoy positive wealth effects in acquisitions. In particular, returns from acquisitions depend on many other factors such as acquirer’s size (Moeller et al., 2004), method of payment (Alshwer et al., 2011), target characteristics (Harford et al., 2012), and financial constraints (Dogru, 2017). Furthermore, acquisitions that are motivated with managerial overinvestment may be inferior acquisitions and may result in valuedestruction rather than value-creation for shareholders (Jensen, 1986).