Mistaking Bad News for Good News? M&A Optimism and Mispricing of Strategic Alternatives Announcements
65 Pages Posted: 11 Jan 2023 Last revised: 6 Dec 2023
Date Written: December 5, 2023
An announcement that a company is evaluating strategic alternatives is one of the most disruptive corporate events, since the company is calling into question its future existence. This event also results in one of the most severe cases of stock mispricing. We seek to understand why mispricing occurs. Our empirical findings are consistent with the availability heuristic (Tversky and Kahneman, 1973)—a behavioral bias—causing investors to overweight a potential merger or acquisition and not fully incorporate the negative fundamental news conveyed. In addition, in an experiment, we activate the availability heuristic in treated subjects and observe them making relatively optimistic assessments of the corporate announcements. We also find, empirically, that sophisticated investors appear aware of the mispricing. Finally, we evaluate risk, market frictions, and interactions with extant anomalies. This study is important because it sheds light on one of the most severe cases of mispricing (-10% future six-month returns), challenges the conventional wisdom held by market participants that SA announcements reflect good news, and informs investors and analysts about a behavioral heuristic they might unknowingly adopt.
Keywords: Asset Pricing; Stock Returns; Corporate Announcements; Market Efficiency; Mergers and Acquisitions; Behavioral Finance; Bounded Rationality; Corporate Disclosure
JEL Classification: G12, G14, G34, G41, M41
Suggested Citation: Suggested Citation