Behavioural Finance & Corporate Investment: M&A Success, Pre-Merger Issuance and the Media

Abstract

Classical economics proposed that individuals are rational beings that undertake essential due diligence when making a financial decision so as to reduce avoidable risk when investing. Despite the intuition behind such a conclusion, it has become widely recognised that investors are driven by animal spirits. These emotions can influence an investment decision and lead to a less than optimal outcome. This thesis includes three empirical chapters, which provide compelling evidence on the importance of behavioural finance in Mergers and Acquisitions. The results herein have practical relevance for academics, practitioners and regulators alike.

The prevailing literature has focussed on corporate finance decisions under the assumption of universal rationality. Moreover most empirical research to-date has focussed on the US market, and yet the UK offers attractive characteristics worthy of future research. Firstly, most M&As (circa 80.2%) within the UK are financed using cash. Secondly, a large majority (circa 91%) of UK targets are unlisted companies. Finally, the UK remains the second-most active M&A market outside of the US. This chapter offers research in pursuit of understanding the UK market deeper, while simultaneously assessing the value of established findings in different settings.

In this pursuit, the first empirical chapter of this thesis relaxes universal rationality, modelling inefficiency at a firm and market level. Temporary deviations away from fundamental values can lead managers to attempt to time capital markets both in the decision to merge and in the choice over the payment method to be used. Using an intuitive methodological approach, the empirical results in Chapter Three indicate that market-timing using overvalued equity is not supported in the UK with evidence contrasting established US findings. The results suggest that undervaluation however is a stronger motive for merger activity as shareholders benefit twofold from the revaluation of the firm as well as the addition of the target’s assets.

An additional weakness of previous literature lies in the failure to interact various corporate decisions together. Chapter Four combines capital structure changes with the effects on an acquirer’s abnormal return. The choice between debt and equity can give the market an indication over the beliefs of the managerial team regarding the firm’s future cash flows. The decision to issue equity can signal overvaluation while issuing debt can exert an external monitoring mechanism on managerial teams leading to better corporate investments. Chapter Four supports the view of debt as a disciplinary mechanism with significantly lower losses experienced by acquirers that issue debt in the three years before announcing a M&A.

The final empirical chapter of this thesis takes note of the power of mass media to influence an investor’s decision-making process. In an attempt to undertake in-depth due diligence, individuals can utilise prestigious mass media to help decide which firms to invest within, while the mass media can also reflect public opinion of the firm. Chapter Five indicates that acquirers that are covered in the media, and thus are placed in investor’s minds, earn significantly better returns long-term than those that are not in the media. The results indicate that it is the coverage rather than the attitude of the media that influences an acquirer’s stock price. This finding supports the view that any publicity is good publicity.

Overall, this thesis provides valuable evidence that challenges the assumption of universal rationality. It is recommended that if we wish to understand financial markets better, then we must seek to understand the people that make decisions within them.