Uncertainty triggers overreaction: evidence from corporate takeovers

Behavioural finance models suggest that under uncertainty, investors overweight their private information and overreact to it. We test this theoretical prediction in an M&A framework. We find that under high information uncertainty, when investors are more likely to possess firm-specific information, acquiring firms generate highly positive and significant gains following the announcement of private stock and private cash acquisitions (positive news) while the market heavily punishes public stock (negative news) deals. On the other hand, under conditions of low information uncertainty, when investors do not possess private information, the market reaction is complete (i.e. zero abnormal returns) irrespective of the type of acquisition. Overall, we provide empirical evidence that shows that information uncertainty plays a significant role in explaining short-run acquirer abnormal returns.     

Exploring the Double‐Sided Effect of Information Asymmetry and Uncertainty in Mergers and Acquisitions

We examine the joint effect of bidder and target information asymmetry and uncertainty on the payment consideration and subsequent wealth effects in a large sample of acquisitions with both listed and private targets. In line with a risk‐sharing argument, we find that acquisitions of targets characterized by higher uncertainty are more likely to be settled with stock. In contrast, higher target information asymmetry increases the likelihood of a cash payment, consistent with bidders strategically exploiting superior information. Acquirers of more opaque targets obtain a larger fraction of total acquisition gains and avoid sharing these gains with target shareholders by offering cash.     

Do financial markets care about SRI? Evidence from mergers and acquisitions

Mergers and acquisitions offer a framework for shedding new light on the stock market performance of socially responsible investments (SRI). We use Innovest’s Intangible Value Assessment (IVA) ratings as a measure of firms’ ability to cope with social and environmental risks. The IVA ratings allow us to uncover a positive relation between acquirer gains and the level of the target’s social and environmental risk management practices. Our findings suggest that the stock market rewards the acquirer for making socially and environmentally responsible investments. We also document that the environmental and social performance of the acquirer increases following the acquisition of a SRI aware target. These results are consistent with acquirer learning from the target’s SRI practices and experiences.     

The medium of exchange in acquisitions: Does the private information of both acquirer and target matter?

We present a direct test of the choice of the medium of exchange in acquisitions when both acquirers and targets possess private information about their own intrinsic values. We test three hypotheses: first, whether acquirers are more likely to choose a stock offer as their equity is more overvalued; second, whether acquirers facing a greater extent of information asymmetry in evaluating targets are more (or less) likely to use a stock versus a cash offer; and third, whether a cash offer deters competing bids. Our findings are as follows. First, acquirers choosing a stock offer are overvalued and those choosing a cash offer are correctly valued. Second, the greater the extent of acquirer overvaluation, the greater the likelihood of it using a stock offer; further, the greater the extent of information asymmetry faced by an acquirer in evaluating its target, the greater its likelihood of using a cash offer. Third, the extent of an acquirer's under- or overvaluation significantly affects the abnormal returns to its equity upon the acquisition announcement. Finally, the use of cash by an acquirer deters competing bids. We conclude that private information held by both acquirers and targets together determine the medium of exchange.     

Does deregulation induce competition in the market for corporate control? The special case of banking

Using a sample of 936 acquisitions of commercial banks, we examine the relation between the probability to engage in value-reducing acquisitions and corporate governance structures, as well as the relation between acquirer announcement-period abnormal stock returns and antitakeover indices and measures, and how these relations were affected by the change in the market for corporate control, caused by deregulation due to the implementation of the Interstate Banking and Branching Efficiency Act of 1994 and the Financial Service Modernization Act of 1999. We find that prior to deregulation there is no relation between probability to engage in value destroying acquisitions or acquirer returns and antitakeover indices, whereas after the adoption of the FSMA, probability to engage in value destroying acquisitions and the stock market reaction to bidder M&A announcements are both significantly related to governance indexes and measures. Our findings further confirm the linkage between the market for corporate control, antitakeover indices and firm value.     

Stock price informativeness on the sensitivity of strategic M&A investment to Q

Using a strategic merger sample that covers the period from 1985 to 2011, we find that the acquirer’s stock price firm-specific information, the new information created by investors about the value of firm fundamentals, increases the positive sensitivity of strategic merger investment to the acquirer’s Q; the target’s stock price firm-specific information increases the negative sensitivity of merger investment to the target’s Q. These results suggest that managers learn from financial markets in identifying strategic merger investment opportunities by transferring assets from poorly managed firms to well managed firms. In addition, the target’s stock price firm-specific information itself increases the acquisition size, indicating that informed acquirer managers are more likely to take out large merger investment. Last but not the least, stock price informativeness increases merger synergies and post-merger performance, suggesting that informed managers make better merger investment that increases shareholder value. Our study contributes to the recent increasing stream of studies on managerial learning from the market.     

Determinants of earnout as acquisition payment currency and bidder’s value gains

We examine the wealth effects of a comprehensive sample of UK bidders offering contingent payment, or earnout, as consideration for their acquisitions. We show that bidders using earnout generate significantly higher announcement and post-acquisition value gains than bidders using non-earnout currencies (such as cash, stock exchange, or mixed payments). We construct a logistic model to predict when it is optimal for a bidder to offer earnout. We show that bidders offering earnout optimally enjoy significantly higher announcement and post-acquisition gains than bidders offering non-earnout currencies, consistent with our model of the choice of the optimal method of payment. Overall, we provide robust evidence that earnout is an effective payment mechanism to mitigate valuation risk to acquirers, and also enhances acquirer value during the announcement and post-acquisition periods. Our paper contributes to the broader literature on how corporate acquirers use payment currency to manage information asymmetry and the attendant valuation risk.     

Firm size,sovereign governance,and value creation: Evidence from the acquirer size effect

This paper examines the relationship between acquirer size, sovereign governance, and value-creation in acquisitions. Prior literature indicates that larger acquirers' acquisitions create less shareholder wealth in developed markets, arising primarily from agency and entrenchment problems. However, in weak governance environments, size might have off-setting benefits, including increased market power and political connections. We use a sample of 17,647 takeovers from 45 countries to examine the acquirer size effect around the world. We find that the acquirer size effect exists internationally, but is smaller in magnitude in weak governance markets. Compared with larger acquirers in strong governance countries, large acquirers in weak governance countries do takeovers that generate higher stock-returns and increase post-takeover operating performance. Their deals are also more likely to be friendly, and take less time to complete. We also find that the benefits of larger acquirer size increase with the importance of political connections in the acquirer's country. The results suggest that country-governance can moderate the impact of corporate characteristics, such as corporate size.     

Stock price firm‐specific information on the choice of stock payment in mergers and acquisitions

Previous studies on the choice of stock payment in M&A mainly focus on managerial private information. This study shows that managers also learn new firm‐specific information from financial markets in making this decision. The acquirer's stock price firm‐specific information increases the stock‐payment‐to‐Q sensitivity. The target's stock price firm‐specific information decreases the stock payment probability. Further analyses on deal and firm characteristics as well as shareholder wealth in stock mergers support the managerial learning argument. Overall, this study highlights a new set of information that affects the form of merger payment in mergers and acquisitions.     

Impact on Target Firm Risk-Return Characteristics of Domestic and Cross-Border Mergers and Acquisitions in Emerging Markets

Using a large sample of partial cross-border mergers and acquisitions from emerging countries, we show that these acquisitions significantly reduce the risk of the target firms and that the risk reduction is directly related to the changes in the international shareholder base and the strength of the investor right protection of the acquirer. We also find that these acquisitions are value creating because we see improvements in both the short-term and long-term risk-adjusted stock performance in target firms during the postacquisition period.     

The Method of Payment in Corporate Acquisitions,Investment Opportunities,and Management Ownership

This article examines the motives underlying the payment method in corporate acquisitions. The findings support the notion that the higher the acquirer's growth opportunities, the more likely the acquirer is to use stock to finance an acquisition. Acquirer managerial ownership is not related to the probability of stock financing over small and large ranges of ownership, but is negatively related over a middle range. In addition, the likelihood of stock financing increases with higher pre-acquisition market and acquiring firm stock returns. It decreases with an acquirer's higher cash availability, higher institutional shareholdings and blockholdings, and in tender offers.     

Method of payment and risk mitigation in cross-border mergers and acquisitions

We argue that the method of payment in cross-border mergers and acquisitions (M&As) can mitigate country-level governance risk for the acquirer. We find a greater use of stock as the method of payment in cross-border deals involving targets from countries with high governance risk relative to that in the acquirer's country. This increased use of stock in riskier cross-border deals is consistent with the optimal reaction of the acquirer to avoid overpayment, even though we also show that the use of stock (instead of cash) as the method of payment in cross-border deals is associated with a lower likelihood of deal completion. Furthermore, for more recent periods (i.e., after 2000) we show that the use of stock (cash) has increased (decreased) significantly in cross-border deals, resulting in convergence with the method of payment used in domestic deals.     

The informational consequences of good and bad mergers

We study the information production dynamics in financial markets in response to Mergers and Acquisitions (M&As) announcements. We find that acquirers with low levels of pre-announcement stock price informativeness experience a substantial increase in their corresponding post-announcement stock price informativeness in response to positive Cumulative Abnormal Returns (CAR). We show that this increase is due to the enhanced prospect of deal completion. By contrast, high levels of acquirer pre-announcement stock price informativeness limit traders' incentives to search for, and acquire, new information. We also find that similar dynamics apply to the changes in acquirers' analyst coverage. Emphasizing the important role of information acquisition costs in influencing informed trading, a positive acquirer CAR increases the acquiring firm's post-announcement stock price informativeness in M&As involving public rather than private and subsidiary targets. Overall, we show that M&As have important informational consequences beyond their immediate effects on stock prices.     

The underpricing of private targets

We examine acquisitions of private firms with valuation histories and find a positive relation between acquirer announcement returns and target valuation revisions. Similar to other studies, acquirer announcement returns are positive, on average. However, positive acquirer announcement returns are mainly driven by targets that are acquired for more than their prior valuation. This relation is consistent with pricing effects associated with target valuation uncertainty and behavioral biases in negotiation outcomes.     

Is M&A different during a crisis? Evidence from the European banking sector

The financial crisis has affected the landscape of the banking sector around the world. We use a sample of transactions carried out by European acquirers in 2007–2010 to study the acquirer’s stock price market reaction to both announcements and completions of acquisitions. At the aggregate level, we find that there are no significant abnormal returns around the announcement of an acquisition while there are positive abnormal returns at completions. We study the cross-sectional determinants of abnormal returns and find that announcement returns are mainly explained by the acquirer bank characteristics, while completion returns mainly depend on opacity of the target and on the drop in idiosyncratic volatility associated with a reduction of uncertainty.     

The attenuation effect of social media: Evidence from acquisitions by large firms

We examine the role of social media in firm acquisitions. Twitter utilizes the “push” technology that allows firms to reduce information asymmetry by disseminating news to a broader set of investors in a timely manner. Using hand collected acquisition announcements from Twitter covering the period from 2009 to 2012, we find that the acquirer size is a main determinant of disclosing acquisition announcements on Twitter. Large acquirers announce their acquisitions on Twitter and, as a result, are able to attenuate the anticipated negative market reaction at acquisition announcement. We find no evidence that the attenuation effect of announcing acquisitions on Twitter subsequently reverses or that announcing acquisitions on Twitter is positively associated with pre-announcement earnings management. Overall, our results suggest that Twitter has become an important investor relation channel for major corporate events such as acquisition announcements and that large acquirers can use this new channel to enhance stability in their stock prices.     

Going private transactions,bondholder returns,and wealth transfer effects

We examine how buyout activity and deal characteristics drive bondholder returns and the wealth transfer effects between bondholders and stockholders in going private transactions from 1981 to 2006. We find that various deal characteristics are major determinants of the cross-sectional variation in bondholder returns. In particular, a single private equity acquirer mitigates bondholder losses. On the other hand, bondholders have larger losses when a reputable buyout firm is involved in the deal. Bondholders experience losses in the 1980s and 2000s, but enjoy gains in the 1990s. Our findings remain robust to consideration of deal financing, relative cost of credit, and level of market overheating. We find a negative and significant relationship between stockholder and bondholder wealth effects, which supports the wealth transfer hypothesis.     

Value creation around merger waves: The role of managerial compensation

This paper examines the relation between executive compensation and value creation in merger waves. The sensitivity of CEO wealth to firm risk increases the likelihood of out-of-wave merger transactions but has no influence on in-wave merger frequency. CEOs with compensation linked to firm risk have better out-of-wave merger performance in comparison to in-wave mergers. We also present evidence that cross-sectional acquirer return dispersion is greater for in-wave acquisitions. Our results suggest that the underperformance of acquiring firms during merger waves can be attributed in part to ineffective compensation incentives, and appropriate managerial incentives can create value, particularly in non-wave periods.     

Liquidity and information asymmetry considerations in corporate takeovers

ABSTRACT

We examine how stock market liquidity and information asymmetry considerations influence the wealth effects of Mergers and Acquisitions (M&As). We present a simple model predicting that M&As of listed targets that have relatively illiquid stocks are profitable for acquirers due to (a) the weak bargaining power of the targets’ shareholders, and (b) the limited information asymmetry concerns when evaluating takeover synergies. Our results show that cash-financed M&As of listed targets that have relatively illiquid stocks are associated with an increase in acquirer risk-adjusted returns. These gains are equivalent to those realized from comparable private target M&As. When engaging in stock-financed listed-target M&As, acquirers with liquid stocks enjoy significant gains when the targets have relatively illiquid stocks. This result holds especially when the deal is announced during periods of deterioration in the overall stock market liquidity. Lastly, we find that liquidity considerations affect the acquirer’s choice of the target firm’s listing status, as well as the M&A method of payment.     

Taking stock or cashing in? Shareholder style preferences,premiums and the method of payment

We develop and test hypotheses on the impact of target shareholders' investment style preferences on the method of payment and premiums in acquisitions. Stock offers (unlike cash offers) allow target shareholders to defer capital gains taxes. This deferral value, however, depends on target shareholders' willingness to retain acquirer stock. The empirical findings support our hypotheses. Bid premiums in stock offers are negatively and jointly related to target shareholder tax liabilities and to variables proxying for target shareholder willingness to hold acquirer stock. Moreover, the difference between predicted cash and stock premiums due to these factors significantly explains the method of payment choice.