CAPM-BASED COMPANY (MIS)VALUATIONS Flashcards
What is the primary discrepancy discussed regarding the CAPM model?
The average realized returns of low beta securities are higher and those of high beta securities lower than what the CAPM predicts, leading to misvaluations.
How do managers using CAPM for capital budgeting decisions differ in their willingness to undertake low beta projects compared to the market?
Managers using CAPM are willing to undertake low beta projects at prices the market deems too high, leading to less favorable stock market reactions to low beta investments.
What is Cumulative Abnormal Return (CAR) and how does it relate to the bidder’s reaction to target betas?
CAR is the realized return minus the expected return, and the bidder’s reaction to target betas is reflected in the stock market reaction around bid announcements, with low beta targets causing smaller bidder’s CAR.
How do the authors explain the difference in stock market reactions to low beta and high beta targets?
Low beta targets cause smaller bidder’s CAR because CAPM misvaluation leads to overpayment, while high beta targets lead to more favorable reactions due to undervaluation by the market.
How do private and public targets differ in their negotiations with bidders according to the study?
Public targets have better outside options during negotiations, as their owners can choose between accepting the bid, keeping the shares, or selling shares in the stock market, influencing the relation between target’s beta and takeover price.
Why are public targets less likely to receive takeover bids as their beta increases?
Public firms’ probability of receiving a takeover bid decreases as beta increases because the CAPM-implied equity value decreases with beta, while market capitalization is less sensitive to beta.
What broader implication do the findings have regarding high-beta firms and equity issuance?
High-beta firms are more likely to issue equity and less likely to repurchase shares, even in the absence of M&A activity, consistent with the findings of the study.
