The Association between Market-Based Merger Premiums and Firms' Financial Position Prior to Merger

Abstract

This paper tests the association between firms' prior financial performance and the magnitude and timing of merger premiums. The basic finding is that both financially healthy firms and financially troubled firms, as classified by the Altman Z score, earn merger premiums of 25%. However, the troubled firms experience market price increases earlier than healthy firms. Further analysis indicates that the early market price recovery of the troubled firms is consistent with the notion that tax loss carryforwards make acquisition attractive. In fact, the troubled firms with tax loss carryforwards experience merger premiums of 33.7% as opposed to 19.6% for troubled firms without tax loss carryforwards. These results indicate that the availability of the tax loss carryforwards may have facilitated mergers for troubled firms.