Essays on value and valuation in mergers and acquisitions

Wei Zhang

doi:10.7273/000005820

This dissertation contains three chapters. Chapter one discusses the relevant literature; chapter two examines the value and valuation of merged firms in the long run; and chapter three investigates which type of investors is more likely to drive prices away from fundamentals. In chapter one, I review the relevant literature on mergers and acquisitions that addresses two fundamental questions: Do mergers create value? What drives mergers? I first summarize extant evidence on both short-horizon and long-run stock performance of mergers and discuss three possible explanations for long-run abnormal returns. I further review the motives for mergers from behavioral, neoclassical and agency perspectives. In chapter two, I address the question of whether mergers create value in the long run by examining changes in intrinsic values (estimated using the residual income model). The results indicate that overvalued (high price-to-value) value (low price-to-book) firms experience a significant increase in intrinsic value following mergers. In contrast, undervalued (low price-to-value) glamour (high price-to-book) firms suffer a significant loss in intrinsic value. The results are consistent with value-firm managers using their overvalued equity to make prudent acquisitions that increase intrinsic value while glamour-firm managers overextrapolate past good performance and destroy firm value when using their undervalued equity to make acquisitions. In chapter three, I examine which investor type, institutional versus individual, is more likely to be responsible for the overvaluation of acquiring firms, assuming, consistent with prior work and interpretation, that acquirers are, on average, overvalued. The findings can be summarized as follows. First, stock acquirers exhibit high valuation levels at the quarter end before announcement. Second, institutional investors are net buyers of acquiring firms in the three years prior to acquisition. Third, changes in valuation and institutional demand over the same pre-merger periods are positively strongly correlated in the cross-section even after controlling for institutional momentum trading. Last, abnormal returns in the post-merger period are inversely related to institutional demand in the pre-merger period. Overall, my findings suggest that institutional investors, rather than individual investors, are more likely to drive misvaluations that encourage companies to exploit their overvalued equity in making acquisitions.

Essays on value and valuation in mergers and acquisitions

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