Academic journal article Journal of Economics and Finance

Investment Banks Advising Takeover Targets

Academic journal article Journal of Economics and Finance

Investment Banks Advising Takeover Targets

Article excerpt

Abstract Should takeover target firms hire top-tier investment bank advisors? For a sample of mergers and acquisitions between publicly traded U.S. acquirers and targets, in deals in which targets hire top-tier banks, targets earn higher premiums and abnormal returns; the probability of stock payment is lower, especially when bidder stock is potentially overvalued; acquirers, however, do not necessarily earn lower abnormal returns, and combined returns are higher. Controlling for selfselection does not erode, but, in some cases even strengthens the results. The evidence suggests that top-tier investment banks advising targets benefit shareholders of client firms by making better deals, instead of simply bargaining against the acquirers. The findings shed light on the role of advisor incentives when linking advisor quality and shareholder wealth.

Keywords Merger · Acquisition · Investment Banking · Incentive

JEL Classification G34 · G24

(ProQuest: ... denotes formulae omitted.)

1 Introduction

Billions of dollars are paid to investment banks for advising firms engaged in mergers and acquisitions-$10.7 billion by targets and $4 billion by acquirers in 1997-2003 according to the Securities Data Corporation (SDC). Of these fees, more than half went to a small group of "top-tier ' banks, led by Goldman Sachs with $3.3 billion. However, whether they add value to client firm shareholders in exchange for the fees remains an open question. This paper studies the effect of hiring top-tier investment banks in mergers and acquisitions from the perspective of target firms. Specifically, the following questions are addressed. Do target firm shareholders gain more from hiring top-tier banks, compared to hiring other banks? Do acquiring firms lose when targets hire top-tier banks? How do top-tier banks advising targets affect acquisition terms?

The literature of investment banks as merger advisors has been focusing on the acquirer side (Servaes and Zenner 1996; Rau 2000), with few studies examining the effect of banks advising targets (Kale et al. 2003). Moreover, one of the main findings in the literature is somewhat puzzling: Acquiring firms do not seem to benefit from hiring bank advisors, even those in the top-tier (Servaes and Zenner 1996; Rau 2000; Stoiuaitis 2003). One reason for such a finding might reside in the potential conflict of interest between acquiring firms and their bank advisors. McLaughlin (1990) examines investment bank fee contracts in tender offers and finds that a large portion of the fees involved is contingent on deal completion, and that this portion increases with deal value. Bao and Edmans (2011) find that acquirer returns are positively related to advisors' past returns but negatively related to market share; when choosing their advisors, however, acquirers focus on market share but ignore past performance. Both fee contract terms and market share concerns directly create conflicts of interest between acquirers and their banks- acquirers hope to pay lower prices for acquisition, while their bank advisors are better off with higher prices. In contrast, target firms and their bank advisors both look for higher prices, suggesting that interests are better aligned between shareholders and bank advisors. As a result, the target side provides a cleaner environment for examining the roles of investment banks as merger advisors.1 Moreover, McLaughlin (1990, p221) reports that targets pay higher fees than acquirers, suggesting the importance of studying the role of investment banks advising targets.

In a sample of 2,156 takeover deals involving publicly traded U.S. acquirers and targets from 1980 to 2003, over 89% of targets, representing 98% of transaction value, hired investment banks.2 Therefore, I focus on the question of which investment banks to hire rather than whether to hire or not. Because the investment banking industry is rigidly hierarchical in nature, and several top-ranked banks persistently dominate the business, including providing merger advisory services, I classify investment banks into two groups, top-tier and non-top banks, according to their market shares in the advisory business. …

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