Cosmetic Mergers: The Effect of Style Investing on the Market for Corporate Control

Abstract

We study the impact of "style investing" on the market for corporate control. We argue that a firm may boost its market value by merging with a firm that belongs to an investment style that is more popular with the market. By using data on the flows in mutual funds, we construct a measure of popularity, which relies directly on the identification of sentiment-induced investor demand, rather than being a direct transformation of stock market data. We show that differences in popularity between bidder and target help to explain their pairing. The merger with a more popular target generates a halo effect from the target to the bidder that induces the market to evaluate the assets of the less popular bidder at the (inflated) market value of the more popular target. Both bidder and target premia are positively related to the difference in popularity between the target and the bidder. However, the target's ability to appropriate the gain is reduced by the fact that its bargaining position is weaker when the bidder's potential for asset appreciation is higher. We document a better short and medium-term performance of less popular firms taking over more popular firms. The bidder managers engaging in these cosmetic mergers take advantage of the window of opportunity induced by the deal to reduce their stake in the firm under convenient conditions.

Keywords: mergers and acquisitions, popularity, style investing, short-termism, mutual funds, dumb money

JEL Classification: G34, G23, G32