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

Abstract

We study earnings surprises involving 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, a week after the M&A announcement, acquirers' response to the earnings surprises disappears. While the acquirers' stock misvaluation is transitory, other effects are not. We also show that larger earnings surprises are related to increased bid competition, to higher premiums received by target shareholders, and to more withdrawn M&As. These results indicate that behavioral biases, characterized by trend-seeking and extrapolation, create material distortions in some M&A transactions.

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

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