Behavioral Finance Spotlight: January 2013

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Prior stock price peaks of targets affect several aspects of merger and acquisition activity. Offer prices are biased toward recent peak prices although they are economically unremarkable. An offer’s probability of acceptance jumps discontinuously when it exceeds a peak price. Conversely, bidder shareholders react more negatively as the offer price is influenced upward toward a peak. Merger waves occur when high returns on the market and likely targets make it easier for bidders to offer a peak price. Parties thus appear to use recent peaks as reference points or anchors to simplify the complex tasks of valuation and negotiation.

Empiritrage Comments:

  • Investors involved in merger arbitrage should be aware of the previous 52-week high, as bids above this peak are more likely to be completed.
  • Appears that valuation may be driven by 52-week highs, as opposed to more complicated methods of valuing a firm.
  • Risk arbitrage desks can use this factor to increase their odds of success.

Team Mission: To empower investors through education.