Divergence of Investment Bank Valuation and the Winner’s Curse in Takeovers

Abstract

We study the winner’s curse in mergers and acquisitions, in which winning bidders fail to account for the uncertainty about target value and thus overpay. Using a unique setting where target firms hire multiple investment banks as advisors, we construct a novel measure of target valuation uncertainty based on investment banks’ disagreement on target valuation. We find that when valuation disagreement is higher, bidders pay significantly higher acquisition premiums. Moreover, bidders who pay high premiums have lower announcement returns and lower long-term post-merger returns when valuation disagreement is high. These bidders also create lower merger synergies. Our findings suggest that the winner’s curse does exist in takeovers and cause distortion in resource allocation.