Learning About Target Firms and Pricing of Acquisitions

Abstract

More information about a firm should lead to a more precise valuation. As more publicly available information accumulates after a firm’s initial public offering (IPO), valuations should become both easier to carry out and more precise. We examine how this declining valuation uncertainty affects the pricing in acquisitions with targets that are acquired within ten years of their IPOs. These effects of evolving firm characteristics on acquisition pricing are poorly understood, have received limited attention in the literature, and yet, they offer new, and substantively different, explanations for results that are well-established in the literature, such as the target listing effect. In our sample, we first establish that individual firms’ valuation uncertainty declines over time after their IPOs. We then show that acquirer announcement returns decrease and takeover premiums increase with the length of time since the targets’ IPOs. When target valuation uncertainty is high, learning about a target should be more costly, but also more important. An acquirer with more information about the target, and a correspondingly more precise valuation of the target, has a competitive advantage compared to less-informed potential acquirers. Such a competitive bidding advantage can reduce competition for the target, allowing the best-informed acquirer to take over the target at a price that is advantageous to the acquirer. As more information about a potential target becomes available over time, the target valuation uncertainty declines, and potential acquirers find it easier to learn about the target. With more competition from potential acquirers, the acquisition price becomes less advantageous to the acquirer, leading to the empirical results we observe. Our study demonstrates how asymmetric information that is resolved slowly over an extended period of time after a target’s IPO plays an important role in acquisition pricing.

Keywords: Mergers and acquisitions, learning, valuation uncertainty, target listing status

JEL Classification: G24, G34