Downside Risk Similarity and M&As

59 Pages Posted: 8 Apr 2022 Last revised: 2 Sep 2022

See all articles by Lei Chen

Lei Chen

Southwestern University of Finance and Economics (SWUFE)

Allen H. Huang

Hong Kong University of Science and Technology - Department of Accounting

Xinlu Wang

School of Management, Jinan University

Liang Xu

SKEMA Business School

Date Written: March 30, 2022

Abstract

This paper examines the role of downside risk similarity between acquirers and targets in M&As. We introduce a measure of downside risk similarity between two firms based on the degree of overlap between their risk factor descriptions. In validity tests, we show that the measure is distinct from the existing similarity measures, can predict the co-occurrence of extremely negative returns of firm pairs, and is negatively associated with acquirers’ change in risk factors during M&As. In the main analyses, we document that the market reacts more positively to deals when merger pairs have more similar downside risks after controlling for similarity measures from the literature. Cross-sectional tests show the effect to be driven primarily by deals in which acquirers have a weaker risk management capacity or face greater uncertainty about targets. We find corroborating evidence using alternative measures of deal quality, including deal-specific goodwill impairment and combined firms’ profitability. Finally, we show that downside risk similarity also influences the M&A process, including the target selection, due diligence, deal completion likelihood, and payment method.

Keywords: Downside risks; M&A quality; risk management; information asymmetry; risk factor descriptions; textual analysis

JEL Classification: G34, M40

Suggested Citation

Chen, Lei and Huang, Allen H. and Wang, Xinlu and Xu, Liang, Downside Risk Similarity and M&As (March 30, 2022). Available at SSRN: https://ssrn.com/abstract=4070162 or http://dx.doi.org/10.2139/ssrn.4070162

Lei Chen

Southwestern University of Finance and Economics (SWUFE) ( email )

55 Guanghuacun St,
Chengdu, Sichuan 610074
China

Allen H. Huang (Contact Author)

Hong Kong University of Science and Technology - Department of Accounting ( email )

LSK Business School Building
HKUST
Clear Water Bay, Kowloon
Hong Kong

HOME PAGE: http://www.AllenHuang.org

Xinlu Wang

School of Management, Jinan University ( email )

No. 601, West Huangpu Road
Guangzhou, Guangdong 510632
China

Liang Xu

SKEMA Business School ( email )

Lille
France

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