Overinvestment and Stock Price Crashes: Evidence from Mergers and Acquisitions

51 Pages Posted: 23 Mar 2021 Last revised: 11 Aug 2022

See all articles by Panayiotis C. Andreou

Panayiotis C. Andreou

Cyprus University of Technology

Konstantinos Bozos

Leeds University Business School

Evridiki Panayi

University of Leeds - Faculty of Business

Date Written: August 9, 2022

Abstract

Stock price crashes are commonly attributed to managerial bad news hoarding practices, whilst the vast literature relies on financial reporting opacity as the predominant channel to explain them. However, the overinvestment channel, another prominent agency-based explanation, remains largely unexplored. In this paper, we synthesize a framework whereby a firm’s mergers and acquisitions (M&A) activity is utilized to proxy for its overinvestment behavior. Accordingly, using a sample of 8,023 completed US M&A deals over 68,186 firm-year observations during 1990-2018, we document a strong positive relation between M&A activity and future stock price crashes. This relation is robust to the inclusion of a large array of control variables, alternative measures of the key variables, and a battery of procedures to mitigate endogeneity concerns. The phenomenon appears to be driven by deals which are received with market disapproval around the announcement date. Notably, stock price crashes occurring through the overinvestment channel have significant consequences on the firms’ future operating profitability, as they are followed by an average decline in return on assets of up to 1.7%.

Keywords: stock price crash risk, overinvestment, bad news hoarding, mergers and acquisitions, crash risk channels, agency theory

JEL Classification: G12, G14, G34

Suggested Citation

Andreou, Panayiotis C. and Bozos, Konstantinos and Panayi, Evridiki, Overinvestment and Stock Price Crashes: Evidence from Mergers and Acquisitions (August 9, 2022). Available at SSRN: https://ssrn.com/abstract=3809872 or http://dx.doi.org/10.2139/ssrn.3809872

Panayiotis C. Andreou (Contact Author)

Cyprus University of Technology ( email )

School Of Management and Economics
P.O. Box 50329
Lemesos, 3036
Cyprus

HOME PAGE: http://www.pandreou.com

Konstantinos Bozos

Leeds University Business School ( email )

Leeds LS2 9JT
United Kingdom

Evridiki Panayi

University of Leeds - Faculty of Business

Leeds LS2 9JT
United Kingdom

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