Takeover Activity and Target Valuations: Feedback Loops in Financial Markets

Abstract

Asset prices both affect and reflect real decisions. This paper provides evidence of this two-way relationship in the takeover market. We find that a firm’s discount to its potential value significantly attracts takeovers (the “trigger effect”) –but market expectations of an acquisition cause the discount to shrink (the “anticipation effect”). By controlling for the simultaneous anticipation effect, we document a markedly stronger trigger effect from prices to takeover probabilities than prior literature – an inter-quartile change in the discount leads to a 4 percentage point increase in acquisition likelihood (compared to a 6 % unconditional takeover probability). This implies that financial markets may discipline managerial agency by triggering takeover threats, but the anticipation effect reduces the effectiveness of this process.

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