Abstract
This study examines the determinants of arbitrage spread of S&P 500 firms between 2004 and 2014. We find that bid hostility, the relative size of the target compared to the potential bidder and the acquisition premium paid by the bidding firm are associated with greater arbitrage spread while the proportion of cash in the offer and target termination fees are associated with smaller arbitrage spread.
Highlights
Risk arbitrage is generally understood to be “trading around corporate events that alter the capital structure of a firm” [1]
We find that bid hostility, the relative size of the target compared to the potential bidder and the acquisition premium paid by the bidding firm are associated with greater arbitrage spread while the proportion of cash in the offer and target termination fees are associated with smaller arbitrage spread
The idea of risk arbitrage can be applied in the context of mergers and acquisitions (“merger arbitrage”), wherein the securities of a firm targeted for acquisition are acquired, and the arbitrager takes a long position in the target stock, hoping that the acquisition will go through
Summary
Risk arbitrage is generally understood to be “trading around corporate events that alter the capital structure of a firm” [1]. Acquisition premiums are often used by bidding firms to encourage the target's shareholders to sell On average, this premium is between 30% and 50% [2] which means that, in order to encourage current shareholders to sell their shares, the bidding firm offers a 30% to 50% premium over target’s current stock price. As there is always a chance that the acquisition will not go through, investors seek to manage this completion risk while still benefitting from the increase in stock price. Merger arbitragers help to manage this completion risk.
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