Abnormal Returns and Expected Managerial Performance of Target Firms

Abstract

We document a negative association between the market valuation of a target firm around the announcement date and the target firm's future performance predicted by Value Line. This result is robust after controlling for possible simultaneous equation bias. We provide evidence of a systematic decline in target firms' operating performance over the five-year period prior to the takeover. It seems that the capital market is willing to pay a higher price for target firms that performed poorly in the past and are expected to perform even worse in the future. We also show that the greater the decline the future operating performance, as predicted by Value Line, the more likely that the firm will become a takeover target. We hypothesize that disciplining a poorly performing target firm through takeovers is a possible explanation for the above results.

Note: Previously titled Accounting Information and Market Valuation of Target Firms

JEL Classification: D46