Are Market Reactions to M&As Biased by Overextrapolation of Salient News?

Abstract

We study earnings surprises involving firms in a takeover target’s 1-digit SIC released hours before the M&A public announcement. We find that these surprises correlate with the acquirers’ M&A announcement return, but not with the returns to 4-digit SIC matched bidder and target peer firms. A week after the M&A announcement, acquirers exhibit a stock price reversal and their response to the earnings surprises disappears. We cannot reconcile these findings with rational Bayesian updating, information transmission, or strategic timing theories. The evidence that salient events affect investors’ M&A valuations, supports behavioral theories predicting asset pricing distortions due to cognitive biases.

Keywords: Salience; Over-extrapolation, Behavioral bias, Mergers and acquisitions; Mispricing; Earnings surprises

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