Overvaluation theory and the wave effect in the 1990s US merger wave

Abstract

Purpose. There is a dispute about efficiency and sustainability of acquisitions. Shleifer and Vishny (2003), in their stock market driven acquisition theory, claim that managers are rational and use mergers as arbitrage if the firm is overvalued. The aim of the current study is to test the predictions of the overvaluation theory on a sample of high technology industry MandA transactions in the 90s.

Methodology. This paper has the form of an empirical study. The author employs event study analysis, the market adjusted approach with standard parametric tests, and the Fama-French 3-factor model to explore the wealth effects for amalgamating firms in different stages of the MandA wave.

Findings. The results reveal a distinct wave effect: abnormal returns to bidders are lower in the second half of the merger wave. Bidders' performance in the early and late stages of the MandA wave follows the predictions of the overvaluation theory. Bidders exhibit particularly poor performance if the bid is announced in the late wave and the method of payment is stock. The long-run negative abnormal returns to the bidders cast out the neoclassical explanations of the wave effect and indicate market inefficiencies.

Value. The present study serves as a complementary argument in the widespread dispute about merger wave explanation theories. The outcome confirms the behavioural characteristics of merger activity, particularly stock market driven acquisition theory. Misvaluation as an integral factor of merger activity may have a detrimental effect on the efficiency of acquisitions.