Acquirer Overvaluation and Stock Payment in M&A Transactions: What Explains the Spurious Correlation?

Abstract

The widely cited empirical relation between equity misvaluation and the choice of merger currency has been recently called into question in a substantive manner. How can it be that the academic community was misled by this spurious correlation for more than a decade? We investigate this question and show that, most likely, failing to account for the abolishment of pooling in 2001 is the culprit. We start by arguing that pooling was the accounting method of choice for highly-valued acquirers, and that failing to control for this regulatory incentive (and the eventual disappearance of that incentive) leads to invalid inference. We finally confirm these arguments with new empirical results: (i) the relation between acquirer valuation and the choice of mode of payment disappears in analysis of U.S. mergers with fresh data that post-date 2001; (ii) this relation also fails in examination of data from Europe and Australia, environments where pooling was either not allowed or almost never used; (iii) this relation is absent even in analyses of pre-2001 subsamples of U.S. mergers that did not use pooling. We conclude that the abolishment of pooling played the role of an endogenous omitted variable, leading to the erroneous interpretation of empirical evidence.

Keywords: Mergers and acquisitions; Mode of payment; Pooling of interest; Valuation

JEL Classification: G34