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The Pricing Effects of Interfirm Cash Tender Offers
Abstract
The tools provided by option pricing theory of tender offer analysis provides evidence consistent with the "synergy" theory of corporate takeovers and has implications conce rning the economic effects of regulations of cash tender offers. The analysis further suggests that the market prices information uncertai nty in a manner not captured by the standard Capital Asset Pricing Mo del. The study introduces a technique for unbundling the prices of a primary asset and a contingent claim when only the prices of the comb ination are observed. Copyright 1987 by American Finance Association.
... Studies in this area argue that option pricing is able to capture the full value of target firms as flexibility would not be accounted for within other modelling set ups. After one of the earliest work applying a general option pricing model to M&A operations- Bhagat et al. (1987), other researchers adopted the same theoretical framework to study stocks financed deals in the real estate investment trust (REIT) industry- Sebehela (2008)-and cash financed M&As in non-real estate sectors- Sorwar and Sudarsanam (2010). The value of new information, especially in option trading environment has been illustrated by He et al. (2010). ...
... From mid 2000s, Hackbarth and Morellec (2008) and Sorwar and Sudarsanam (2010) started to value M&A synergies using option pricing techniques. Sorwar and Sudarsanam (2010) priced put options within B-S framework and, as in Bhagat et al. (1987); they assumed that the observed price is the difference between the underlying price and fractional put option ** . Implied options prices and volatilities were modelled based on the logic of the later statement. ...
... In 2008, all sectors excluding self-storage had negative annual returns-probably because the self-storage sector has defensive stock characteristics. If one adopts a principle similar to Bhagat et al. (1987), and Sorwar and Sudarsanam (2010) using the differences between mean and median, spreads significantly different from zero are found in every group especially in the funding group. This evidence supports the fact assumption that funding group variables should contribute more to options values than other variable groups. ...
This article models mergers as exchange options where acquirers offer stocks and/or cash to target firms in exchange of acquiring some shareholding in target firms. Mergers analysed in this article happen between homogeneous entities. The B-S and Margrabe models are used to price cash and stocks (including stocks and cash) deals respectively. The M&A traits are grouped as conflict of interest, market growth, funding and specialisation. Regression results illustrate that exchange options react to M&A characteristics differently. Thus, the results are beneficial to both sell-and buy-side investors in terms on how one manages merging firms. The goodness of fit suggests that strategic acquisitions played important roles. anonymous reviewer. All the remaining errors are own.
... The next econometric hurdle imposed is isolating the target's theoretical equity value from the market price, which includes the implied option to receive cash or bidder stock. As discussed in Bhagat et al. (1987), the degree to which the offered option is "in the money," i.e. the margin by which the offering price exceeds the target's underlying equity, indicates the market's assessment of intra firm synergies and their relatedness with the target's equity. The existing empirical literature follows their suggested estimation method to calculate the option value in a Black-Scholes, non-stochastic, volatility framework. ...
... The moment the formal announcement of a bidding offer takes place, the value of the target stock in the trading session incorporates the option to participate in the cash or stock exchange. Following Bhagat et al. (1987), the prevailing market price P F B Mkt immediately following the bid announcement is constituted from the underlying theoretical value of the firm P F B T h plus a put value P Put , which incorporates the offered terms: ...
... Two distinctive modeling approaches are pursued accordingly, distinctive for each of the exchange mediums offered. For cash offers, the existing literature (Bhagat et al. 1987;Sudarsanam and Sorwar 2010) assumes that volatility is nonstochastic, and the implied European put to sell the stock at the offered price is modeled based on the Black and Scholes (1973) formula. ...
This paper investigates the value successful bidders generate from acquiring less liquid targets. This synergy is traced with both theoretical and empirical evidence from the squeeze-out stage of going private transactions, when bidders hold sizeable toeholds in target shares. By transferring their superior liquidity, acquirers can add value to the valuation of their toeholds in fully acquired target assets. We use a sample of US delisted targets from globally listed acquirers over 25 years, and, in line with our theoretical analysis, a nonlinear relation is evidenced between the expected added value from liquidity transfer and illiquidity differences. The adjustment of target market prices for the attached option to participate in the bid in a new stochastic volatility framework reveals that the bulk of deal-generated wealth depends on the offered option. Although the market penalizes the mean acquirer with negative abnormal returns, those with higher liquidity differences from their targets are suffering less because of their greater potential of liquidity transfer synergy. The analysis of the probability that the offered option gets in the money reveals that liquidity transfer acts as a catalyst for successfully concluding the deal and underlies underbidding.
... Bhagat et al. 1987. Sorwar andSudarsanam (2010) explored option pricing within M&A framework and it is "shaped" around Bhagat et al. 1987. This empirical study adopts similar option pricing principles to Bhagat et al. 1987, andSorwar andSudarsanma (2010) but it is different in the sense it explores M&A synergies in the U.S. REIT industry. ...
... Sorwar andSudarsanam (2010) explored option pricing within M&A framework and it is "shaped" around Bhagat et al. 1987. This empirical study adopts similar option pricing principles to Bhagat et al. 1987, andSorwar andSudarsanma (2010) but it is different in the sense it explores M&A synergies in the U.S. REIT industry. ...
... One thing that comes out of Bhagat et al. 1987 is that option pricing on M&A captures more parameters such as information asymmetry when compared with CAPM. Option pricing model used in Bhagat et al. 1987 is the B-S model because exchange options are cash financed. ...
This study explores volatility smiles when stock market information is lagged, specifically in the REIT industry. A usual requirement is that REITs can only disseminate information relating to their property valuations once per year; therefore, this leads to the lagging effect. Within the context of exchange options (i.e. mergers), it seems that no study has researched on this theme. This article uses the Black & Scholes model to calculate implied volatilities and their corresponding implied options to illustrate arbitrage opportunities when exchange options emerge. The results illustrate that implied volatilities are different from non-implied volatilities. Further, arbitrage is still higher among REITs as opposed to other capital market instruments. Finally, just like other capital market instruments, REIT acquisitions generate alpha.
... A common way in which firms can engage in growth options is through M&A. Studies that explicitly stated that they are exploring option pricing under the context of M&A can be traced far back to Bhagat et al. (1987). Although, fairly young, Sorwar and Sudarsanam (2010) explored option pricing within M&A framework and it is "shaped" around Bhagat et al. (1987). ...
... Studies that explicitly stated that they are exploring option pricing under the context of M&A can be traced far back to Bhagat et al. (1987). Although, fairly young, Sorwar and Sudarsanam (2010) explored option pricing within M&A framework and it is "shaped" around Bhagat et al. (1987). Both papers illustrated synergies in non-REIT industries and conceptually they are the same. ...
... Reasons cited for overcompensation include hubris, Roll (1986) and bargaining advantages of target firms, Hartzell et al. (2004). This empirical study adopts similar option pricing principles to Bhagat et al. (1987), and Sorwar and Sudarsanma (2010) but it is different in the sense it explores M&A synergies in the U.S. REIT industry. ...
... A mixed-payment offer will follow the rule for equity (cash) offers if the equity (cash) is the dominant portion in the total bid payment. Bhagat, Brickley, and Loewenstein (1987) report an anomaly in the relation between risk and return in targets' stocks during the post-announcement period. They find significant declines in both the beta and the sample unconditional volatility of the target of a cash bid, but rising returns. ...
... They find significant declines in both the beta and the sample unconditional volatility of the target of a cash bid, but rising returns. Bhagat et al. (1987) propose that the price of a target share during that period is the sum of the value of common stock and the value of a put option. The target shareholders have the option to sell their shares to the acquirer firm in the post-announcement period. ...
... The target shareholders have the option to sell their shares to the acquirer firm in the post-announcement period. Bhagat et al. (1987) then show via option theory that a portfolio containing a stock and a put option has a lower standard deviation than the stock itself. This conjecture explains the observed decline in the target's volatility. ...
This paper introduces a new approach for identifying the dates on which the market anticipates both takeovers and their payment forms, prior to their announcement dates. This approach predicts that the variance-covariance of the stock returns shifts when the market is informed by signals about potential takeovers with synergistic gains. Using a sample of acquisitions between U.S. public firms, I find that 86% of takeovers (62% of payment forms) are anticipated on average nine (six) months in advance. This is much earlier than reported by previous studies (two months). Moreover, when I add anticipation dates to the cross-sectional determinants of payment methods, some of the preceding results change. The reason for this finding is that the firm characteristics are not only related to the choice of payment method but also to the extent to which takeovers are anticipated.
... Stylized facts on target stock price dynamics are well documented in the literature. Theoretical and empirical studies have focused on both, the level of target stock prices around the announcement of takeover offers as well as on the (conditional and unconditional) volatility of target stocks (see among others Bhagat et al., 1987; Schwert, 1996; Hutson and Kearney, 2001, 2005 and the literature cited there). As the starting point for our analysis we adopt an idea of Hutson and Kearney (2001, p. 274) who explain the decline in conditional target stock-price volatility after the announcement of the takeover bid by a change in the price formation process during the post-announcement period. ...
... Stylized facts on target stock price dynamics are well documented in the literature. Theoretical and empirical studies have focused on both, the level of target stock prices around the announcement of takeover offers as well as on the (conditional and unconditional) volatility of target stocks (see among others Bhagat et al., 1987;Schwert, 1996;Kearney, 2001, 2005 and the literature cited there). As the starting point for our analysis we adopt an idea of Hutson and Kearney (2001, p. 274) who explain the decline in conditional target stock-price volatility after the announcement of the takeover bid by a change in the price formation process during the post-announcement period. ...
... An alternative interpretation of the concept of abnormal returns is that target stockprice returns change their mean process and become less responsive to market-wide shocks. Bhagat et al. (1987) provide a theoretical explanation of this phenomenon by representing the target stock during the tender period as a portfolio consisting of a hypothetical fundamental target stock plus a fractional put option. By invoking standard arguments of option-pricing theory, they demonstrate that the market-beta of this portfolio lies strictly below the market-beta of the fundamental target stock at every instant during the tender period. ...
This paper examines movements in the conditional volatility of stock prices of takeover targets. Based on a continuous-time modelling framework, we provide theoretical justification for modelling the data-generating process of the target stock price as subject to volatility regime-switching. Using daily stock prices of five European and American targets, we find that adequately specified Markov-switching GARCH models are capable of detecting statistically significant volatility regime-switches in all takeover deal-types (in cash bids, pure share-exchange bids, mixed bids). Overall, volatility regime-switches are found to be most clear-cut for cash bids. Our econometric findings have implications for a broad range of financial applications such as the valuation of target stock options.
... Stylized facts on target stock-price dynamics are well documented in the literature. Theoretical and empirical studies have focused on both, the level of target stock prices around the announcement of takeover offers as well as on the (conditional and unconditional) volatility of target stocks (see among others Bhagat et al., 1987;Schwert, 1996;Kearney, 2001, 2005 and the literature cited there). As the starting point for our analysis we adopt an idea of Hutson and Kearney (2001, p. 274) who explain the decline in conditional target stock-price volatility after the announcement of the takeover bid by a change in the price formation process during the post-announcement period. ...
... An alternative interpretation of the concept of abnormal returns is that target stock-price returns change their mean process and become less responsive to market-wide shocks (meaning that the parameter β in Eq. (1) decreases after the bid announcement). Bhagat et al. (1987) provide a theoretical explanation of this phenomenon by representing the target stock during the tender period as a portfolio consisting of a hypothetical fundamental target stock plus a fractional put option. By invoking standard arguments of option-pricing theory, they demonstrate that the market-beta of this portfolio lies strictly below the market-beta of the fundamental target stock at every instant during the tender period. ...
... For the two cash-bid deals Wella common stock and Wella preferred stock the market betas in regime 2, â 12 , become insignificant as expected. However, for all five target stocks the market betas decrease substantially (in absolute value) in the second regime, a finding that is consistent with the theoretical considerations of Bhagat et al. (1987) and with earlier empirical studies (cf. Section 2). ...
This paper examines shifts in the market betas and the conditional volatility of stock prices of takeover targets. Using daily stock prices of five European and American targets, we find that adequately specified Markov-switching GARCH models are capable of detecting statistically significant regime-switches in all takeover deal-types (in cash bids, pure share-exchange bids, mixed bids). In particular, conditional volatility regime-switches are found to be most clear-cut for cash bids. Our econometric findings have implications for a broad range of financial applications such as the valuation of target stock options.
... 3 The wealth effect associated with an announced change in CEO 1 Increased volatility might result in an increase in the required return to the firm's equity. Kalay and Loewenstein (1985) and Bhagat, Brickley, and Loewenstein (1987) argue that "information risk"-undiversifiable risk associated with event-specific information announcements-may be priced by the market. When this type of risk increases, expected returns will increase. ...
... A number of studies analyze the impact of corporate events on firm volatility. These include the effects of cash tender offers ( Dodd andRuback, 1977, andBhagat, Brickley, andLoewenstein, 1987), mergers and spinoffs (Mandelker, 1974, andVijh, 1994), stock splits ( Ohlson andPenman, 1985, andDubofsky, 1991), stock repurchases (Dann, Masulis, and Mayers, 1991, Hertzel and Jain, 1991, and Bartov, 1991, dividend announcements ( Kalay andLoewenstein, 1985, andJayaraman andShastri, 1993), earnings announcements (Cornell, 1978), and major corporate announcements (Brown, Harlow, and Tinic, 1988). ...
... A number of studies analyze the impact of corporate events on firm volatility. These include the effects of cash tender offers ( Dodd andRuback, 1977, andBhagat, Brickley, andLoewenstein, 1987), mergers and spinoffs (Mandelker, 1974, andVijh, 1994), stock splits ( Ohlson andPenman, 1985, andDubofsky, 1991), stock repurchases (Dann, Masulis, and Mayers, 1991, Hertzel and Jain, 1991, and Bartov, 1991, dividend announcements ( Kalay andLoewenstein, 1985, andJayaraman andShastri, 1993), earnings announcements (Cornell, 1978), and major corporate announcements (Brown, Harlow, and Tinic, 1988). ...
A change in executive leadership is a significant event in the life of a firm. This study investigates an important consequence of a CEO turnover: a change in equity volatility. We develop three hypotheses about how changes in CEO might affect stock price volatility, and test these hypotheses using a sample of 872 CEO turnovers over the 1979-95 period. We find that volatility increases following a CEO turnover, even when the CEO leaves voluntarily and is replaced by someone from inside the firm. Forced turnovers increase volatility more than voluntary turnovers - a finding consistent with the view that forced departures imply a higher probability of large strategy changes. For voluntary departures, outside successions increase volatility more than inside successions. We attribute this volatility change to increased uncertainty over the successor CEO's skill in managing the firm's operations. We also document a greater stock price response to earnings announcements following CEO turnover, consistent with more informative signals of value driving the increased volatility. Our findings are robust to controls for firm-specific characteristics such as firm size, changes in firm operations, and changes in volatility and performance prior to the turnover.
... where x i = return on an ith day for a firm's stock, x = the average return in each period, and n = the number of days in the timeline. Most of those papers which examine the impact of corporate events on changes in risk analyze the risk level of sampled firms comparing before and after the announcement date [102,103,119,120]. This strategy may misjudge actual risk adjustments, as certain macro-factor variables may not have anything to do with the event being considered. ...
... where xi = return on an ith day for a firm's stock, ̅ = the average return in each period, and n = the number of days in the timeline. Most of those papers which examine the impact of corporate events on changes in risk analyze the risk level of sampled firms comparing before and after the announcement date [102,103,119,120]. This strategy may misjudge actual risk adjustments, as certain macro-factor variables may not have anything to do with the event being considered. ...
Information and communication technologies (ICTs) are the cornerstone for sustainable development, but if they are not appropriately managed, they will impede progress towards the United Nations Global Sustainable Development Goals. Among undesirable impacts, emphasis must be put on the risk of information security (ISec) breaches, as they pose a potential threat to businesses there. Especially for publicly traded firms, they could create a long-lasting influence on their financial performance and, thus, stock investors’ confidence. Following the efficient market hypothesis’s footsteps, previous studies have examined only the short-run impact on investors’ confidence ensuing to ISec breach announcements. Therefore, this study investigates the long-run impact of ISec breach announcements on investors’ confidence. Based on a sample of 73 ISec breach announcements during 2011–2019, this paper examines the impact on investors’ confidence, as demonstrated by long-run abnormal returns and equity risk of those firms. Using a one-to-one matched sampling approach, each firm’s performance is analyzed with its control firm over eighteen months, starting six months before the announcement, through twelve months after the announcement. Firms experienced a significant negative abnormal return of 15% to 18% during the twelve months following the breach announcement. In comparison, equity risk increased by 11% within six months before and after an announcement. This study can help investors, managers, and researchers better understand a long-term relationship between ISec breaches and investor confidence in the context of efficient market hypothesis.
... (eg. Kalay and Lewenstein,1985; Bhagat, Brickley, and Loewenstein, 1987). In addition, Barry and Brown (1985), Lowenstein (1988), Coles et al. (1995), and Clarkson and Thompson (1990) suggest that parameter estimation risk may not be diversifiable either. ...
... Park (2008) show that the correlations between two AS component model estimates, effective spreads, and quoted spreads of insurance companies are very high. 8 For further discussion, refer to Andersen et al. (2001) 9 Brown et al. (1993) and Bhagat et al. (1987 also use a daily return standard deviation change as a proxy for a risk change. Barry and Brown (1985) and Clarkson and Thompson (1990) employ the number of trading days as a proxy for the parameter estimation risk. ...
This paper investigates whether investors overreacted to the World Trade Center terrorist attack, using insurers' stock returns. Short-term abnormal return reversals are observed after the 9/11 attack. The reversals may reflect the substantially increased uncertainty surrounding insurer stocks after the event, meaning that the price reactions are efficient risk adjustments. However, after controlling for the change in risk, I still find evidence of price reversals, which I attribute to investor overreaction. To bolster this claim, I provide cross-sectional evidence that reversals are stronger for insurers with higher information asymmetry, which have wider ex-ante bid-ask spreads and smaller numbers of analysts following. This result indicates that the reversals are likely due to behavioral biases.
... They show that the payoff to the trend following strategy is related to the payoff from an investment in a lookback straddle. Glosten's and Jagannathan's (1994) argument is also supported by Bhagat et al.'s (1987) analysis of interfirm cash tender offers. Bhagat et al. argue that investing in the target company's stock after the tender offer announcement is like owning the stock plus a put option (on the target's stock). ...
... Using a sample of 361 cash tender offers between 1981 and 1995, they find that an arbitrageur who purchased the target stock one day after the acquisition announcement and sold one week later would have generated an annualized excess return between 102% and 115%. Bhagat et al. (1987) document tender period excess returns of 2.0% (18% annually, based on an average tender period of 29 days) obtained by buying the target's stock the day after the tender offer announcement and selling one day prior to the offer's expiration. ...
This paper analyzes 4,750 mergers from 1963 to 1998 to characterize the risk and return in risk arbitrage. Results indicate that risk arbitrage returns are positively correlated with market returns in severely depreciating markets but uncorrelated with market returns in flat and appreciating markets. This suggests that returns to risk arbitrage are similar to those obtained from selling uncovered index put options. Using a contingent claims analysis that controls for the nonlinear relationship with market returns, and after controlling for transaction costs, we find that risk arbitrage generates excess returns of four percent per year.
... The relationship between politics and financial market volatility has been actively explored over the years. This is because when information risk increase, expected return is also expected to increase (Kalay & Loewenstein, 1985;Bhagat et al., 1987). Therefore, information risk is an undiversifiable risk that is associated with broadcast of the event. ...
This study investigates the relationship between political connection and firm stock volatility. We examine whether stock return volatility of politically connected firms differ from non-connected firms during four events. These four events are general election, change of leadership, announcement of government budget, and announcement of policies by the government. This paper uses a volatility event study technique to calculate the abnormal stock return volatility during the four events. We use the data of public-listed firms in Malaysia from 2002 to 2013. The result shows that political connection is associated with higher stock volatility in certain events. They appear to be the most volatile in the event of general election and least volatile during budget announcement. Besides budget announcement, the other three events showed a stronger volatility as they are considered as more of a surprise announcement rather than scheduled announcement. The paper adds to a limited body of literature investigating the relationship between political connection and market behavior in Malaysia and hopes to show that political connection can impact the stock return volatility of firms during high-visibility events in Malaysia.
... Bhagat et al. [9] 295 cash tender offers between 1962 and 1980. ...
... In 2008, all sectors excluding self-storage had negative annual returns (probably because the self-storage sector has defensive stock characteristics). If one adopts a principle similar to Bhagat et al. 1987, andSorwar andSudarsanam (2010) using the differences between mean and median, spreads significantly different from zero are found in every group especially in the funding group. This evidence supports the fact assumption that funding group variables should contribute more to options values than other groups. ...
This article illustrates concurrent values emanating from mergers in the REIT industry as prior studies on REIT mergers focused only single merger outcome(s). Concurrent values are disentangled using game theory. Results illustrate in game options, there are more than one option value. Finally, option investors can use game options to design arbitrage strategies.
... In this study, M&A deals financed only through cash are priced using the Black and Scholes (1973) formula (henceforth B-S), and ones financed through combination of stocks and cash or only stocks are priced using the Margrabe (1978) (henceforth Margrabe) formula. Bhagat et al. (1987) and Antonelli et al. (2010) illustrated that only cash-financed M&A deals and only stocks-financed M&A deals are priced using B-S and Margrabe formulas respectively. In cases, where M&A deals are financed through combination of stocks and cash, it is assumed that stocks and cash are uncorrelated as amount of each variable does not influence amount of another variable. ...
This paper illustrates a derivative of a derivative (i.e. "delta") of an exchange option in the U.S. real estate investment trust (REIT) industry. So far, it seems that there is no study that derives a "delta" of an exchange option using Laplace transform. First, the "delta" illustrates that change in exchange option is "driven" by at least one variable which in turn influences the curvature of a "delta" distribution. The empirical results show that each "delta" is 0.03 on average. Lastly, it seems that REIT mergers and acquisitions (M&As) occurred both for strategic and financial reasons.
... As a preliminary analysis, we compare total volatility, systematic risk, and idiosyncratic risk before and after SWF investment. We follow Bhagat, Brickley, and Loewenstein (1987) in using a volatility "event study". ...
My dissertation focuses on examining the role that sovereign wealth funds (SWFs) play in the economy. Research in the foreign investment literature generally finds positive impacts associated with foreign investment. However, the literature generally finds a negative impact associated with government ownership. As SWFs fit partially into both groups, it is unclear what to expect a priori and the issue remains for empirical investigation. My first essay investigates the relation between sovereign wealth fund investment and target firm performance. SWF investments are associated with a reduction in the compensation of risk over the five-year term examined. Firm volatility decomposition suggests that it is mainly idiosyncratic risk that drives these impacts. Granger causality results suggest that SWFs are poorly informed in their investments (compared to the market) or they have nonfinancial motivations. There is no evidence that the media coverage precedes the poor performance. My second essay examines the role of bilateral political relations in sovereign wealth fund investment decisions. Our empirical results suggest that political relations play a role in SWF decision making. Contrary to predictions based on the FDI and political relations literature, we find that relative to nations in which they do not invest, SWFs prefer to invest in nations with which they have weaker political relations. Using a two-stage Cragg model, we find that political relations are an important factor in why SWFs invest but matter less in determining how much to invest. These results suggest that SWFs behave differently than other economic agents. Consistent with the FDI and political relations literature, we find that SWF investment has a positive (negative) impact for relatively closed (open) countries. Our results suggest that SWFs use - at least partially - non-financial motives in investment decisions.
... As a preliminary analysis, we compare total volatility, systematic risk, and idiosyncratic risk before and after SWF investment. We follow Bhagat et al. (1987) in using a volatility ''event study.' ' We examine the relationship between SWF investment and the return-to-risk performance of the target firms. For robustness, we use both the Sharpe ratio (Sharpe, 1966) and the Appraisal ratio (Brown et al., 2008) in our analysis. ...
This paper investigates the relationship between sovereign wealth fund (SWF) investment and the return-to-risk performance of target firms. Specifically, we find that target firm raw returns decline following SWF investment. Though risk also declines following SWF investment, we find that SWF investment is associated with a reduction in the compensation of risk over the five years following acquisition. Firm volatility decomposition suggests that idiosyncratic risk is what mainly drives these impacts toward decline. Employing a multinomial logit framework wherein combinations of target returns and risk movements are categorized, we see that, in cases of foreign investment, SWFs’ target firm performance most closely resembles that of other government-owned firms. The observed results are inconsistent with predictions of higher volatility and improved returns due to monitoring firm activities from the institutional investor literature. This suggests that SWFs may not provide some of the benefits that are offered by other institutional investors.
... Volatility changes are important because they can affect the underlying economics of the firm in a number of ways (see, for example, Galai and Masulis (1976), Smith and Warner (1979), Bhagat et al. (1987), Campbell et al. (2001), Meulbroek (2002), Goyal and Santa Clara (2003), Clayton et al. (2005), and Brown and Kapadia (2006)). First, an increase in volatility can increase the cost of capital that investors use to discount the future earnings of the firm. ...
... Volatility changes are important because they can affect the underlying economics of the firm in a number of ways (see, for example, Galai and Masulis (1976), Smith and Warner (1979), Bhagat et al. (1987), Campbell et al. (2001), Meulbroek (2002), Goyal and Santa Clara (2003), Clayton et al. (2005), and Brown and Kapadia (2006)). First, an increase in volatility can increase the cost of capital that investors use to discount the future earnings of the firm. ...
... The effect of closing out the short position in the acquirer is more uncertain: if the bidder stock falls, there may be an offsetting gain; and if the bidder stock appreciates, there may be additional losses. Several empirical studies suggest that merger arbitrage strategies systematically generate excess risk-adjusted returns (Bhagat and Loewenstein, 1987; Larcker and Lys, 1987; Mitchell and Pulvino, 2001; Mitchell, Pulvino, and Stafford, 2004; Jindra and Walkling, 2004, and others). The literature proposes various explanations for the existence of these returns. ...
This survey introduces a two-volume, 1,900-page reprint collection of articles recently published by Elsevier/North-Holland journals. Volume 1 begins with a comprehensive overview of the empirical evidence, followed by introductions to the econometrics of event studies and various techniques for dealing with corporate self-selection issues. It then delves into classic issues such as the nature of aggregate merger activity (merger waves), market valuation effects of merger announcements (the stock price performance of bidder and target firms), and the nature of the sources of merger gains in the context of industrial rganization (much of it involving estimating the effects of mergers on industry competitors). The volume ends with a review of restructuring transactions other than takeovers, such as divestitures, spinoffs, leveraged buyouts and other highly leveraged transactions.Volume 2 presents a series of specific deal-related topics - and provides reviews of both theory and associated empirical evidence. It begins with surveys of principles for optimal bidding in specific auction settings, followed by a review of actual takeover premiums and their determinants. It then showcases recent empirical contributions on topics such as toehold bidding and winner's curse (does overbidding exist?), bidding for distressed targets (do bankruptcy auctions cause fire-sales?), effects of deal protection devices (do termination agreements and poison pills affect takeover premiums?), large shareholder voting on takeover outcomes (does institutional activism matter?), deal financing issues (does it matter how the bidder finances any cash payment for the target), managerial compensation effects of takeovers (what's in it for the CEO), governance spillovers from cross-border mergers (are there any?) and, finally, the returns to merger arbitrage activity (market efficiency and limits to arbitrage).
... The largest abnormal returns have been documented for cash tender offers. For a sample of 295 cash tender offers from 1962 to 1980, Bhagat, Brickley and Loewenstein (1987) document an average target excess return of 2% from two days after the tender offer announcement to the day prior to the expiration of the offer (on average 29 days). Dukes, Frohlich, and Ma (1992) analyze 761 cash tender offers identified from 14D-1 filings in 1971-1985. ...
This essay surveys the recent empirical literature and adds to the evidence on takeover bids for U.S. targets, 1980-2005. The availability of machine readable transaction databases have allowed empirical tests based on unprecedented sample sizes and detail. We review both aggregate takeover activity and the takeover process itself as it evolves from the initial bid through the final contest outcome. The evidence includes determinants of strategic choices such as the takeover method (merger v. tender offer), the size of opening bids and bid jumps, the payment method, toehold acquisition, the response to target defensive tactics and regulatory intervention (antitrust), and it offers links to executive compensation. The data provides fertile grounds for tests of everything ranging from signaling theories under asymmetric information to strategic competition in product markets and to issues of agency and control. The evidence is supportive of neoclassical merger theories. For example, regulatory and technological changes, and shocks to aggregate liquidity, appear to drive out market-to-book ratios as fundamental drivers of merger waves. Despite the market boom in the second half of the 1990s, the proportion of all-stock offers in more than 13,000 merger bids did not change from the first half of the decade. While some bidders experience large losses (particularly in the years 1999 and 2000), combined value-weighted announcement-period returns to bidders and targets are significantly positive on average. Long-run post-takeover abnormal stock returns are not significantly different from zero when using a performance measure that replicates a feasible portfolio trading strategy. There are unresolved econometric issues of endogeneity and self-selection.
... Our model predicts that for targets of takeover bids that are ultimately successful, the dispersion in traders' beliefs about the value of the stock will diminish during the course of the bid, and the conditional price volatility will consequently decline. Third, previous models of target price behaviour have focussed largely on cash bids, and models of target price volatility (Bhagat, Brickley and Loewenstein (1987)) have focussed on partial bids. Our model applies more generally to targets of full bids, and it distinguishes between bids for which the method of payment is cash-only, share-exchange, and mixed bids (that is, a choice between cash and shares, or a combination of the two). ...
Using daily price and volume data on 112 of the largest takeover targets in Australia during the period from 1985 to 1993, we find that conditional price volatility declines after the takeover announcement. This decline is greatest for targets of cash bids and smallest for targets of share-exchange bids. We argue that the phenomenon is due to convergence of trader opinion regarding the value of the target stock, and reflects a change in the price formation process that has not hitherto been recognised. Our findings have implications for event studies of takeovers that inappropriately assume a time-invariant risk-return relation, and also for regulatory policies in the market for corporate control.
... Increased volatility might also imply an increase in the required return to the firm's equity. Kalay and Loewenstein (1985) and Bhagat, Brickley, and Loewenstein (1987) argue that " information risk " — undiversifiable risk associated with event-specific information announcements — may be priced by the market. When this type of risk increases, expected returns will increase. ...
This study investigates the effect on stock-price volatility of a significant event in the life of the firm, a change in its CEO. We find significant, long-lived increases in volatility following CEO turnover after controlling for firm characteristics and marketwide volatility. These increases are larger after forced departures and outside successions following voluntary departures. Stock prices also respond more strongly to earnings announcements following turnovers. These results are consistent with more informative signals of value driving the increased volatility, helping resolve two sources of uncertainty: possible changes in the firm's strategy and doubt about the successor CEO's ability.
... . As in Bhagat et al. (1987) and Kaplan and Stein (1990), we use the equity beta calculated from a market model regression to proxy for a stock's systematic risk. We find little evidence that changes in beta are systematically influencing the study results, though they do appear to add noise to our estimates. ...
We examine wealth changes for all 1283 publicly traded debt and equity securities of firms involved in 260 pure stock-for-stock mergers from 1963 to 1996. We find no evidence that conglomerate stock-for-stock mergers create financial synergies or benefit bondholders at stockholders' expense. Instead, we document significant net synergistic gains in nonconglomerate mergers and generally insignificant net gains in conglomerate mergers. Conglomerate bidding-firm stockholders lose; all other securityholders at least break even. Convertible securityholders experience the largest gains, due mostly to their attached option values. Certain bond covenants are value-enhancing while leverage increases are value-reducing.
The purpose of this paper is to address inconsistencies identified in the literature published on the subject of the impact of sovereign wealth funds (SWFs) on the market value and performance of the companies in which they invest. We provide a systematic analysis of the methodologies used in the literature with a strong emphasis on the structure and compilation of the SWF dataset and the evaluation of the data. We compare the strengths and weaknesses of the methodologies used in the seminal works published on this topic between 2007 and 2018. The results of our analysis highlight the significant risks and limitations of applying the methodological approach used in studies of large institutional investors to analysis of the impact of SWF investment on their investees.
Enduring interest in the market for corporate control stems from its importance in ensuring that assets are managed as efficiently as possible to generate output from the economy’s stock of productive resources. A plethora of empirical studies examining the efficiency of this market in many countries has provided evidence that firms subject to takeover bids experience substantial revaluation. The emphasis of this research has been on the behavior of the level of prices around the announcement of takeover offers, with very few studies examining the price volatility of target companies, and fewer still investigating what happens to trading volume around takeover announcements.
A detailed look at an important hedge fund strategy. Written by a fund manager who invests solely in merger arbitrage, also referred to as risk arbitrage, and other event-driven strategies, Merger Arbitrage is the definitive book on how this alternative hedge fund strategy works. Initial chapters are dedicated to the ins and outs of the strategy-cash mergers versus stock for stock mergers, legal aspects of mergers, and pitfalls of the merger process-while later chapters focus on giving the reader sound advice for integrating merger arbitrage into an investment portfolio. Merger Arbitrage helps readers understand leverage and options, shorting stocks, and legal aspects of merger arbitrage, including seeking appraisal or filing lawsuits for inadequate merger consideration. For those looking to gain an edge in the merger arbitrage arena, this book has everything they need to succeed. Thomas F. Kirchner, CFA (New York, NY), is the founder and portfolio manager of Pennsylvania Avenue Funds (www.pennavefunds.com), which invests in merger arbitrage and other event-driven strategies.
This chapter surveys the recent empirical literature and adds to the evidence on takeover bids for U.S. targets, 1980–2005. The availability of machine readable transaction databases have allowed empirical tests based on unprecedented sample sizes and detail. We review both aggregate takeover activity and the takeover process itself as it evolves from the initial bid through the final contest outcome. The evidence includes determinants of strategic choices such as the takeover method (merger v. tender offer), the size of opening bids and bid jumps, the payment method, toehold acquisition, the response to target defensive tactics, and regulatory intervention (antitrust), and it offers links to executive compensation. The data provides fertile grounds for tests of everything ranging from signaling theories under asymmetric information to strategic competition in product markets and to issues of agency and control. The evidence is supportive of neoclassical merger theories. For example, regulatory and technological changes, and shocks to aggregate liquidity, appear to drive out market-to-book ratios as fundamental drivers of merger waves. Despite the market boom in the second half of the 1990s, the proportion of all-stock offers in more than 13,000 merger bids did not change from the first half of the decade. While some bidders experience large losses (particularly in the years 1999 and 2000), combined value-weighted announcement-period returns to bidders and targets are significantly positive on average. Long-run post-takeover abnormal stock returns are not significantly different from zero when using a performance measure that replicates a feasible portfolio trading strategy. There are unresolved econometric issues of endogeneity and self-selection.
We test the mixture of distributions hypothesis (MDH) in which equity trading volumes and return volatilities are derived from an unobservable mixing variable, the speed of information flow to the market. Interpreting the public announcement of a takeover offer as a regime-changing firm-specific informational event, we study the daily trading volumes and price volatilities of 190 US targets from four years before the takeover announcement until the conclusion of the bid. We find strong evidence for MDH-consistent positive volume–volatility relationships before and after takeover announcements that are supportive of the applicability of the MDH in the market for corporate control.
M&A deals can be valued as growth options where aquirers offer target companies the right to sell their stocks in exchange of their stocks or a cash amount (or a combination of the two). In this paper we model the pricing of these options for M&As within the REITs industry where M&A deals happen between ‘homogeneous’ entities. We use both Black and Scholes (1973) and Margrabe (1978) models for respectively cash and exchange options. Following previous studies, we identify some REITs characterisitics (i.e. conflict of interest, market growth, funding and specialization) as potential drivers of identified growth options. Using a log-linear model we test their ability to explain prices and find that all these features show a systematic impact on option prices. The overall goodness of fit also suggest that strategic considerations may play an important role.
This paper empirically examines the possibility that there is leakage of information regarding a merger prior to the announcement of the first bid for the target firm. The tests for the existence of market anticipation are based on the behavior of variances implied in the premia of call options listed on the target firms' stocks. We conclude that the evidence is consistent with the hypothesis that the market anticipates an acquisition prior to the first announcement.
We investigate whether accusations by the popular press regarding the potential destabilizing force of sovereign wealth fund (SWF) investment have merit. SWF investments are associated with a reduction in the compensation of risk over the five-year term examined. Firm volatility decomposition suggests that it is mainly idiosyncratic risk that drives these impacts. Granger causality results suggest that SWFs are poorly informed in their investments (compared to the market) or they have nonfinancial motivations. There is no evidence that the media coverage precedes the poor performance. These findings suggest that SWF investment could be potentially destabilizing.
Mergers, acquisitions and takeovers often imply dramatic changes for employees, competitors, customers and suppliers. Not surprisingly, the market for corporate control has generated controversy and is frequently regulated by law or business custom. Though transfers of control take place in many countries, explicit and public struggles for control occur most frequently in the U.S. and U.K. During most of the 20th century, critics of mergers and acquisitions in the U.S. pointed to the danger of monopoly and increased concentration. Partly in response to the emergence of new control transactions such as the hostile takeover and leveraged buyout, more recent criticism has focused on the consequences for corporate productivity, profitability and employee welfare. Subject to qualifications, the market for corporate control reallocates productive assets ? in the form of going concerns ? to the highest bidder. In cases where the bidder uses his own money or acts on behalf of the bidding firm1s shareholders, the asset goes to the highest value use. In cases where managers of the bidding firm are able to serve their own interests rather than the interests of shareholders, the market for corporate control plays a paradoxical role. It simultaneously provides (1) a means by which managers may acquire companies using other people's money and (2) a means by which they may themselves be disciplined or displaced.
Because hedge funds tend to be market neutral, they have made it increasingly difficult for traditional portfolio managers to hide behind comparative performance matrices (such as Standard & Poor's 500 Stock Index) in times of flat or declining markets (such as 2000-2002). Of particular interest among hedge funds is the merger arbitrage hedge play. This article examines the various forms of merger arbitrage based on cash transactions and stock transactions. The important message is that by carefully assessing the likelihood and time period for consummation, appropriate returns can be earned in different types of market environments.
In takeovers bidders offer a premium to target firm shareholders but the determinants of such premium are not clearly identified. Among the factors previously examined in the literature are prior target undervaluation, expected synergy and overpayment due to behavioural biases like hubris. In this paper we use an option pricing approach to decompose the observed takeover premia. We also test the implications of recent real options-based models of takeover premia and risk changes surrounding takeovers. We model the observed target stock price as a portfolio of unobserved stock price and a put option whose value depends on a number of target and deal characteristics that impinge on the probability of bid success. For a sample of over 200 UK cash takeover bids during 1990-2004, we estimate the put value using the Black-Scholes option pricing model and find that target firm revaluation accounts for a substantial part of the observed takeover premium and the put value accounts for a smaller, but still significant, proportion. The latter is higher in hostile, failed and longer bids. The put option value is also significantly correlated with the relative riskiness of bidders and targets, and synergy as predicted by Lambrecht (2004) . Movements in betas in the run up to takeover announcements and in the post-announcement period are consistent with the real options-based predictions of Hackbarth and Morellec (2008) . This study contributes to a better understanding of the true determinants of takeover premium and demonstrates the usefulness of option pricing models and provides a preliminary test of real options models in understanding and measuring the impact of UK takeovers on firm risk and shareholder gains. Copyright (c) 2010 Blackwell Publishing Ltd.
Many firms find that they can benefit from copying orotherwise misusing the trademarks of their competitors. Firmsthat have maintained a positive brand image are likely to fightany dilution or eventual loss of their trademark by using lawsuitsagainst offending firms. These lawsuits help to staunch any lossesto the brand and leave the potential for the benefits from thetrademark to flow back to the firm. These benefits will be temperedby legal costs, potential infringement by other firms in futureand the need to file lawsuits in response. In contrast, firmsthat have infringed on a trademark are likely to lose if theowner of the trademark challenges them in court. This study relatesthe stock returns of firms to the filing of lawsuits to defendtrademarks. We study the impact of both the filing of the lawsuitand the eventual verdict of the court on the stock market valueof defendant and plaintiff firms. The protection of a trademarkby a plaintiff using a lawsuit resulted in a negative returnto the shareholders of the defendant firm that infringed on thetrademark. The returns to the plaintiff firms were mixed andof marginal magnitude due to offsetting factors although largefirms experienced positive returns.
This study investigates the information conveyed by intrafirm exchange offers. I find that leverage increases and leverage decreases convey qualitatively different information. Leverage-increasing offers appear to lower investors' assessment of risk of the firm's common stock, but do not appear to change their expectations of cash flows; leverage-decreasing offers appear to lower investors' expected cash flows, but do not appear to change their assessment of risk. The nature of changes in leverage, capital outlays, and dividends is also asymmetric. Further, I find that, for leverage-increasing offers, corporate control activity does not explain the information content or its asymmetry.
We examine analysts' earnings forecasts for a sample of takeover targets and document that the announcement-month forecasts are systematically revised upward, supporting the hypothesis that a takeover announcement conveys favorable information about the target firm. In addition, we find that abnormal forecast revisions of future stand-alone earnings are significantly greater for targets with low Tobin's q-ratios relative to targets with high q-ratios, lending further support to the information hypothesis. Finally, we provide evidence that managerial resistance to the takeover does not destroy value. Our results are in direct contrast to Pound (1988).
Almost 20% of stock-swap merger bids contain collars that affect the payment received by target shareholders. I argue that a collar bid offers two sources of value to target shareholders: the basic offer premium and the value of the implicit collar options. Hypothesizing that the market should price both sources of value implicit in a collar merger bid, I value the implicit collar options and find the market prices both the offer premium and option value equally. This suggests that market participants are cognizant of the "fine print" of merger agreements and, in particular, implies that the two offer components are substitutable.
For most companies in China, especially privately owned enterprises, going public to raise external funds is very difficult. Therefore, entering the capital market through corporate control of a publicly listed firm provides a plausible channel for private firms to raise funds externally. The decision to acquire a publicly listed company in China is often motivated by buying the "shell" (opportunity of financing through public offering) of the target, instead of operation synergy. When the largest shareholder of a publicly listed firm passes his shares on to a new owner, the newly acquired firm tends to engage in large-scale corporate restructuring. This article focuses on two of the most popular ownership-restructuring strategies utilized in China's capital market: negotiated ownership transfer and ownership transfer without payment. We also examine the performance of acquired firms after the ownership change and the effects that restructuring has upon the firm
This paper investigates the influence of target firm performance, capital structure, and ownership profile on the decision to pursue a hostile tender offer or, alternatively, a proxy contest. Empirically, firms with poorer financial performance are more likely to experience a proxy contest as opposed to a tender offer. Firms that are more highly leveraged and that tend to be management-controlled are more likely to be targets of proxy contests than of tender offers.
We model and experimentally examine the board structure-performance relationship. We examine single-tiered boards, two-tiered boards, insider-controlled boards, and outsider-controlled boards. We find that even insider-controlled boards frequently adopt institutionally preferred rather than self-interested policies. Two-tiered boards adopt institutionally preferred policies more frequently but tend to destroy value by being too conservative, frequently rejecting good projects. Outsider-controlled single-tiered boards, both when they have multiple insiders and only a single insider, adopt institutionally preferred policies most frequently. In those board designs where the efficient Nash equilibrium produces strictly higher payoffs to all agents than the coalition-proof equilibria, agents tend to select the efficient Nash equilibria. Copyright 2008, Oxford University Press.
The excess returns earned by takeover targets raises questions of efficiency in the market for corporate control. Brown and Raymond and Samuelson and Rosenthal explain the target share pricing process as a function of the probability of success of the takeover bid. We highlight weaknesses in this work, propose an alternative model, and apply it to 245 Australian takeovers from 1980 to 1993. We find, for targets of successful bids, considerable non-convergence to the bid price. This is consistent with speculative trading models whereby the reduction in dispersion of traders' beliefs leads to the evaporation of market liquidity.
Changes in variance, or volatility, over time can be modeled using the approach based on autoregressive conditional heteroscedasticity. Another approach is to model variance as an unobserved stochastic process. Although it is not easy to obtain the exact likelihood function for such stochastic variance models, they tie in closely with developments in finance theory and have certain statistical attractions. This article sets up a multivariate model, discusses its statistical treatment, and shows how it can be modified to capture common movements in volatility in a very natural way. The model is then fitted to daily observations on exchange rates.
The validity of the classic Black-Scholes option pricing formula depends on the capability of investors to follow a dynamic portfolio strategy in the stock that replicates the payoff structure to the option. The critical assumption required for such a strategy to be feasible, is that the underlying stock return dynamics can be described by a stochastic process with a continuous sample path. In this paper, an option pricing formula is derived for the more-general case when the underlying stock returns are generated by a mixture of both continuous and jump processes. The derived formula has most of the attractive features of the original Black-Scholes formula in that it does not depend on investor preferences or knowledge of the expected return on the underlying stock. Moreover, the same analysis applied to the options can be extended to the pricing of corporate liabilities.
This paper examines the pricing behavior of securities of firms which repurchase their own shares. The results are consistent with a market in which investors price securities such that expected arbitrage profits are precluded. The results are also consistent with the hypothesis that firms offer premia for their own shares mainly in order to signal positive information, and that the market uses the premium, the target fraction and the fraction of insider holdings as signals in order to price securities around the announcement date. The observation that repurchases via tender offer are followed by abnormal increases in earnings per share and that mainly small firms engage in repurchase tender offers, provides further support for the signalling hypothesis.
The long history of the theory of option pricing began in 1900 when the French mathematician Louis Bachelier deduced an option pricing formula based on the assumption that stock prices follow a Brownian motion with zero drift. Since that time, numerous researchers have contributed to the theory. The present paper begins by deducing a set of restrictions on option pricing formulas from the assumption that investors prefer more to less. These restrictions are necessary conditions for a formula to be consistent with a rational pricing theory. Attention is given to the problems created when dividends are paid on the underlying common stock and when the terms of the option contract can be changed explicitly by a change in exercise price or implicitly by a shift in the investment or capital structure policy of the firm. Since the deduced restrictions are not sufficient to uniquely determine an option pricing formula, additional assumptions are introduced to examine and extend the seminal Black-Scholes theory of option pricing. Explicit formulas for pricing both call and put options as well as for warrants and the new "down-and-out" option are derived. The effects of dividends and call provisions on the warrant price are examined. The possibilities for further extension of the theory to the pricing of corporate liabilities are discussed.
This paper examines a sample of firms experiencing proxy contests for seats on their board of directors. Dissident shareholders usually fail to obtain a majority of board seats. Nevertheless, they capture some seats, via mechanisms such as cumulative voting, in over half of the sample contests. Regardless of proxy contest outcome, positive and statistically significant share price performance is associated with the contest. That finding is predicted by the standard economic analysis of proxy contests, in which the challenges benefit shareholders by improving corporate performance. The finding runs counter to the claim of Berle (1962) that the economists' view of proxy contests is ‘a wholly imaginary picture’. A portion of the positive share price changes taking place in the early stages of some proxy contests is not permanent, however, and as suggested by Manne (1962) is at least partially attributable to temporary increases in the market value of the vote attached to corporate shares.
This paper reviews much of the scientific literature on the market for corporate control. The evidence indicates that corporate takeovers generate positive gains, that target firm shareholders benefit, and that bidding firm shareholders do not lose. The gains created by corporate takeovers do not appear to come from the creation of market power. With the exception of actions that exclude potential bidders, it is difficult to find managerial actions related to corporate control that harm shareholders. Finally, we argue the market for corporate control is best viewed as an arena in which managerial teams compete for the rights to manage corporate resources.
This paper hypothesizes that the risk per unit of time and the required rate of return are higher than normal during an event period whose timing can be predicted. Consistent with this hypothesis this paper presents empirical evidence indicating that the unconditional mean rate of return, the variance of stock returns and their systematic risk are higher than ‘usual’ during dividend announcement periods. However, the documented increases in the systematic risk are not large enough to fully explain the ‘excess returns’. This finding is puzzling and hard to reconcile with existing theory.
This paper contains a test of a new aspect of the informational content of dividend; namely, is there information in the timing of the announcements? The empirical evidence indicates that the market expects ‘bad news’ to be delivered late and that these expectations are confirmed. Mean excess returns of stock prices around late announcements are, depending on the assumed returns generating process, either significantly negative or insignificant while significantly positive around the entire population of announcements. Moreover, the proportion and magnitude of dividend reductions associated with late announcements are significantly larger than in the complete universe of announcements.
Numerous studies have analyzed the stock market reaction to information released in proxy statements. Two possible biases in proxy statement research are suggested frequently: misspecification of the return benchmark and a sample selection bias from analyzing only “clean” events. This paper presents evidence that most of the conclusions of existing studies are not affected by these potential biases. A significantly positive abnormal return was found around a random sample of shareholder meeting dates. The result indicates that interpreting event study results for announcements occurring around annual shareholder meetings must be conducted carefully. The results are consistent with the findings of Kalay and Loewenstein [14], who argue that risk and expected return can increase around predictable, information-producing events. Alternatively, the study can be viewed as being consistent with several recent studies that find anomalous results, using daily return data and large samples.
We propose a simple model of equilibrium asset pricing in which there are differences in the amounts of information available for developing inferences about the returns parameters of alternative securities. In contrast with earlier work, we show that parameter uncertainty, or estimation risk, can have an effect upon market equilibrium. Under reasonable conditions, securities for which there is relatively little information are shown to have relatively higher systematic risk when that risk is properly measured, ceteris paribus. The initially very limited model is shown to be robust with respect to relaxation of a number of its principal assumptions. We provide theoretical support for the empirical examination of at least three proxies for relative information: period of listing, number of security returns observations available, and divergence of analyst opinion.
This study documents substantial gains accuring to shareholders of discounted closed-end investment companies when these funds are reorganized to allow shareholders to obtain the market value of the fund's assets. The findings indicate that the discounts on closedend funds are real, i.e., they are not the sole result of inaccurate reporting of the fund's net asset value. The study also documents significant abnormal returns after the announcement of management-sponsored proposals to reorganize. This finding is inconsistent with the joint hypothesis of market efficiency and that the market model (as estimated) is the correct return bench mark for funds undertaking reorganization.
This paper provides empirical estimates of the stock market reaction to tender offers, both successful and unsuccessful. The impact of the tender offer on the returns to stockholders of both bidding and target firms is examined. The evidence indicates that for the twelve months prior to the tender offer stockholders of bidding firms earn significant positive abnormal returns. In the month of the offer, only successful bidders earn significant positive abnormal returns. Stockholders of both successful and unsuccessful targe firms earn large positive abnormal returns from tender offers, and most of these returns occur in the month of the offer. For all classes of firms, there is no significant post-offer market reaction. The market reaction to ‘clean-up’ tender offers is also estimated and target stockholders again earn significant positive abnormal returns.
This paper examines the structure of option valuation problems and develops a new technique for their solution. It also introduces several jump and diffusion processes which have not been used in previous models. The technique is applied to these processes to find explicit option valuation formulas, and solutions to some previously unsolved problems involving the pricing of securities with payouts and potential bankruptcy.
In this paper we examine the ex-dividend day returns of several taxable and non-taxable distributions. The ex-dividend day returns for the taxable common stocks are consistent with the hypothesis that dividends are taxed more heavily than capital gains. However, the ex-dividend day returns of preferred stocks suggest that preferred dividends are taxed at a lower rate than capital gains; non-taxable stock dividends and splits are priced on ex-dividend days as if they are fully taxable; and non-taxable cash distributions are priced as if investors receive a tax rebate with them. We also find that each of these distributions exhibits abnormal return behavior for several days surrounding the ex-dividend day. We investigate several possible explanations for this anomaly, but none is capable of explaining the phenomenon.
In this paper a combined capital asset pricing model and option pricing model is considered and then applied to the derivation of equity's value and its systematic risk. In the first section we develop the two models and present some newly found properties of the option pricing model. The second section is concerned with the effects of these properties on the securityholders of firms with less than perfect ‘me first’ rules. We show how unanticipated changes in firm capital and asset structures can differentially affect the firm's debt and equity. In the final section of the paper we consider a number of theoretical and empirical implications of the joint model. These include investment policy as well as the causes and effects of non-stationarity in the systematic risk of levered equity and risky debt.
If options are correctly priced in the market, it should not be possible to make sure profits by creating portfolios of long and short positions in options and their underlying stocks. Using this principle, a theoretical valuation formula for options is derived. Since almost all corporate liabilities can be viewed as combinations of options, the formula and the analysis that led to it are also applicable to corporate liabilities such as common stock, corporate bonds, and warrants. In particular, the formula can be used to derive the discount that should be applied to a corporate bond because of the possibility of default.
Public tender offers for control are often resisted by the target's top management. This recalcitrance takes many forms, from newspaper advertisements urging shareholder rejection to more costly legal actions. This paper focuses on litigious target managements, since these serious defensive effects usually delay considerably the execution of the defendant's tender offer. In some cases the litigious defense forces the sole bidder to withdraw the premium offer, imposing large losses on shareholders. These losses cause many to question whether strenuous legal defense by target management is consistent with their legal duty to maximize shareholder wealth.
Using the option pricing methods developed by Black and Scholes as a general technique for contingent claims analysis, this paper examines a class of mutual funds known as Dual Purpose Funds. By constructing a simplified model for these funds under the ‘perfect hedge’ conditions of Black and Scholes, it is demonstrated that the asset value of the fund will always exceed the market value and that it is not inconsistent with market equilibrium or efficiency for the capital shares to sell at a discount. The simple model predicts price fluctuations in the seven dual funds studied quite well; however, there is a persistent downward bias in the predicted price level. Finally, refinements to the model are examined to determine the nature of the misspecification causing this bias.
This paper calculates indices of central bank autonomy (CBA) for 163 central banks as of end-2003, and comparable indices for a subgroup of 68 central banks as of the end of the 1980s. The results confirm strong improvements in both economic and political CBA over the past couple of decades, although more progress is needed to boost political autonomy of the central banks in emerging market and developing countries. Our analysis confirms that greater CBA has on average helped to maintain low inflation levels. The paper identifies four broad principles of CBA that have been shared by the majority of countries. Significant differences exist in the area of banking supervision where many central banks have retained a key role. Finally, we discuss the sequencing of reforms to separate the conduct of monetary and fiscal policies. IMF Staff Papers (2009) 56, 263–296. doi:10.1057/imfsp.2008.25; published online 23 September 2008
We examine a model of market equilibrium in which there is less information available about some of the securities in the market than about others. We consider the model as a potential explanation of the well-known small firm anomaly. Using period of listing as a proxy for quantity of information, we find an association between period of listing and security returns that cannot be accounted for by firm size and which is not diminished by an elimination of January returns data from our sample. Thus, we observe a new empirical regularity in the data and refer to the regularity as the ‘period of listing’ effect.
This paper reviews much of the scientific literature on the market for corporate control. The evidence indicates that corporate takeovers generate positive gains, that target firm shareholders benefit, and that bidding firm shareholders do not lose. The gains created by corporate takeovers do not appear to come from the creation of market power. With the exception of actions that exclude potential bidders, it is difficult to find managerial actions related to corporate control that harm shareholders. Finally, we argue the market for corporate control is best viewed as an arena in which managerial teams compete for the rights to manage corporate resources.
This paper investigates the rationale behind interfirm tender offers by examining the returns realized by the stockholders of firms that were the targets of unsuccessful tender offers and firms that have made unsuccessful offers. Our results suggest that the permanent positive revaluation of the unsuccessful target shares [documented by Dodd and Ruback (1977) and Bradley (1980)] is due primarily to the emergence of and/or the anticipation of another bid that would ultimately result in the transfer of control of the target resources. We also find that the rejection of a tender offer has differential effects on the share prices of the unsuccessful bidding firms depending upon whether the tender offer process results in a change in the control of target resources. On the basis of these results we conclude that acquisitions via tender offers are attempts by bidding firms to exploit potential synergies, not simply superior information regarding the ‘true’ value of the target resources.
Past studies have documented an ex‐dividend day price drop which is less than the dividend per share and positively correlated with the corresponding dividend yield. In contrast to prior work, we show that, without additional information, the marginal tax rates cannot be inferred from this phenomenon which is, therefore, not necessarily the result of a tax induced clientele effect. Despite adjustments for potential biases in earlier work, however, the correlation between the ex‐dividend relative price drop and the dividend yield is still positive which is consistent with a tax effect and a tax induced clientele effect.