Speculation spreads and the market pricing of proposed acquisitions

This paper examines speculation spreads following initial acquisition announcements in 362 cash tender offers spanning the 1981–1995 period. Speculation spreads in acquisitions, defined as the percentage difference between the bid price and market price one-day after the initial announcement, are the starting point for arbitrage returns, a subject receiving increased attention in practice and in the literature. Speculation spreads exhibit a positive mean, with considerable cross-sectional variation. In fact, over 23% of speculation spreads are negative, indicating a post-announcement price greater than the initial bid price. In spite of its importance, the informational content of the speculation spread and the reasons for its cross-sectional variation have not been previously examined. We model speculation spreads as the visible component of total speculative returns of the target. Rational traders set speculation spreads anticipating the expected price resolution and length of the acquisition bid. Empirically, we find strong support for key implications of our model. Speculation spreads are significantly related to bid and offer characteristics observable ex ante. Consistent with our model, they are also significantly negatively related to the magnitude of price revision and significantly positively related to offer duration. These results are robust to the inclusion of bid and offer characteristics known ex ante as well as those only revealed ex post. The results are consistent with market pricing of both offer duration and price resolution at the time of the initial announcement.