Market reactions and their impact on acquisition decisions

What is it about?

This paper shows a V shaped relationship between abnormal stock returns surrounding the prior acquisition and the risk associated with the subsequent acquisition. Managers appear to be choosing riskier targets (measured using stock volatility) both as prior abnormal gains as well as prior abnormal losses increase. We argue that these findings support behavioral theories- on the positive side the findings are consistent with the house money effect and the tendency of gamblers to become risk seeking when they are in the money. On the negative side the behavior is consistent with prospect theory, and the tendency of decision makers to take risks to restore break even positions in the face of prior losses. The added implication is the prior market reactions appear to be acting as reference points in decision makers’ minds as they choose their targets in subsequent decisions.

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Why is it important?

The paper cautions managers in terms of being influenced in their decisions by stock market reactions. Market reactions can provide important information for decision making, but our study suggests they can also induce biases and stimulate risk seeking tendencies which may not create value for shareholders.