The acquisition puzzle and mispricing: evidence of over-optimism
International Journal of Managerial Finance
ISSN: 1743-9132
Article publication date: 26 August 2014
Abstract
Purpose
Researchers suspect that the overvaluation of equity issuing acquirers is a major cause of their subsequent post-event underperformance. Definitive conclusions regarding this overpricing hypothesis have not been possible since indicators of overpricing such as the book-to-market ratio and subsequent underperformance are open to alternative interpretations. The purpose of this paper is to corroborate or refute overvaluation as a driver of equity issuing acquirers’ subsequent underperformance.
Design/methodology/approach
The literature has linked overvaluation of acquirers to over-optimistic expectations. The authors use analysts’ earnings forecasts to reflect the market's expectations. Over-optimism is indicated by subsequent earnings disappointments. The authors examine the relation between acquirers’ choice of payment method and their tendency to report disappointing earnings. The authors also examine the effect of including a more direct measure of over-optimism in a model to explain the long-run post-event buy-and-hold-abnormal returns of acquirers.
Findings
The post-acquisition earnings of equity issuing acquirers disappoint more often than those of acquirers employing alternative financing methods. This relationship is confined to glamour acquirers. The ability of financing method to predict long-run post-acquisition performance is subsumed when direct measures of optimism are included in a model explaining long-run post-acquisition performance. This result is robust to controls for overpayment and other potential explanations of post-acquisition underperformance.
Research limitations/implications
Acquirers’ management exploit their information advantage to exchange overvalued equity for the assets of the target company in accordance with Loughran and Ritter's (2000) behavioural timing hypothesis.
Originality/value
The study provides new and unambiguous evidence that equity-issuing acquirers are optimistically priced at the time of acquisition.
Keywords
Acknowledgements
The authors would like to acknowledge the helpful comments of John Holland and an anonymous reviewer.
Citation
Donnelly, R. and Hajbaba, A. (2014), "The acquisition puzzle and mispricing: evidence of over-optimism", International Journal of Managerial Finance, Vol. 10 No. 4, pp. 470-493. https://doi.org/10.1108/IJMF-01-2012-0001
Publisher
:Emerald Group Publishing Limited
Copyright © 2014, Emerald Group Publishing Limited