Week 2 - Mergers and Acquisitions

Question 1

What does the Behaviroual corporate finance focus on?

Answer 1

focuses on the beliefs and preferences of these two sets of agents.

Question 2

What are the two apporaches to Behavioural corporate finance?

Answer 2

Some investors are less than fully rational. (Markets are inefficient, but managers are rational)
Managers can be less than fully rational. (The market is efficient, but managers are irrational. (biased))

Question 3

What is the apporach of irrational investors?

Answer 3

• Limits to arbitrage - prices can differ from fundamental values.
• Investors can influence security prices.
• Rational managers can identify mispricings and try to exploit them.
• Superior information.
• Fewer constraints than money managers.
• Experience, knowledge, and ability to manufacture information advantage.
• Managers balance between three objectives:
• Maximizing fundamental value.
• Catering to irrational short-term investor demands. Exploiting the mispricing by market timing.

Question 4

What are the buidling elements of the approach of irrational managers?

Answer 4

Rational investors (efficient markets).
Main managers biases: optimism and overconfidence.

Question 5

What are some of the application of Behavioural corporate finance?

Answer 5

Investment policy:
- Real investments.
- Mergers and acquisitions.
Financial policy:
- Equity issues (IPOs, SEOs). - Share repurchases.
- Debt issues.
Other corporate decisions:
- Earnings management.
- Firm names

Question 6

What are the problems with the two approaches to Behavioural corporate finance?

Answer 6

• The two approaches give opposite normative implications:
  -Irrational investors approach recommends isolating managers from short-term share price pressures.
  -Irrational managers approach recommends reducing discretion and obligating managers to respond to market price signals.

Question 7

What are the building elements of the Hubris hypothesis?

Answer 7

1. Why are there so many acquisitions, when there is little evidence that they create value for the acquirer, on average?
2. Rational investors and efficient markets.
3. Irrational managers approach:
   - Overconfidence and illusion of control.
   - Takeover is an individual decision.
   - Inexperience: average managers make only a few takeover decisions.

Question 8

What are the Hubris explanations for the M&A activity?

Answer 8

M&A decision is based on a valuation of an asset that has an already observable market price.
The valuation can be considered as random variable.
Offer is made when the valuation (random variable) exceeds the market price.
The takeover premium is a random error and that represent a transfer form acquirer shareholders to target shareholders.
The combined value of the target and bidder firms falls slightly due to wasted resources on unproductive activity.

Question 9

What are the results of Malmendier and Tate (2008): Test of hubris hypothesis?

Answer 9

Optimistic CEOs complete more mergers, especially diversifying mergers.
Optimism has its biggest effect among the least equity dependent firms.
Investors are more skeptical about offers made by optimistic CEOs.