Corporate Financing Decisions When
Investors Take the Path of Least Resistance
Malcolm Baker
Harvard Business School and NBER
Joshua Coval
Harvard Business School and NBER
Jeremy C. Stein
Harvard Economics Department and NBER
First draft: August 2004
This draft: April 2005

We argue that inertial behavior on the part of investors can have significant consequences for
corporate financial policy. One implication of investor inertia is that it improves the terms for
the acquiring firm in a stock-for-stock merger, since acquirer shares are placed in the hands of
investors, who, independent of their beliefs, do not resell these shares on the open market. In the
presence of a downward-sloping demand curve, this leads to a reduction in price pressure, and
hence to cheaper equity financing. We develop a simple model to illustrate this idea, and present
supporting empirical evidence. Both individual and institutional investors tend to hang on to
shares granted them in mergers, with this tendency being much stronger for individuals.
Consistent with the model and with this cross-sectional pattern in inertia, acquirers targeting
firms with high institutional ownership experience more negative announcement effects and
greater announcement volume. Moreover, the results are strongest when the overlap in target
and acquirer institutional ownership