Stock Recalls As a Source of Informational Advantage Through Short Selling: Empirical Evidence from Mergers and Acquisitions

Abstract

We apply the idea of Strych (2020) that short sellers of acquirers’ stocks infer from their private observations of stock recalls that the deal will be more likely terminated. To profit from such informational advantage through short selling, Strych (2020) expects that acquirers’ short sellers become merger arbitrageurs after deal announcement to obtain a trading option on acquirers’ stock recalls. The higher this trading option value, the more merger arbitrageurs are willing to pay for target shares than incumbent target shareholders require as premium from the acquirer. Anticipating this, we expect that acquirers reduce bid premiums accordingly. Consistently, in a sample of U.S. deal announcements from 2004 to 2017, we find that a one standard deviation increase of acquirers’ short interest (i.e., magnitude of merger arbitrage activity) and institutional ownership concentration (i.e., likelihood of an observable recall) is associated with a 10.53 percent decrease of the one-week premium. In addition, this premium reduction effect is accompanied with positive long-term buy-and-hold abnormal returns for acquirer stocks and tighter arbitrage spreads. As channel of the information about this premium reduction effect, we regard advice to acquirers by M&A advisors with high equity capital market expertise. As a result, M&A advisors add value to acquirers consistent with Dessaint, Eckbo, and Golubov (2019). Moreover, this effect is more pronounced for targets with low insider ownership and for acquirers with high active institutional ownership.