The Endowment Effect in Corporate Mergers and Acquisitions and Its Impact on Merger Premiums

Abstract

Ignoring income effects and transaction costs, the price individuals are willing to pay for an item should be equal to the price they are willing to sell it for. However, Professor Thaler discovered some "anomalous" phenomena in real life where individuals assign higher value to the items they possess, leading to inconsistency between the "willingness to pay" and "willingness to sell" prices. This phenomenon is often used in the analysis of behavioural economics and is linked to the theory of loss aversion. Thaler explained these anomalies using loss aversion from prospect theory and referred to this phenomenon as the endowment effect. The paper conducts a multiple regression analysis to investigate the existence of the endowment effect and its impact on the M&A premium, using a sample of 425 M&A events in which both parties were US-listed companies from 2010-2018. The results show that the endowment effect exists in the M&A process and significantly increases the M&A premium; the impact of the endowment effect on the M&A premium varies across M&A events in different industries, and the impact of the endowment effect is more prominent in the M&A of companies in emerging industries. It is recommended that acquirers should fully consider the increased M&A costs due to the endowment effect when evaluating target companies; industrial policy makers should consider the impact of the endowment effect on the efficiency of industrial integration.