The Real Effects of Trend-Seeking and Extrapolation: Evidence from M&As

Abstract

We study earnings surprises by firms in a takeover target’s 1-digit SIC released hours before M&A announcements. These surprises correlate with the acquirers’ M&A announcement return. Consistent with the effect of behavioral biases, one week after the M&A announcement, acquirers’ response to the earnings surprises disappears. While the acquirers’ stock misvaluation is transitory, other effects to the M&A process are permanent. Larger earnings surprises are related to increases in bid competition, in takeover premiums, and in withdrawn M&As. These results, which withstand numerous robustness tests, indicate that behavioral biases, characterized by trend-seeking and extrapolation, generate material distortions in some M&A transactions.

Keywords: Mergers and acquisitions; Earnings surprises; Trend-seeking; extrapolation

JEL Classification: D03; G02; G14; G34; M41