Winner’s Curse in Takeovers? Evidence from Investment Bank Valuation Disagreement

Abstract

Existing literature debates the existence of the winner’s curse in mergers and acquisitions, a phenomenon in which the winning bidder fails to account for the uncertainty about the target value and thus overpays for the acquisition. Using a unique setting where target firms hire multiple investment banks as advisors, we construct a novel measure of target valuation uncertainty based on the disagreement of investment banks on target valuation. We find that in the presence of high valuation disagreement, bidders on average pay significantly higher acquisition premiums, and bidders who pay higher premiums have lower returns around merger announcements and in the long run. These bidders also create lower merger synergies. Our results are robust to the control for selection bias using Heckman two-stage model with an exclusion restriction. Moreover, the winner’s curse is more pronounced when bidders have overconfident CEOs. Overall, our findings suggest that the winner’s curse does exist in takeovers and causes distortions in resource allocation.

Keywords: Mergers and acquisitions, winner’s curse, valuation disagreement, acquisition premiums, bidder returns, merger synergies, CEO overconfidence

JEL Classification: G41; G14; G34