M&A Rumors about Unlisted Firms

Alexander Groh is Professor of Finance at Emlyon Business School. This post is based on a recent paper, forthcoming in the Journal of Financial Economics, by Mr. Groh; Yan Alperovych, Associate Professor of Finance at Emlyon Business School; Douglas J. Cumming, DeSantis Distinguished Professor of Finance and Entrepreneurship at Florida Atlantic University; and Veronika Czellar, Professor of Data Science, Economics and Finance at SKEMA Business School. Related research from the Program on Corporate Governance includes Are M&A Contract Clauses Value Relevant to Target and Bidder Shareholders? by John C. Coates, Darius Palia, and Ge Wu (discussed on the Forum here) and The New Look of Deal Protection by Fernan Restrepo and Guhan Subramanian (discussed on the Forum here).

Mergers and acquisitions (M&As) are important events in the life cycle of corporations and have the potential to affect a wide range of stakeholders. They can lead, among many other possibilities, to strategic reorganization, product discontinuation, accelerated growth, geographic expansion, layoffs, or increased competition. The transactions are usually initiated by the acquirer or the seller or, alternatively, by the target or outside managers. Deal negotiations eventually start after direct contact between the future partners or following a limited auction process organized by M&A intermediaries. Regardless of the process used to begin “merger talks”, the participants regularly bind themselves to strict confidentiality using non-disclosure agreements (NDAs). The purpose of these NDAs is to limit the incidence of deal negotiation information leaks, with their potential knock-on effects on deal consummation and value. These effects are caused by the uncertainty regarding the final merger outcome, as revealed in an M&A transaction rumor. In particular, information leaks can create tension in the respective companies, e.g. among employees, customers, and suppliers, or mistrust among the negotiating parties. Rumors are known to damage employee morale and impede organizational communication. They hamper restructuring and layoffs during periods of corporate change and may damage sales. For listed companies, it has been shown that M&A rumors are spread to manipulate stock prices. In general, rumors adversely affect stock prices and thus reduce market efficiency. Merger talks may fail because of rumors, leading deals to collapse or transactions to close at changed deal values.

The value and deal-closing effects of M&A rumors have, to date, been studied exclusively on public capital markets. Literature shows that M&A transaction information leakages can affect negotiations, deal value, and the market capitalization of the bidder. Important papers revealed run-ups in targets’ stock prices prior to the actual merger announcements as part of the deal premium. These run-ups may stem from toehold acquisitions, from insider trades, or from transaction rumors. They can create additional costs for the bidder and may thus eliminate the economic viability of the transaction.

Shareholders, stakeholders, competitors, individuals involved in the transaction process, or indeed anybody else, may intentionally diffuse information about merger talks to take advantage in some way. In public stock markets, would-be manipulators can deliberately spread M&A rumors to trade on the expected stock price reaction even if the respective companies have no intention of merging. Most of the rumors in public capital markets are indeed inaccurate and probably caused by would-be manipulators. Our focus on non-listed targets leaves only two reasons for the emergence of M&A transaction information leaks. First, a rumor may arise unintentionally due to carelessness in the negotiation process. Second, someone may spread a rumor on purpose to affect the likelihood of transaction closing and deal value.

Our paper analyzes the impact of M&A rumors on deal completion and deal values, elaborating on a large sample of 68,044 closed, or envisaged but failed, M&A transactions relating to unlisted targets. Our sample spans the period from 1996 to 2017 and includes transactions in a large variety of industries in 88 countries. Approximately 26% of the transactions were rumored prior to their announcement or failure and 34% ultimately failed. Our focus on unlisted companies carries with it special features that are unique and interesting. There are no confounding effects of run-ups on, or other types of manipulation of, the target price thereby enabling a direct focus on the rumor impact on M&A transaction outcomes. However, the analyses are not straightforward for several reasons. There are scant disclosure requirements and analyst coverage in private market M&As. In addition, the reported information is not necessarily captured by M&A data providers and deal values are infrequently reported.

We develop a model to accommodate the characteristics of M&A transactions involving non-listed entities. The model first determines the likelihood of an M&A rumor emerging. Second, it allows us to estimate the probability of deal consummation. Third, it traces deal value observability. Fourth, the model controls for the conditional effects on consideration of a rumor emerging, a transaction closing, and a deal value being observed. We apply indirect inference methodology to overcome the resulting econometric challenges. Indirect inference is a simulation-based estimation technique and increasingly common in the economics and finance literature. It is based on two requirements. First, it must be possible to simulate the model. Second, a simple auxiliary model needs to exist, suitable for maximum likelihood, least squares, or moment-based assessment. We determine the structural model by choosing the parameter values that yield auxiliary estimates similar to the auxiliary estimates obtained with empirical data.

Our analyses reveal the following. First, M&A rumors are deal breakers. Information leaks prior to the official announcements diminish the likelihood of deal closing by 26.11%. Second, if a deal does finally manage to close, the premium is 16.0% higher for leaked transactions compared to non-leaked. The effects are robust with respect to the party “who leaks”, and after controlling for unobserved deal values. Third, and most importantly, the joint economic impact of M&A rumors as drivers of transaction values and as deal breakers is strongly negative. We estimate that 32.42% of the aggregate transaction value of our sample deals is destroyed. Our paper therefore reveals an important trade-off among M&A deal partners. A seller, for example, may leak confidential information about M&A negotiations, expecting a premium compared with a non-leaked transaction. However, at the same time, the likelihood of consummating the deal decreases, as does the propensity of receiving the premium. The aggregate economic impact is negative, explaining why M&A market participants appreciate confidentiality, bind themselves in NDAs, and dislike transaction rumors.

The complete paper is available for download here.

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