Small acquirers enjoy announcement period returns that are significantly higher than announcement returns for larger acquirers, but small acquirers significantly underperform after the acquisition is consummated. We investigate why the market appears to “get it wrong” at the announcement of an acquisition by a small firm. We provide evidence consistent with an initial optimistic overreaction, followed by a correction as updated information is revealed. Overreaction is clustered in small acquirers offering stock and acquiring relatively larger targets. Low post-acquisition returns and poor fundamental performance are clustered in small acquirers offering stock and diversifying.
This is a preview of subscription content, access via your institution.
Buy single article
Instant access to the full article PDF.
Tax calculation will be finalised during checkout.
Subscribe to journal
Immediate online access to all issues from 2019. Subscription will auto renew annually.
Tax calculation will be finalised during checkout.
We define a small acquirer as having a market capitalization below the 25th percentile of NYSE firms in the year the acquisition is announced.
Hubris is generally defined as an overestimation of managers’ ability to manage the acquisition (Roll 1986). Managers with hubris are more likely to pursue a poor acquisition target and/or more likely to overpay.
The market’s assessment of the acquisition need not be perfect, but if it is unbiased then average interim and post-acquisition returns will be zero.
Along this line, our paper corroborates the findings of Drake et al. (2015), who show that market efficiency in general is improved when EDGAR filings are accessed more frequently.
Small acquirers have less acquisition experience than larger acquirers; small acquirers have a mean of 4.23 prior acquisitions versus 13.46 prior acquisitions for larger acquirers.
As we explain later, our results are robust to defining diversification using the Fama and French (1997) industry classifications.
Prior research suggests that small firms operate in a less rich information environment; for example, the press is less likely to cover small firms (Miller 2006). Small acquirers, in general, also have lower analyst coverage. These factors lead to greater market inefficiency for smaller firms (Loughran and Ritter 2000). For example, Bernard and Thomas (1989) find that post-earnings announcement drift is stronger in smaller firms, also suggesting less market efficiency for those firms.
MSS’s sample period begins with 1980, however, we begin our sample with 1984 as recent research evaluating the completeness and accuracy of the SDC merger database finds that coverage is poor to moderate before 1984 (Barnes et al. 2014).
Consummation can occur at any date before the first post-acquisition year-end (year + 1), and accordingly we examine years + 2 to + 4 in order to ensure that we examine fiscal years that are clearly attributable to post-acquisition performance. Year + 1 also reflects the first annual financial report that investors see after consummation. Even if the “year + 1” financial statements do not fully reflect the acquisition’s performance, many investors may believe that it does. Willengborg et al. (2015) use average total assets instead of end-of-year total assets; however, in an acquisition setting beginning-of-year total assets would include only the acquirer’s assets without the target’s, deflating the denominator and inflating ROA for year + 1. However, our conclusions are very similar if we use average assets.
Results are similar if we use performance as of year − 1 as our control.
Acquirer market capitalization and book-to-market are also common controls; however, they are controlled for with our selection of matching firms. To be consistent with MSS, we exclude them from our multivariate analysis.
Small (large) acquirers experience average abnormal announcement period returns of 2.3% (0.08%) in the MSS study.
This lack of experience is especially prominent in small acquirers offering stock (average prior acquisitions are 2.75 for small stock acquirers), purchasing relatively larger targets (3.52), and diversifying (4.02).
For brevity, we will refer to clustered p-values hereafter unless explicitly noted otherwise.
As our interest is in small acquirers in general, we do not exclude 3805 cross-border acquisitions. However, our conclusions are unchanged if we exclude these observations.
We note that some of our median p-values (e.g., medians for Panel B, pre-acquisition analyst coverage) reflect statistical significance when the medians themselves are exactly the same (e.g., median coverage of 1 for Panel B). This is because the Wilcoxon test we use is a rank-sum test (i.e., all observations are ranked, the ranks are added, and then the rank-sums are compared), and this procedure can sometimes result in statistically significant results even when the medians themselves are the same because the rank-sums are different.
We also note that mean trading volume figures are exceptionally high, while medians are not quite as inflated. This suggests there are still some significant outliers, and that some small acquirers were thinly traded prior to the announcement. Further, the median announcement volume for small acquirers is lower than for larger acquirers (109 vs. 123%), and this appears to be because trading volume for non-stock small acquirers, non-large target small acquirers, and non-diversifying small acquirers is low.
Although the results for the first year-end after consummation may not be a suitable reflection of post-acquisition performance (for example, if the acquisition is consummated on December 30 and the fiscal year-end is December 31), those financial statements will still be the first post-acquisition financial statements investors will receive. Even if incorrect, the perception of many investors will likely be that those financial statements reflect, in some measure, the performance of the acquisition.
One difference between our use of unadjusted ROA as opposed to abnormal ROA is that, with unadjusted ROA, the small acquirer dummy alone has a significantly negative coefficient.
Our use of ROA from 3 years prior to confirmation ensures that we do not have contamination in our control from operating decisions made in anticipation of the acquisition.
We thank an anonymous reviewer for this robustness suggestion. Overall, a more refined measure of relatedness may be an interesting avenue of exploration for future research; see Alhenawi and Stilwell (2019).
Aktas N, de Bodt E, Roll R (2009) Learning, hubris and corporate serial acquisitions. J Corp Financ 15:543–561
Aktas N, de Bodt E, Roll R (2011) Serial acquirer bidding: an empirical test of the learning hypothesis. J Corp Financ 17:18–32
Alhenawi Y, Stilwell ML (2019) Towards a complete definition of relatedness in merger and acquisition transactions. Rev Quant Financ Acc 53(2):351–396
Asquith P, Bruner RF, Mullins DW (1983) The gains to bidding firms from merger. J Financ Econ 11:121–139
Bailey W, Li H, Mao C, Zhong R (2003) Regulation fair disclosure and earnings information: market, analyst, and corporate responses. J Financ 58(6):2487–2514
Baker M, Wurgler J (2006) Investor sentiment and the cross-section of stock returns. J Financ 61(4):1645–1680
Bamber LS, Barron OE, Stevens DE (2011) Trading volume around earnings announcements and other financial reports: theory, research design, empirical evidence, and directions for future research. Contemp Acc Res 28(2):431–471
Barber BM, Lyon JD (1996) Detecting abnormal operating performance: the empirical power and specification of test statistics. J Financ Econ 41(3):359–399
Barber BM, Odean T (2008) All that glitters: the effect of attention and news on the buying behavior of individual and institutional investors. Rev Financ Stud 21(2):785–818
Barnes B, Harp N, Oler D (2014) Evaluating the SDC mergers and acquisitions database. Financ Rev 49(4):793–822
Beaver W (1968) The information content of annual earnings announcements. J Acc Res (Selected Studies) 67–92
Beaver W, McNichols M, Price R (2007) Delisting returns and their effect on accounting-based market anomalies. J Acc Econ 43:341–368
Ben-David I, Roulstone DT (2008) Why do small acquirers underperform in the long-term? Working paper, University of Chicago
Bernard VL, Thomas JK (1989) Post-earnings announcement drift: delayed price response or risk premium? J Acc Res 27:1–36
Bhagat S, Dong M, Hirshleifer D, Noah R (2005) Do tender offers create value? New methods and evidence. J Financ Econ 76:3–60
Bhattacharya N (2001) Investors’ trade size and trading responses around earnings announcements: an empirical investigation. Acc Rev 76(2):221–244
Bradshaw MT (2011) Analysts’ forecasts: what do we know after decades of work? Working paper, Boston College
Drake MS, Roulstone DT, Thornock JR (2015) The determinants and consequences of information acquisition via EDGAR. Contemp Acc Res 32(3):1128–1161
Elgers PT, Lo MH, Pfeiffer RJ Jr (2001) Delayed security price adjustments to financial analysts’ forecasts of annual earnings. Acc Rev 76(October):613–632
Fama EF, French KR (1997) Industry costs of equity. J Financ Econ 43:153–193
Fuller K, Netter J, Stegemoller M (2002) What do returns to acquiring firms tell us? Evidence from firms that make many acquisitions. J Financ 57:1763–1794
Gao Y, Oler D (2012) Rumors and pre-announcement trading: why sell target stocks before acquisition announcements? Rev Quant Financ Acc 39(4):485–508
Ghosh A (2001) Does operating performance really improve following corporate acquisitions? J Corp Financ 7(2):151–178
Gleason CA, Lee CMC (2003) Analyst forecast revisions and market price discovery. Acc Rev 78(1):193–225
Gow ID, Ormazabal G, Taylor DJ (2010) Correcting for cross-sectional and time-series dependence in accounting research. Acc Rev 85(2):483–512
Harford J (1999) Corporate cash reserves and acquisitions. J Financ 54:1969–1997
Harp NL, Barnes BG (2018) Internal control weaknesses and acquisition performance. Acc Rev 93(1):235–258
Healy PM, Palepu KG, Ruback RS (1992) Does corporate performance improve after mergers? J Financ Econ 31:135–175
Jansen I, Sanning LW, Stuart NV (2015) Do hubris and the information environment explain the effect of acquirers’ size on their gains from acquisitions? J Econ Financ 39:211–234
Lee C, Shleifer A, Thaler R (1991) Investor sentiment and the closed-end fund puzzle. J Financ 46(1):75–109
Linn SC, Switzer JA (2001) Are cash acquisitions associated with better postcombination performance than stock acquisitions? J Bank Financ 25:1113–1138
Loughran T, McDonald B (2017) The use of EDGAR filings by investors. J Behav Financ 19(2):231–248
Loughran T, Ritter JR (2000) Uniformly least powerful tests of market efficiency. J Financ Econ 55:361–389
Loughran T, Vijh AM (1997) Do long-term shareholders benefit from corporate acquisitions? J Financ 52(5):1765–1790
Mian GM, Sankaraguruswamy S (2012) Investor sentiment and stock market response to earnings news. Acc Rev 87(4):1357–1384
Miller EM (1977) Risk, uncertainty, and divergence of opinion. J Financ 32(4):1151–1168
Miller GS (2006) The press as a watchdog for accounting fraud. J Acc Res 44(5):1001–1033
Moeller SB, Schlingemann FP, Stulz RM (2004) Firm size and gains from acquisitions. J Financ Econ 73:201–228
Mola S, Rau PR, Khorana A (2013) Is there life after the complete loss of analyst coverage? Acc Rev 88(2):667–705
Morck R, Shleifer A, Vishny RW (1990) Do managerial objectives drive bad acquisitions? J Financ 45:31–48
Nissim D, Penman SH (2001) Ratio analysis and equity valuation: from research to practice. Rev Acc Stud 6:109–154
Oler DK (2008) Does acquirer cash level predict post-acquisition returns? Rev Acc Stud 13:479–511
Petersen MA (2009) Estimating standard errors in finance panel data sets: comparing approaches. Rev Financ Stud 22(1):435–480
Rau PR, Vermaelen T (1998) Glamour, value, and the post-acquisition performance of acquiring firms. J Financ Econ 49:223–253
Richardson SA, Sloan RG, Soliman MT, Tuna I (2005) Accrual reliability, earnings persistence and stock prices. J Acc Econ 39:437–485
Roll R (1986) The hubris hypothesis of corporate takeovers. J Bus 59(2):197–216
Savor PG, Lu Q (2009) Do stock mergers create value for acquirers? J Financ 64(3):1061–1097
Servaes H (1991) Tobin’s Q and the gains from takeovers. J Financ 46(1):409–419
Shleifer A, Vishney RW (2003) Stock market driven acquisitions. J Financ Econ 70:295–312
Stambaugh RF, Yu J, Yuan Y (2012) The short of it: investor sentiment and anomalies. J Financ Econ 104:288–302
Travlos NG (1987) Corporate takeover bids, methods of payment, and bidding firms’ stock returns. J Financ 42(4):943–963
Willengborg M, Wu B, Yang YS (2015) Issuer operating performance and IPO price formation. J Acc Res 53(5):1109–1149
Wu C, Xu XE (2000) Return volatility, trading imbalance and the information content of volume. Rev Quant Financ Acc 14(2):131–153
Springer Nature remains neutral with regard to jurisdictional claims in published maps and institutional affiliations.
The authors thank participants at the 2012 BYU Accounting Research Symposium, workshop participants at the University of Mississippi, Utah State University, participants at the 2013 AAA SW Regional Meeting, and Fei Xie (at University of Delaware) for helpful comments and suggestions.
Appendix: Variable definitions and calculations
Appendix: Variable definitions and calculations
Stock price and shares outstanding are taken from the CRSP database. All financial statement information is taken from the combined CRSP/Compustat (annual) database provided by Wharton Research Data Services (WRDS). Information is taken as at the most recent month-end that is at least 30 days before the announcement of the acquisition. We assume a 3-month lag between a firm’s year-end and when financial statements are publicly available.
Our multivariate BHARs are calculated as follows:
Returns for firm i over the period beginning with day s and ending with day e, where s = day − 2 and e = + 2 relative to announcement for announcement period returns, s = + 3 and e = deal consummation date for interim period returns, and s = day + 1 relative to deal consummation date and e = end of month + 24 for post-acquisition returns, and
Mean portfolio returns (from four peer firms) over the same period
Table 9 provides details on calculations of our independent variables.
About this article
Cite this article
Harp, N.L., Kim, K.H. & Oler, D.K. A bold move or biting off more than they can chew: examining the performance of small acquirers. Rev Quant Finan Acc 56, 393–422 (2021). https://doi.org/10.1007/s11156-020-00893-x
- Post-acquisition returns
- Small acquirers
- Trading volume
- Fundamental performance