Prior Target Valuation Changes and Acquirer Announcement Returns in Acquisitions of Recently Listed Targets

Abstract

We provide new insights into the determinants of acquirer announcement returns with a unique sample of targets that are acquired within three years of their IPOs. Existing studies of acquisitions of private and established public targets find positive relations between acquirer announcement returns and prior target valuation changes. In our sample of recently listed targets, we measure the prior target valuation change as the return from the IPO offer price to two weeks before the acquisition. Inconsistent with the behavioral biases based on prospect theory studied in the related literature, the relation between acquirer announcement returns and targets’ returns since their IPOs is negative. We separate our target prior return variable into two components, the target’s first day return (IPO underpricing) and the return from the first day close until two weeks before the acquisition (Prior return). We contend that IPO underpricing is a proxy for target valuation uncertainty and Prior return is a proxy for target distress-related bargaining power. The positive relations of these two variables to other proxies for target valuation uncertainty and target distress support our interpretation. Both IPO underpricing and Prior return have significantly negative relations with acquirer announcement returns. Therefore, our empirical findings show that rational causes related to target valuation uncertainty and bargaining power explain a large part of the effect that prior target valuation changes have on acquirer announcement returns. Our study also adds to the debate over how much irrational behavior, as opposed to rational actions, affect major corporate events.