Academic journal article Financial Management

Market Misvaluation, Managerial Horizon, and Acquisitions

Academic journal article Financial Management

Market Misvaluation, Managerial Horizon, and Acquisitions

Article excerpt

This paper analyzes the impact of managerial horizon on mergers and acquisitions activity. The main predication is that acquiring firms managed by short-horizon executives have higher abnormal returns at acquisition announcements, less likelihood of using equity to pay for the transactions, and inferior postmerger stock performance in the long run. I construct two proxies for managerial horizon based on the CEO's career concern and compensation scheme, and provide empirical evidence supporting the above prediction. Moreover, I also demonstrate that long-horizon managers are more likely to initiate acquisitions in response to high stock market valuation.


The purpose of this paper is to analyze the motives and consequences of mergers and acquisitions from a managerial horizon perspective. In particular, I examine the effect of managerial horizon on acquirers' announcement returns, methods of payment in the transactions, and long-term performance following the acquisitions as well as acquisition frequency. Managers with a long horizon place additional emphasis on the firm's long-term value rather than the short-term value; they tend to make takeover decisions to increase the firm's long-run stock price. In contrast, short-horizon managers stress the firm's short-term performance and prefer acquisitions that enhance the firm's stock value in the short run. I test the above hypothesis using two proxies for managerial horizon and provide supporting evidence.

Managerial horizon determines whether the managers are more concerned with the firm's short-run stock price or with the long-run price. It significantly shapes acquisition decisions in an inefficient stock market where the firm's current market value (short-run value) deviates from its fundamental value (long-run value). Long-horizon managers tend to exploit overvalued stock prices by making equity transactions, while short-horizon executives are more inclined to boost the near-term stock price by catering to investor sentiments.

The existing literature proposes two channels through which managerial horizon influences takeover events. The first is the equity issuance channel. Long-horizon managers use overpriced equity to acquire the target's assets. Shleifer and Vishny (2003) provide a model of market-driven acquisitions to illustrate this idea. These mergers benefit the bidders' long-run shareholders as they cushion the subsequent drop of the overvalued stock price. One of the key assumptions in the model is that the acquiring firm managers act in the interests of the long-term shareholders (i.e., the managers have a long horizon). Their paper also suggests that short-horizon managers may avoid using equity for the acquisition if equity issuance reduces the short-term stock price by revealing signs of overvaluation to the market.

The second perspective is the catering channel. Short-horizon managers may undertake acquisitions that the market wants to see and enhance the firm's short-term stock price even though these mergers may cost the shareholders in the long run. As suggested by Jensen (2005), short-horizon managers tend to make financing and investment decisions to cater to market sentiment; they are likely to follow this sentiment and make risky negative net present value (NPV) investments that the market deems profitable.

The paper's main prediction is that long-horizon acquiring managers (as opposed to short-horizon ones) experience lower abnormal returns at merger announcements, are more likely to use equity as the payment mode, and have better postmerger stock performance. The key explanatory variable is managerial horizon, which I propose two proxies to measure. The first one is a dummy variable indicating whether or not the CEO is near retirement. Career concern is a natural factor correlated with managerial horizon. A near-retirement CEO usually has little time to remain in office and, therefore, is less likely to benefit from the firm's long-term performance (Dechow and Sloan, 1991; Gibbons and Murphy, 1992). …

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