A New Misvaluation Perspective on Why Cash Is King in M&As
37 Pages Posted: 7 Mar 2007 Last revised: 27 Nov 2017
Date Written: 2007
We propose and test a new misvaluation approach to mergers and acquisitions (M&As) using a sample of 302 UK bidders and targets 1986-2002. Our model assumes that managers have insider information on book values while investors only have publicly available information. We find that bidders are overvalued relative to targets. Strikingly, bidders in cash mergers appear more overvalued to managers than do bidders in stock mergers in direct opposition to what is predicted by misvaluation theories. Since mergers directly benefit both bidder and target managers, they mutually agree on cash payment to ensure a friendly deal and thus maximize its chances of success by placating the target investors. This explains the puzzle of why bidders pay cash instead of their overvalued stock to finance the majority of UK M&As.
Keywords: Market-to-book, means of payment, manager-perceived misvaluation
JEL Classification: G14, G34
Suggested Citation: Suggested Citation