Applied Mergers and Acquisitions. Robert F. Bruner

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(1992), and others, we are gaining a clearer view of the role of behavioral influences in financial decision making. But behavioral finance remains a young field; more research remains to be done. Questions for the analyst include these:

       Who are the decision maker and his or her advisers? What, in their background, might suggest a tendency to disregard rational analysis and disciplined thinking? M&A arbitrageurs often develop psychological profiles of the CEOs of companies they follow. Though imperfect, these give hints about the decision maker’s ability or willingness to think critically about M&A proposals and to act in the interests of shareholders.

       Is the decision maker isolated or in touch with reality of the M&A situation? One hears about the imperial CEO. Like the fabled emperor who had no clothes, the CEO might have a culture of “yes people” who simply endorse what the CEO proposes.

       Does the decision maker operate under a governance system of monitoring and control? One of the benefits of good governance systems is to forestall problems of hubris. Chapter 26 discusses dimensions of governance.

      Market Manias

      The practical person will find it hard to know what to do with the mania explanation. Chapters 30 and 31 emphasize the influence of psychological effects on M&A outcomes. Our understanding in this area is still in its infancy. Still, the practitioner seeking to understand M&A activity should ask at least two questions:

      1 Does the market, my industry, or my firm seem in the grip of “deal frenzy”?

      2 What is the tendency of the “herd” in my industry with respect to M&A? What is the “lead steer” doing?

      Both of these questions invite, at best, qualitative answers. Generally, the size of acquisition premiums relative to historical averages will give some sense of whether the deal flow is hot or cold. A close following of speeches, interviews, scuttlebutt, and, above all, M&A actions is the grist from which answers to these questions will be made.

      Overvaluation of Stocks and the Asymmetry of Information

       We do not assume that markets are efficient, but rather that the stock market may misvalue potential acquirers, potential targets, and their combinations. In contrast, managers of firms are completely rational, understand stock market inefficiencies, and take advantage of them in part through merger decisions. This theory is in a way the opposite of Roll’s (1986) hubris hypothesis of corporate takeovers, in which financial markets are rational, but corporate managers are not. In our theory, managers rationally respond to less than rational markets. (Page 2)

      Rhodes-Kropf and Viswanathan (2003) (RV) build on this framework. While Shleifer and Vishny offer a rationale for the behavior of buyers, why should targets accept stock offers from buyers whose shares are likely to be overvalued? RV suggest that targets are canny enough to assess the misvaluation of the buyer and target, but not canny enough to correctly assess the value of synergies—this is because of an information asymmetry between the buyer and target in which the buyer has a better idea of the possible economic gains between the two firms. They write, “Thus, when the market is overvalued then the target is more likely to overestimate the synergies even though he can see that his own price is affected by the same overvaluation.” (Page 2) Ang and Cheng (2003) give empirical evidence in support of the overvaluation/information asymmetry theory. Based on a sample of 9,000 observations from 1984 to 2001, they find:

       Acquirers are much more overvalued than their targets. Successful acquirers are more overvalued than the unsuccessful ones. The probability of a firm becoming an acquiree significantly increases with its degree of overvaluation, after we control for other factors that may potentially affect the firm’s acquiring decision. Since overvalued acquirers could only gain from their misvaluation by paying for the acquisitions with their stocks, we postulate and verify that stock-paying acquirers are substantially more overvalued than their cash-paying counterparts…. The probability of stocks being utilized

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