Stock Mergers Research Articles

Stock merger activity and industry performance

We propose a merger activity variable ( MAV ) as an alternative to industry merger waves. Unlike discrete merger waves that separate periods of extreme activity from the rest, our continuous MAV utilizes information in the full range of stock merger activity. We rank Fama-French 12 industries by MAV each quarter and arrange them into 12 bucket portfolios. We examine their prior and subsequent three-year excess returns using calendar-time portfolio method. The prior returns are positively related to MAV ranks while the subsequent returns are negatively related to MAV ranks. This evidence suggests a build-up of misvaluation (undervaluation of relatively less stock merger active industries and overvaluation of relatively more active industries) followed by a correction. On average, the most active industry outperforms the least active industry by 13.46% during the prior period, but underperforms by 10.30% during the subsequent period. Industry operating performance results further support the industry misvaluation theory of stock merger activity.

The Role of Lockups in Stock Mergers

We document the frequent use of stock lockup agreements in mergers and acquisitions (MA ex-ante, lockups adoption likelihood increases with acquirers’ valuation. Lockups also come with higher deal completion likelihood; shorter merger negotiations; higher long-term operating performance. We conclude the market interprets lockups as a signal of strong fundamentals, particularly when acquirers’ valuations are high.

Informed trading or liquidity trading: a theoretical formulation

This paper provides theoretical formulations of informed trading contrasted with liquidity trading. Informed trading occurs when traders flock to purchase or sell securities, based upon private information. In contrast, liquidity traders purchase or sell securities for their own inventory. Informed traders purchase in large volume over very short periods of time, with a definite direction of price movement. Liquidity trading consists of unlimited market entry of traders, reducing profit per trader, along with a long time period of investment in which the direction of price movement is uncertain, diminishing gains. This paper presents optimal trade prices for informed traders prior to stock mergers, whereupon traders have been observed short selling the acquirer stock, using the proceeds to purchase target stock, or to purchase put options. A capital structure arbitrage strategy is used for liquidity traders, with the trader purchasing or selling bonds at trade prices influenced by the market maker's prices. Proceeds from this strategy may be used to purchase equities.

Does Stock Misvaluation Drive Merger Waves?

Despite the mounting evidence that stock misvaluation affects takeover characteristics and outcomes at the deal level, there remains a prolonged debate over whether mispricing drives aggregate industry-level merger activity. We depart from the extant literature and investigate whether stock misvaluation drives industry-level merger waves by contrasting the effects of acquirer valuation during “stock” and “cash” merger waves, defined using pure stock or cash acquisitions during 1981-2015. Using the timing of stock waves, we find that acquirer valuation peaks during wave periods, and acquirers have low stock performance in the 5-year period after the merger bid, with especially acute underperformance for mergers announced during stock waves. There is little evidence of such patterns around cash merger waves. These results suggest that equity misvaluation drives stock merger waves, and agency costs associated with overvalued equity prevent acquirer shareholders from reaping gains from merger waves.

Expectation Management in Mergers and Acquisitions

Takeover bidders in stock-for-stock mergers have strong incentives to increase their own premerger stock prices to lower their acquisition costs. We find that before announcements of stock mergers, bidders manage down analyst earnings forecasts prior to earnings releases. Such expectation management benefits bidders by increasing their own stock prices and saving on acquisition costs. Additionally, analysts who have close relations with stock bidders are more likely to participate in expectation management. For identification, we use an instrumental variable analysis, a pseudo-event analysis, and a propensity score-matching approach. Our paper provides evidence on expectation management as a previously underexplored opportunistic behavior by takeover bidders. This paper was accepted by Shivaram Rajgopal, accounting.

Earnings Management and Stock for Stock Mergers

This study investigates the relationship between stock for stock mergers and three earnings management methods: (1) accrual-based earnings management; (2) real earnings management; and (3) misclassification of items within the income statements. The findings show that stock for stock merger firms in the year of mergers are more likely to use accrual-based and real earnings management instead of classification shifting. In addition, this study develops an aggregate earnings quality index and compares future operating and stock market performance based on the earnings quality index.

Stock mergers and acquirers’ subsequent stock price crash risk

We examine the changes in acquirers’ stock price crash risk following mergers and acquisitions (M&As). We employ the three measures of crash risk most commonly used in the literature: the negative conditional skewness of acquirer-specific stock returns, a down-to-up volatility measure, and the excess of extreme negative stock returns over extreme positive returns. We find that stock acquirers experience significantly higher stock price crash risk as compared to cash acquirers. The change in risk is positively correlated with the percent of stock used as a payment method. The findings are confined to acquirers with overvalued stock, lower profitability and more financial constraints, as well as to acquisitions of public targets. We confirm that stock market crises do not drive our findings. Furthermore, our results are robust to endogeneity concerns, controlling for non-acquirers and post-merger acquirer changes.

Merger Activity and Stock Prices

Fitting aggregate merger data to a stylized model, we estimate 10-15% of aggregate stock market valuation can be attributed to broad anticipation of mergers. Accordingly, exogenous shifts in deal activity lead to significant changes in aggregate price levels. In empirical tests, every additional dollar of announced merger premiums is associated with up to $40 dollars of increased aggregate market valuation over the following week. Changes in deal activity have broad effects on returns across industries, exchanges, and firm types. Large embedded merger premiums imply traditional event study methods used in M&A research significantly underestimate merger synergies and premiums. Lastly, we show part of the observed link between stock prices and merger activity comes from increased deal activity inducing higher prices, as opposed to the general assumption that higher prices induce more merger activity.

Stock price firm‐specific information on the choice of stock payment in mergers and acquisitions

AbstractPrevious studies on the choice of stock payment in M&A mainly focus on managerial private information. This study shows that managers also learn new firm‐specific information from financial markets in making this decision. The acquirer's stock price firm‐specific information increases the stock‐payment‐to‐Q sensitivity. The target's stock price firm‐specific information decreases the stock payment probability. Further analyses on deal and firm characteristics as well as shareholder wealth in stock mergers support the managerial learning argument. Overall, this study highlights a new set of information that affects the form of merger payment in mergers and acquisitions.

Stock Merger Activity and Industry Performance

We propose a merger activity variable (MAV) as an alternative to industry merger waves. Unlike discrete merger waves that separate periods of extreme activity from the rest, our continuous MAV captures information in the entire spectrum of stock merger activity. We rank industries by MAV within each quarter and arrange into 12 bucket portfolios. During 1989-2018, prior and subsequent three-year excess portfolio returns are positively and negatively related to bucket numbers and with each other, consistent with a build-up of misvaluation (undervaluation of less merger-active industries and overvaluation of more merger-active industries) followed by a proportional correction. We estimate differences of 4.49% and -3.43% between prior and subsequent annual alphas of most and least merger-active industries. Operating performance results provide further evidence in favor of the misvaluation theory of industry stock merger activity. Such return and operating performance based evidence for entire industries has not been documented before.

An Analysis of the Characteristics of Firms Conducting Corporate Events Inside and Outside Waves

We document how firms participating in corporate transactions, classified in four types of corporate events (seasoned equity offerings, stock and cash-financed mergers, and share repurchases) within waves differ in predictable patterns from firms that engage in event activity outside waves. Despite only small differences in the characteristics of firms that conduct transactions outside waves and during short single-quarter waves, there are very large differences in the characteristics of these firms and the firms that conduct transactions in the beginning of long multi-quarter waves. Waves seem driven by the availability of growth opportunities or the presence of misvaluation and end when these opportunities disappear, with the exception of repurchase waves which appear to be driven by undervalued firms. Firm characteristics appear to diverge more at different stages within the wave.

Lower the Basket for Easy Shots? Expectation Management Before Takeovers

There is a large literature analyzing the different, and sometimes conflicting, goals of various parties in mergers and acquisitions. While it is well known that bidders in stock-for-stock mergers have a strong incentive to boost their own pre-merger stock prices to lower the acquisition costs, the role played by financial analysts in the takeover process is underexplored. We find strong evidence that analysts adjust downward their near-term earnings forecasts for stock bidders prior to merger announcement, and such forecast adjustment helps bidders ensure good earnings surprises, support stock prices, and save on acquisition costs. This finding is robust to alternative measures of forecasts, and cannot be explained by firm and deal characteristics or omitted variables. Further analyses reveal that the forecast adjustment reflects conflicts of interest instead of analysts’ truthful opinions. Overall, our paper suggests that the downward adjustment of analyst forecasts is a surprising yet robust feature of the stock mergers.

Executive compensation and informed trading in acquiring firms around merger announcements

This paper analyzes informed trading in acquiring firms through (stock) merger announcements. We show that pre-announcement abnormal option volumes in acquiring firms strongly increase ahead of a stock merger (by approximately 300%). Furthermore, we show that the direction of option trades (puts or calls) prior to an announcement can predict post-announcement stock returns. Our results also indicate that higher wealth-to-performance sensitivities of top executives are related to higher abnormal put than call option trading before stock merger announcements. Overall, our results support the view that top executives have a hedging motive. They tend to purchase protection against, e.g., confounding (negative) information policies and/or empire-building mergers with negative NPVs, in order to avoid short-term salary losses (lower bonuses, lower stock options, etc.).

Lower the Basket for Easy Shots? Expectation Management Before Takeovers

Takeover bidders in stock-for-stock mergers have a strong incentive to support or boost their own per-merger stock prices to lower the acquisition costs. We find that before the announcements of stock mergers, bidders manage down analyst earnings forecasts prior to earnings releases, and such expectation management helps bidders ensure good earnings surprises, support stock prices, and save on acquisition costs. This finding is robust to alternative measures of forecasts, and cannot be explained by firm and deal characteristics or omitted variables. Further analyses reveal that such downward adjustment of earnings forecasts mainly reflects conflicts of interest instead of analysts’ truthful opinions. Overall, our findings identify expectation management as a previously underexplored opportunistic behavior by takeover bidders.

Merger arbitrage short selling and price pressure

We evaluate the over-valuation hypothesis and merger arbitrage price pressure hypothesis as potential explanations for the observed negative returns to stock acquirers around merger announcement. Using daily shorting flow data, we show that the majority of the negative announcement returns can be attributed to price pressure induced by merger arbitrage short selling. Additional analysis of shorting activity and associated returns for floating-exchange-ratio stock acquirers at deal closings and among withdrawn stock deals further supports merger arbitrage price pressure explanation. We also find merger arbitrage activity increases with estimated arbitrage spread on a daily basis. As a whole, the results suggest that merger arbitrageurs play a critical role in stock mergers.

Who Writes the News? Corporate Press Releases during Merger Negotiations

ABSTRACTFirms have an incentive to manage media coverage to influence their stock prices during important corporate events. Using comprehensive data on media coverage and merger negotiations, we find that bidders in stock mergers originate substantially more news stories after the start of merger negotiations, but before the public announcement. This strategy generates a short‐lived run‐up in bidders' stock prices during the period when the stock exchange ratio is determined, which substantially impacts the takeover price. Our results demonstrate that the timing and content of financial media coverage may be biased by firms seeking to manipulate their stock price.

Trading Responses to Negative Signals

Mergers may be undertaken by giving shareholders of the target firm the right to exchange their stock for stock in the combined firm. Such stock mergers release the negative signal that the acquiring firm lacks cash. Informed traders seeking immediate gain may short sell acquirer stock or buy puts and sell calls. Liquidity traders, desiring longterm gain, may purchase stock or call options to benefit from lower stock prices, or sell stock or buy put options to maintain liquidity. This paper constructs a theoretical model in which option volume forms the bounds of the final stock price for informed traders while random stock purchase or sale volume establishes the final stock price for liquidity traders.

Executive Compensation and Informed Trading in Acquiring Firms Around Merger Announcements

This paper analyzes informed trading in acquiring firms through (stock) merger announcements. We show that pre-announcement abnormal option volumes in acquiring firms strongly increase ahead of a stock merger (by approximately 300%). Furthermore, we show that the direction of option trades (puts or calls) prior to an announcement can predict post-announcement stock returns. Our results also indicate that higher wealth-to-performance sensitivities of top executives are related to higher abnormal put option trading before stock merger announcements. Overall, our results support the view that top executives have a hedging motive. They tend to purchase protection against, e.g., confounding (negative) information policies and/or empire-building mergers with negative NPVs, in order to avoid short-term salary losses (lower bonuses, lower stock options, etc.).

Predicting informed trading at merger announcements

Purpose – This paper aims to propose a method of forecasting the level of informed trading at merger announcements by permitting liquidity traders to adjust their trading based upon signals from informed traders. Informed traders typically take advantage of their knowledge of forthcoming mergers by trading heavily at announcement. For cash mergers, they respond to a positive signal by purchasing stock, and for stock mergers, they respond to a negative signal by selling stock. In response, exchanges (market makers) set wider spreads (charge higher transaction fees) for informed buyers. Uninformed traders are subject to such excessive fees unless they can accurately predict the period during which such fees are charged. Design/methodology/approach – This paper proposes a technique by which uninformed traders may make predictions by creating a vector autoregressive framework that links informed and liquidity trading through price changes. Findings – For cash mergers, transaction fees remained excessive for days −1 to +1. For stock mergers, fees remained high on days −1 to +1, started declining on days 2 and 3, and vanished on days 4 and 5. Research limitations/implications – Most theoretical models of informed trading have viewed informed trading and liquidity trading as tangentially linked. This study finds a direct link between these two trading activities. Practical implications – Uninformed traders may wish to limit their trading until after day +1 for both types of mergers. Originality/value – This paper defines the time period during which transactions costs for traders are at the maximum level. Short sellers have more information about the direction of stock movements and may sell during days of informed selling set forth by this study and repurchase stock afterwards.

Holdups, Renegotiation, and Deal Protection in Mergers

We examine the contracting and negotiation process in mergers using an incomplete contracts framework. Our multi-period model allows for the arrival of new information and renegotiation after the signing of an initial merger agreement but before deal completion or termination. A properly designed initial contract solves the holdup problem during renegotiation and induces higher deal-specific effort, including the due diligence assessment of the deal. The contract grants an option to the target to terminate the merger, where the strike on the option compensates the acquirer’s deal-specific effort without imposing excessive costs on the target for pursuing non-merger alternatives. The option strike can be implemented by the use of deal protection devices, such as a target termination fee and/or an acquirer lockup. Employing a large sample of stock mergers, we find evidence supporting model predictions for the renegotiation of contracts, deal outcomes and the use of deal protection devices.