Abstract
This study examines the acquisition dynamics associated with the target management’s choice to initiate the sale of the firm using the auction method. Specifically, we examine opportunistic merger and acquisition (M&A) dynamics related to the target-initiated method-of-sale decision (auctions vs. one-on-one negotiations), as a noteworthy example of Akerlof’s (1970) theory of the market for lemons. While we find a strong positive relationship between proxies of adverse selection risk and the likelihood of target initiation, robustness tests suggest target initiation itself is a unique indicator of information asymmetry in an acquisition environment. We also find that most target-initiated transactions follow an auction as the method of sale, which increases target information asymmetry advantages. While wealth accrued to both bidders and targets increases in non-target-initiated auctions, this benefit disappears when the target initiates the acquisition, causing both bidders and targets to suffer wealth losses. According to Akerlof’s theory, these wealth losses represent the cost of perceived dishonesty due to enhanced adverse section risk, which provides noteworthy implications for both business and society.
Highlights
1.1 Purpose and Introduction to the IssueThe purpose of this study is to initially examine the acquisition dynamics associated with the target management’s choice to initiate the sale of the firm as a salient example of Akerlof’s (1970) theory of the market for lemons
We show that non-target-initiated acquisitions drive the benefit from auctions, and that the target-initiation discount assumed by Boone and Mulherin (2009) and Aktas et al (2010) is significant, both economically and statistically, due to adverse selection risk which is consistent with Akerlof’s theory
Institutional ownership and the Number of analysts are lower for targets that initiated the transactions, relative to non-target-initiated transactions. These results provide evidence that target firms with greater levels of adverse selection risk are more likely to initiate the sale of the firm. We find that these untabulated results are largely driven by target-initiated transactions that pursue an auction as the method of sale, suggesting that targets initiating the sale of the firm pursue an auction as the method-of-sale in an attempt to constrain information sharing when adverse selection risk is high
Summary
1.1 Purpose and Introduction to the IssueThe purpose of this study is to initially examine the acquisition dynamics associated with the target management’s choice to initiate the sale of the firm as a salient example of Akerlof’s (1970) theory of the market for lemons. We are interested in assessing heightened adverse selection risk in target-initiated auction sales that likely exacerbate Akerlof’s “lemons” problem related to merger and acquisition (hereafter M&A) buyers (bidder–acquirers) versus sellers (targets), where “lemons” refer to low quality target firms. Akerlof’s (1970) “lemons” problem occurs because of perceived seller dishonesty that is a function of information asymmetry adverse selection that potentially permits sellers (targets) to overstate the value of their firm to buyers (bidder–acquirers), where bidders have difficulty identifying good versus bad (lemon) target deals. Perhaps distressing is that the “lemons” problem discourages the finalization of other potentially mutually beneficial transactions (Akerlof, 1970), which shrinks collective economic wealth These M&A ethical dilemmas create noteworthy deleterious outcomes for accounting and finance, in particular, and for society, in general. Adverse selection risk is a key concern for interested bidders who may not have the same time or access to perform extensive due diligence in a competitive auction environment as they would in a one-on-one negotiation with a target of interest
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