Anchoring & Acquisitions Qingzhong Ma, CSU, Chico, CA David A. Whidbee, WSU, Pullman, WA Wei Athena Zhang, CSU, Chico, CA AFA, Chicago, January 6, 2017 Anchoring and Acquisitions Ma, Whidbee, Zhang

Our Research Question When evaluating firms making acquisitions, are investors influenced by the anchoring bias? At the announcement Tendency to anchor on recent peak prices Anchoring and Acquisitions Ma, Whidbee, Zhang

The M&A Literature M&A: significant corporate event Fundamental factors in market response Free cash flows (Jensen, 1986; Harford, 1999) Size (Moeller et al., 2004) Target uncertainty (Officer et al., 2009) Management entrenchment (Harford et al., 2012) Valuation levels (Shleifer & Vishny, 2003; Dong et al., 2006; RKRV, 2005; Akbulut, 2013; Fu, Lin, Officer, 2013; Duchin and Schmidt, 2013) Management overconfidence (Malmendier & Tate, 2008) And many others Anchoring and Acquisitions Ma, Whidbee, Zhang

Work on Non-Fundamental Factors Investor sentiment (Facebook status update) influencing perceived synergies (Danbolt, Siganos, & Vagenas-Nanos, 2015) The role of target peak prices on offer prices (Baker, Pan, & Wurgler, 2012) Anchoring and Acquisitions Ma, Whidbee, Zhang

We Focus on Acquirers Question: Do past peak prices factor in the evaluation of acquirers at announcement? Anchoring bias “… most reliable and robust” (Kahneman, 2011) Widely applied in the finance literature Anchoring phenomenon When estimating the value of an uncertain amount, subjects are influenced by salient reference points. (Tversky & Kahneman, 1974) E.g., list prices in housing markets and new car markets Anchoring and Acquisitions Ma, Whidbee, Zhang

Our Predictions Low price/52-week peak  higher acquirer returns Being far from the 52-week high => estimates of merged firm stock prices may lean toward the plausible value reflected in the 52-week high Being near the 52-week high => estimates of merged firm stock prices may be limited as there is no recently observed higher plausible value More pronounced for greater uncertainty, poorer info environment, less investor sophistication Long term reversal Anchoring and Acquisitions Ma, Whidbee, Zhang

Main Findings Lower Pt–6/H  higher acq. returns (Reference Price Effect) Univariate, regressions with a host of controls, estimated on a variety of subsamples Lasts for at least 20 days The effect is not explained by valuation levels Exists even for cash-only deals The effect is stronger in deals involving greater uncertainty (volatility, #analysts, relative size, non-cash payment) more opaque information environments (target listing status) less sophisticated investors (individual investor ownership) The effect reverses over the longer horizon (1 year), consistent with a behavioral bias Anchoring and Acquisitions Ma, Whidbee, Zhang

Sample /Data 19,119 M&A deals from SDC, 1981-2014 U.S. acquirers covered in CRSP & Compustat Targets public & private Trivial deals excluded (deal value < $1mil; relative size < 5%) Percent own < 50% before deal Other common filters (e.g., relative size < 200%) Anchoring and Acquisitions Ma, Whidbee, Zhang

Key Variables (CAR & RPR) CAR: Cumulative Abnormal Returns [–5, +1] Market model, estimated [–370, –253] Harford (1999) RPR: Pt – 6 / H Pt – 6 Closing price at day t – 6 H The 52-week high relative to t – 6 Anchoring and Acquisitions Ma, Whidbee, Zhang

The Reference Price Effect (Two-group results in Table 2, Panel B) All CAR(%) Low RPR (L) High RPR (H) Mean Median 1.501*** (0.566)*** 2.108*** (0.981)*** 0.894*** (0.288)*** Anchoring and Acquisitions Ma, Whidbee, Zhang

The Reference Price Effect (Fig. 1) Anchoring and Acquisitions Ma, Whidbee, Zhang

The Reference Price Effect (In regressions) CAR = f(RPR, controls) Control variables (size; relative size; listing status; cash; stock; M/B; leverage; dormant; relatedness; tender offer; hostile; toehold; cross border; past return) Industry and year fixed effects Standard errors clustered at firm level RPR coefficient = -5.487% (t=-8.56) One SD change in RPR  11.0% SD change in CAR One SD change in Size  7.5% SD change in CAR Economically significant Anchoring and Acquisitions Ma, Whidbee, Zhang

Anchoring Versus Valuation Proxies for valuation levels Market-to-book Rhodes-Kropf, Robinson, Viswanathan (2005) Others (not shown) Our analysis Regressions on subsamples Our main findings remain strong RPR coefficients are negative and significant RPR coefficient significant for cash-only deals Anchoring and Acquisitions Ma, Whidbee, Zhang

Role of Valuation Levels (Table 5) Anchoring and Acquisitions Ma, Whidbee, Zhang

Additional Evidence of Anchoring Proxies for uncertainty, information opaqueness, and investor sophistication (s) High volatility of acquirer stock Acquirers followed by fewer analysts Higher relative size Use of non-cash payment Unlisted (private or subsidiaries) targets Higher individual investor ownership CAR = f(RPR, RPR*s, controls, s) All coefficients on RPR*s are negative and significant Anchoring and Acquisitions Ma, Whidbee, Zhang

Role of Uncertainty (Table 6) Anchoring and Acquisitions Ma, Whidbee, Zhang

Role of Listing Status (Table 7) Anchoring and Acquisitions Ma, Whidbee, Zhang

Role of Investor Sophistication (Table 8) Anchoring and Acquisitions Ma, Whidbee, Zhang

Unobserved Fundamental Factor(s)? Other possible alternative explanations? Hubris, entrenchment, anticipated acquisitions, … If reference price effect acts as a proxy for a fundamental factor, market reaction should be long-lived  long-horizon returns should not differ between high and low RPR groups. Our finding: There is reversal in the longer term Anchoring and Acquisitions Ma, Whidbee, Zhang

Long-term Reversal (BHAR 1-year, Table 9, Panel A) Low RPR – 5.93*** High RPR – 1.33*** H – L 4.60*** Low M/B – 2.80 High M/B – 4.45*** H – L – 1.66** Low RKRV – 3.27 High RKRV – 3.92*** H – L – 0.65 Anchoring and Acquisitions Ma, Whidbee, Zhang

Long-term Reversal and deal success (BHAR 1-year, Table 9, Panel C) Anchoring and Acquisitions Ma, Whidbee, Zhang

Robustness Alternative hypotheses Alternative CARs Alternative RPRs Volatility subsamples Size subsamples Alternative CARs Window; eq’m return CAR controlling for RPR Alternative RPRs Investor learning? (1980s, 1990s, 2000s) 52-week low RPR of S&P 500 Index Alternative measures of valuation levels (Mt–6/B, Pt–6/V) Alternative measures of past returns (one month) Falsification tests (price relative to the 99th, 95th, 90th, 75th percentiles of past prices) Anchoring and Acquisitions Ma, Whidbee, Zhang

Summary & Conclusion Summary Conclusion A strong reference price effect in acquirer CAR. Stronger effects among deals of greater uncertainty, poorer information, less sophisticated investors. The effect lasts for 20 days and is reversed in one year. Conclusion Anchoring bias helps shape investor demand for stocks. The market reaction to acquisition announcements is affected by anchoring bias and the effect is economically meaningful. Anchoring and Acquisitions Ma, Whidbee, Zhang