A rapidly growing literature claims to reject the efficient market hypothesis by producing large estimates of long-term abnormal returns following major corporate events. The preferred methodology in this literature is to calculate average multi-year buy-and-hold abnormal returns and conduct inferences via a bootstrapping procedure. We show that this methodology is severely flawed because it assumes independence of multi-year abnormal returns for event firms, producing test statistics that are up to four times too large. After accounting for the positive cross-correlations of event firm abnormal returns we find virtually no evidence of reliable abnormal performance for our samples.

Kyle, Jeremy Stein, and Jeff Wurgler, for useful discussions and ideas. We also thank workshop participants Merger intensity spikes in times of high market valuations (i.e., when average M/B ratios are at their highest). This is especially true for stock-based mergers, supporting recent theories by Rhodes-Kropf and Viswanathan (2002) and Shleifer and Vishny (2003). To explore whether this is the result of correlated valuation errors or behavioral mispricing we decompose M/B into three components: firm-specific deviation from short-run industry valuations; short-run industry deviations from long-run values, and long-run value to book. The fact that high M/B buys lower M/B is driven mostly by firm-specific deviations from short-run industry average pricing. However, both targets and acquires are priced above their long-run industry average. When we find differences between bidders and targets in long-run valueto-book, we find that low buys high. We also find that the industry-specific component of M/B is highly positively correlated with merger intensity, and correlated with the use of stock. However, long-run value-to-book is uncorrelated with cash merger intensity and negatively correlated with stock merger intensity, leading to little overall correlation between long-run

This paper tests the hypothesis that irrational market misvaluation a#ects firms' takeover behavior. We employ two contemporaneous proxies for market misvaluation, pre-takeover book/price ratios and pre-takeover ratios of residual income model value to price. Misvaluation of bidders and targets influences the means of payment chosen, the mode of acquisition, the premia paid, target hostility to the o#er, the likelihood of o#er success, and bidder and target announcement period stock returns. The evidence is broadly supportive of the misvaluation hypothesis

By examining how executive compensation structure determines corporate acquisition decisions, we document a strong positive relation between acquiring managers' equity-based compensation (EBC) and stock price performance around and following acquisition announcements. This relation is highly robust when we control for acquisition mode (mergers), means of payment, managerial ownership, and previous option grants. Compared to low EBC managers, high EBC managers pay lower acquisition premiums, acquire targets with higher growth opportunities, and make acquisitions engendering larger increases in firm risk. EBC significantly explains post-acquisition stock price performance even after controlling for acquisition mode, means of payment, and “glamour ” versus “value ” acquirers.

This paper analyzes the amount of information that can be extracted from stock prices around takeover contests. The first part of the paper shows that it is not generally possible to use target and bidder stock price movements to infer the market’s estimates of synergies, bidder overpayment, and changes in bidder and target values. In two generic cases, however, we show that it is possible to use bidder and target stock prices to obtain market estimates of overpayment. In the second part of the paper, we illustrate one of these two generic cases through a clinical study of the takeover contest for Paramount. We find that the market estimated that Viacom, the eventual “winner ” of the takeover battle, overpaid by over $1.5 billion when it agreed to purchase Paramount in a $9.2 billion acquisition in February 1994. We also find that the market believed that QVC, the eventual “loser ” of the battle, had substantially larger synergies (on the order of $1billion more) with Paramount than Viacom did. Viacom prevailed due to its willingness to overpay. That this overpayment occurred despite the fact that Sumner Redstone, the CEO of Viacom, owned roughly 2 3 of Viacom supports Roll’s Hubris hypothesis (1986) as well as

It is fundamental to good governance that corporate decision makers be well informed, have the knowledge-base necessary to use the information effectively, and share the same motivations as the owners. Further, managers must provide owners with accurate, timely, and complete disclosure of the company’s positions. Regarding the first part of the problem, value based inc entive systems have been under development in order to aid in resolving conflicts of interest between owners who lack the specific information (or the background knowledge to utilize it) and the managers who act as their agents. Such systems often focus exclusively upon cash flows relative to resource investment; yet, share values are often substantially greater than the amount that could be explained by expected cash flows from existing operations. Indeed, in some firms the majority of share value may de rive from growth opportunities or other real options that add flexibility or reduce risk. So, value based incentive systems could be improved by explicitly rewarding actions that create or enhance the firm’s real options. Further, satisfactory disclosure requires that accounting reports include adequate information about the firm’s real options, with market-based mechanisms for defining the necessary information and calling it into the appropriate arena.

We identify firms undertaking major investments during the period 1989-99. Compustat’s disaggregated flow-of-funds data indicates that major investments are mostly externally financed. New debt provides roughly half of the funds required for these investments, equity issuances supply only about 20%, and internal cash flows supply most of the remainder. When we evaluate the long-run performance of our sample firms, we find that large investments per se do not cause underperformance. Only firms financing large projects with external funds exhibit negative long-run abnormal returns, and this effect is most clearly associated with debt financing. Firms making major investments funded primarily with internally generated funds do not underperform. Our results raise doubts about underperformance explanations based on managerial overinvestment, for which negative value effects should be the most pronounced under internal financing.

Earnings management by acquirers may affect the terms of a deal, whether a bid succeeds, which management team emerges from the market for corporate control in command of the target’s assets, and can therefore have irreversible consequences for industrial structure and the distribution of gains between target and acquirer shareholders. Using a sample of UK acquirers, the study documents opportunistic behaviour in the periods preceding the announcement of a takeover bid. If acquiring firms do engage in earnings management activities, the following question naturally arises: Is earnings management successful? Furthermore, given that income-increasing manipulation inevitably requires equal offsetting changes in later years, if prospective bidders indeed resort to such creative accounting devices, to what extent could then the evidence on poor post-merger performance be attributed to the reversal of the effects of past earnings management?

This study looks at the difference between the fundamental value and the market value of firms during the merger and acquisition process, and investigates the role of that difference on the method of payments (cash vs. stock) and on the subsequent stock performance around the merger and acquisition (M&A) announcement date. The number of M&A transactions has dramatically increased since the stock swap and stock transfer schemes were introduced in 1999. We investigate the scenario that managers who specialize in analyzing the corporate value of the firms possibly shorten the value correction time and partially reduce misvaluation in the capital market. The Means of Payment hypothesis suggests that the managers should choose stock payment over cash payment when the acquiror is over-valued in the market. However, we found that Japanese managers more positively use cash payment when the firm has sufficient financial slack (is cash rich). The Misvaluation hypothesis suggests that positive excess returns of the acquiror could be detected around the announcement day of M&A transactions, when the acquiror and/or the target is/are under-valued in the market. We found strong evidence which supports the Misvaluation hypothesis. In calculating the fundamental value of the firms, we employed the Residual Income Model, using financial analysts forecast value of future profits, after controlling the book-to-market ratio. We found strong evidence

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