BakerPanWurgler2012 - The effect of reference point prices on mergers and acquisitions

BakerPanWurgler2012 - The effect of reference point prices on mergers and acquisitions

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1 The effect of reference point prices on mergers and acquisitions * Malcolm Baker Harvard Business School and NBER [email protected] Xin Pan Harvard University [email protected] Jeffrey Wurgler NYU Stern School of Business and NBER [email protected] September 10, 2010 Abstract The use of the target’s recent peak prices as reference points or judgmental anchors affects several aspects of merger and acquisition activity including offer prices, deal success, market reaction, and merger waves. Offer prices are biased toward the target’s recent peak prices although such prices are economically unremarkable. The offer’s probability of acceptance jumps discontinuously when it exceeds a peak price, a real effect of the use of peak prices. Conversely, bidder shareholders react more negatively as the offer price is influenced upward toward a peak price. Merger waves occur when high recent returns on the stock market and on likely targets make it easier for bidders to offer a peak price. * For helpful comments we thank the Honorable William Allen, Yakov Amihud, Nick Barberis, Lauren Cohen, Ravi Dhar, Ming Dong, Robin Greenwood, Steven Huddart, Ulrike Malmendier, Florencia Marotta-Wurgler, Steven Mintz, Daniel Paravisini, Gordon Phillips, Gerald Rosenfeld of Rothschild North America, Rick Ruback, Meir Statman, Joshua White, Russ Winer, and seminar participants at Columbia University, Harvard Business School, Michigan State, the NBER Corporate Finance Summer Institute, NYU Stern, the Rising Star Conference at RPI, and the Securities and Exchange Commission. Baker gratefully acknowledges financial support from the Division of Research of the Harvard Business School.
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2 I. Introduction The price that a bidding firm offers for a target is generally the outcome of a negotiation with the target’s board. The standard textbook story emphasizes synergies. The offer price starts with an estimate of the increased value of the combined entity under the new corporate structure, deriving from cost reductions in labor or capital equipment, supply chain reliability, debt tax shields, market power, market access and expertise, improved management, internal finance, and other economic factors (e.g., Lang, Stulz, and Walkling 1989 or Jovanovic and Rousseau (2002)). This value gain is then divided between the two entities’ shareholders according to their relative bargaining power. In theory, the textbooks suggest, all of this leads to an objective and specific price for the target’s shares. In practice, valuing a company is subjective. A large number of assumptions are needed to justify any particular valuation of the combination. In addition, relative bargaining power may not be fully established. Boards can bluff in the negotiation. Other bidders may emerge. These real-life considerations mean the appropriate target price cannot be set with precision, but established only to be within a broad range. We hypothesize that this indeterminacy, in turn,
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