Advanced Auditing

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Do Stock Mergers Create Value for Acquirers?

This paper finds support for the hypothesis that overvalued firms create value for long-term shareholders by using their equity as currency. Any approach centered on abnormal returns is complicated by the fact that the most overvalued firms have the greatest incentive to engage in stock acquisitions. We solve this endogeneity problem by creating a sample of mergers that fail for exogenous reasons. We find that unsuccessful stock bidders significantly underperform successful ones. Failure to consummate is costlier for richly priced firms, and the unrealized acquirer-target combination would have earned higher returns. None of these results hold for cash bids.

THE LATE 1990S WITNESSED a large mergers and acquisitions wave. Many transactions involved equity as the mode of payment (Andrade, Mitchell, and Stafford (2001), Holmstrom and Kaplan (2001)), and this equity was usually very richly valued by historical standards. The positive correlation between market valuation and merger activity has also been documented in other periods (Martin (1996), Verter (2002)) and is especially strong for stock deals (Maksimovic and Phillips (2001)). One interpretation of this evidence is that managers try to time the market by paying with stock when they believe it is overvalued. Recently, a number of papers formally recognized this link between possible mispricing and acquisition activity. Shleifer and Vishny (2003) propose that overvalued firms engage in stock-financed acquisitions in order to obtain hard assets at an effective discount. This discount comes at the expense of the target’s long-term shareholders, so their theory relies on different stock price performance horizons for the managers of the two involved firms.1 Rhodes-Kropf

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Advanced Auditing

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