Week 2 - Baker, Pan and Wurgler (2012)

Question 1

What are the main ideas and research questions of this paper?

Answer 1

• Do stock price peaks of targets affect M&A activity? The authors try to find out whether offer prices are biased towards recent peak prices.
• Offer’s probability of acceptance jumps when it exceeds a peak price. Conversely, bidder shareholders react negatively when the offer price is influenced upward toward a peak.
• Merger waves occur when high returns are present on the market and likely targets make it easier for bidders to offer a peak price.
• Parties thus appear to use recent peaks as reference points (anchors) to simplify the complex task of valuation.
• The main research questions are: (1) Is there an anchoring bias in the M&A offer prices; (2) Does the anchoring bias influence the probability of deal success; (3) Does it influence bidder’s announcement returns; (4) What is the relation between anchoring in offer prices and merger waves?

Question 2

What does the anchoring means in this paper?

Answer 2

Anchoring in this setting means that the 52-weeks highest price serves as a reasonable
aspiration level to serve as a common anchor for multiple investors that are not fully rational.
However, this price is not relevant, as prices today should incorporate all publicly available
past information.

Question 3

Why recent price peaks will serve as an anchor in M&A transactions according to the paper?

Answer 3

1. Target’s perspective:
   - Bounded rational investors can consult recent peak prices when considering an offer due to constrained resources (time, information, knowledge).
   -Use recent price peaks to improve negotiating position.
   -For the management recent price peaks can serve as a litigation protection.
2. Bidder’s perspective:
   -Constrained bidders will use it as a valuation input.
   -Use recent price peaks to justify offer price to own shareholders.
   -Consider the probability of offer acceptance.

Question 4

What are the shareholders of bidder company reaction to announcement returns?

Answer 4

Bidders shareholders react more negatively to increases in offer premium.
Bidders shareholders react even stronger if the offer price depends on the price peak anchors: if the component of offer premium driven by 52-week high increases by 10%, the bidders announcement return is 2.45% lower.
Overpayment amount: between $24.0 and $140.9 million per deal.

Question 4

What is the summary of this paper?

Answer 4

• Recent peak prices of the target can serve as an anchor when determining the offer price in
  M&A deals.
• Anchoring the offer price on the recent peaks increased the probability of reaching a
  successful deal.
• Distribution of capital across investment opportunities