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Takeovers and the Cross-Section of Returns


Martijn Cremers


University of Notre Dame

Vinay B. Nair


University of Pennsylvania - Finance Department

Kose John


New York University (NYU) - Department of Finance

August 2007

Yale ICF Working Paper No. 07-13

Abstract:     
This paper considers the impact of takeover (or acquisition) likelihood on firm valuation. If firms are more likely to acquire during times when they have free cash and/or when the required rate of return is low, takeover targets become more sensitive to shocks to aggregate cash flows and/or to the price of risk. Thus, ceteris paribus, firms that are exposed to takeovers will have a different rate of return from firms that are protected from takeovers. Using estimates of the likelihood that a firm will be acquired, we create a takeover-spread portfolio that buys firms with a high likelihood of being acquired and shorts firms with low likelihood of being acquired. Relative to the Fama-French model, the takeover-spread portfolio generates annualized abnormal returns of up to 12% between 1980 and 2004. Further, the takeover-spread portfolio is shown to be important in explaining cross-sectional differences in equity returns. Additionally, using a two-beta model that distinguishes cash flow shocks from discount rate shocks, we show that firms more likely to be taken over have higher betas on the aggregate cash factor. Finally, we provide an explanation for the existence of abnormal returns associated with governancespread portfolios (Gompers, Ishii and Metrick, 2003 and Cremers and Nair, 2005), and relate the takeover-spread portfolio returns to takeover activity in the economy.

Number of Pages in PDF File: 50

Keywords: Governance, equity prices, risk, time-varying risk premia, takeovers

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Date posted: February 7, 2005  

Suggested Citation

Cremers, Martijn and Nair, Vinay B. and John, Kose, Takeovers and the Cross-Section of Returns (August 2007). Yale ICF Working Paper No. 07-13. Available at SSRN: http://ssrn.com/abstract=690185 or http://dx.doi.org/10.2139/ssrn.690185

Contact Information

K. J. Martijn Cremers
University of Notre Dame ( email )
P.O. Box 399
Notre Dame, IN 46556-0399
United States
Vinay B. Nair (Contact Author)
University of Pennsylvania - Finance Department ( email )
The Wharton School
3620 Locust Walk
Philadelphia, PA 19104
United States
215-746-0004 (Phone)
215-898-6200 (Fax)
Kose John
New York University (NYU) - Department of Finance ( email )
Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States
212-998-0337 (Phone)
212-995-4233 (Fax)
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