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«David Becher Department of Finance, Drexel University; Wharton Financial Institutions Center, University of Pennsylvania; Philadelphia, PA 19014, ...»

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Do Shareholders Listen?

M&A Advisor Opinions and Shareholder Voting

David Becher

Department of Finance, Drexel University; Wharton Financial Institutions Center, University of

Pennsylvania; Philadelphia, PA 19014, USA; tel: (215) 895-2274; e-mail: becher@drexel.edu

Jay Cai

Department of Finance, Drexel University, Philadelphia, PA 19014, USA; tel: (215) 895-1755;

e-mail: jaycai@drexel.edu

Wenjing Ouyang

Department of Finance, Drexel University, Philadelphia, PA 19014, USA; tel: (215) 895-1741;

e-mail: wenjing.ouyang@drexel.edu July 2010 Abstract Recent studies find that merger advisors, in particular acquirer advisors, often face conflicts of interest and present biased opinions about an underlying deal. It is not clear, however, how shareholders react to these opinions. Using a sample of mergers announced from 2000 to 2006, we examine whether target and acquirer advisors’ opinions (valuation of target equity, long-term earnings forecast, and affiliated analyst recommendations) impact acquirer shareholders votes on mergers. Our results show that target advisor opinions, but not those of acquirer advisors, significantly impact shareholder voting. Further, if a deal receives higher shareholder support, the merger advisor is more likely to be retained in future deals. We conclude that shareholders are able to discern the potential bias in the opinions of merger advisors and follow the advice of the less-biased target advisors. Our study provides important evidence for the ongoing debate about regulatory reform governing investment banking transactions.

Keywords: Merger and Acquisition, Shareholder Voting, Investment Banking, Financial Advisor JEL Classification: G24, G30, G34 We thank Anup Agrawal, John, Coates, Fabrizio Ferri, Dalida Kadryzhanova, Kate Litvak, Adam Pritchard, Roberta Romano, Katsiaryna Salavei, and seminar participants at the 2010 American Law and Economics Association meetings, the 2010 Eastern Financial Association meetings, and Drexel University.


1. Introduction In merger transactions, acquirer and target firms frequently seek fairness opinions from financial advisors. Kisgen, Qian, and Song (2009) document that 45% of acquirers and 82% of targets obtain financial advisors’ opinions during 1,175 mergers from 1994-2003. In their letters to the boards and shareholders of the merging companies, financial advisors systematically come to the conclusion that the merger under consideration is fair to the target or acquirer firms. Prior studies, however, document that financial advisor fees are likely contingent upon deal completion (Kisgen et al. 2009; Makhija and Narayanan, 2007; Becher and Jeurgens, 2010). As a result, financial advisors often provide biased opinions to increase the likelihood of deal completion, rather than to maximize acquirer shareholder wealth (McLaughlin, 1990; Rau, 2000; and Kolasinski and Kothari, 2008). This potential conflict of interest has attracted attention from regulators. In 2007, the Securities and Exchange Commission (SEC) approved Rule 2290 that requires Financial Industry Regulatory Authority (FINRA) member firms to fully disclose any potential conflict of interest in the process of reaching their fairness opinions presented to shareholders of public firms involved in acquisitions.

Nevertheless, mergers, on average, do not create wealth for acquirer shareholders (Travlos, 1987;

Amihud, Lev, and Travlos, 1990; Moeller, Schinglemann, and Stulz, 2005). For example, Moeller et al. (2005) detail that acquirer shareholders lose nearly $216 billion in the 1990s. Kisgen et al. (2009) document that merger announcement returns are 2.3% lower for acquirers with fairness opinion.

Many mergers, however, require shareholder approval and shareholders can block a deal if the majority of them believe the merger is not in their best interest. Thus, it is a puzzle why these valuedestroying mergers receive shareholder support and are completed.

–  –  –

  In this study we examine whether advisor opinions influence shareholder voting on mergers. The answer to this question is important. If shareholders have full knowledge about a merger’s value and vote on its merit, financial advisors’ biased opinion will have no impact on how shareholders vote. In this case, financial advisors’ potential conflict of interest has little consequence on shareholder wealth.

On the contrary, if merger advisors’ opinion can substantially affect how shareholders reach their voting decision, these opinions can significantly affect shareholder wealth. In this case, additional regulations and/or disclosure may be warranted to help reducing the conflict of interests.

Based on the existing literature, we propose three hypotheses to examine the relation between financial advisors’ opinions and shareholder voting on mergers: the passive listener, uninterested listener, and active listener hypotheses. The Passive Listener hypothesis postulates that acquirer shareholders listen to financial advisors’ opinions regardless of potential conflicts of interest. This hypothesis predicts higher shareholder support for a deal when the financial advisor’s opinion is more favorable. The Uninterested Listener hypothesis, however, suggests that acquirer shareholders do not listen to their financial advisors’ opinions and vote without considering these opinions. This hypothesis predicts no significant relation between shareholder voting and financial advisor’s opinion.

Finally, the Active Listener hypothesis proposes that acquirer shareholders are able to recognize the potential conflict of interest and bias in financial advisors’ opinions and are more likely to listen to less biased opinions. Previous studies, as well as our own empirical evidence, suggest that target firm advisors are more conservative and less biased.1 This hypothesis, therefore, predicts that target advisor opinions are more likely to impact acquirer shareholders votes.


1 See, for example, Kesner, Shapiro, and Sharma (1994), Allen, Jagtiani, Peristiani, and Saunders (2004), and Cain and Denis (2008).

2   The focus of our analyses is on the acquirer shareholders’ approval rate, which is measured as the percent of shares held by outside shareholders that support a deal. We exclude managerial and board ownership and shares held by financial advisors as we expect that these parties always vote for a deal, given our sample of friendly negotiated mergers. Our acquirer shareholders’ approval rate, therefore, reflects the outside shareholders’ assessment of the deal. Furthermore, Burch et al. (2004) find some shareholders may not cast a vote when they are not satisfied with the deal. They conclude that the approval rate based on outstanding voting rights rather than votes cast better represents shareholders’ attitude to a deal. As a result, we use outstanding votes held by outside shareholders as the base.

To measure financial advisors’ opinions, we collect three sets of information. First, we collect financial advisors’ valuation on target firm equity. Since financial advisors often provide a valuation range for target equity, we use the scaled difference between the offer price and the midpoint of target equity valuation as a measure of whether an acquirer over- or under-pays. Second, we measure financial advisors’ opinions with their long-term EPS forecasts for the combined firm. Blockholders and institutional investors likely focus on long-term profits, rather than the short term gains or losses (Chen, Harford, and Li, 2007; Holmstrom and Tirole, 1993). As a result, acquirer shareholders may more likely vote for a deal if they perceive an increase in long-term EPS. Third, we examine a merger advisor’s affiliated analysts’ recommendations after the deal announcement. Affiliated analysts work for the same investment bank as the merger advisor. Their recommendations, therefore, may be motivated by deal completion (Kolasinski and Kothari, 2008; Becher and Juergens, 2010).

Using hand-collected data of financial advisors’ opinions on 148 mergers announced from 2000 to 2006, we show that acquirer shareholders listen to target advisors but tend to value acquirer advisors’ opinions less. Based on multivariate regressions, we document acquirer shareholders’ 3   approval rate increases 3.2% when target advisors’ equity valuation increases one standard deviation and 6.6% when they provide EPS forecasts. This rate increases by 11.3% when target-affiliated analysts update recommendations after the deal is announced. We, however, find no evidence that acquirer shareholder voting is related to their own advisor’s opinion. These results support the active listener hypothesis in that acquirer shareholders appear more likely to respond to less biased opinions.

In addition, we provide evidence on whether merger advisors’ opinions are biased. We find that the acquirer advisors are more optimistic in their valuation of target firm equity. Their affiliated analysts also provide optimistically biased recommendations when the market reacts negatively to a deal announcement. Target advisors and their affiliated analysts, on the other hand, do not appear to be optimistically biased. Finally, we examine whether shareholder support for a merger impacts the likelihood that an advisor is retained in future deals. We find that a one standard deviation increase in the shareholder voting ratio increases the probability of advisor retention for future deals by 13%.

This suggests a merger advisor’s ability to garner shareholder support is highly valued.

Overall, our results imply that acquirer shareholders are able to discern that acquirer advisors’ opinions are biased and listen only to target advisors’ opinions. Our paper contributes to the discussion about financial advisors’ conflict of interests on shareholder wealth as well as provides evidence on the efficacy of shareholder voting.2 The remainder of the article is organized as follows.

Section 2 discusses related literatures and develops three hypotheses. Section 3 describes the data and defines the main variables. Section 4 presents empirical results while Section 5 concludes.


2 Studies on acquirer shareholder voting find that shareholder voting is significantly related with deal characteristics, indicating that acquirer shareholder voting has a monitoring effect (Hamermesh, 2003 and Hsieh and Wang, 2008). Our results provide further evidence that the monitoring effect from acquirer shareholder voting is robust to the presence of financial advisors’ biased opinions.


2. Literature review and hypotheses development This paper is related to two streams of literature: financial advisors’ role in mergers and acquisitions and shareholder voting on corporate decisions. The discussion about financial advisors’ role focuses on the benefits and potential conflict of interests of their advisory services. The debate on shareholder voting centers on how shareholders vote and the efficacy of their votes. In this section, we review these studies and propose three hypotheses.

–  –  –

Financial advisors possess certain expertise that may reduce information asymmetry in financial transactions (Bowers and Miller, 1990). Servaes and Zenner (1996) note that acquirers are more likely to hire financial advisors when deals are more complex and information on targets is less available.

Kisgen et al. (2009) find the presence of a fairness opinion is positively related to deal complexity as well as board monitoring, which suggests that fairness opinions provide valuable information to management and shareholders as well as legal protection to managers and boards of directors.

The reputation of the financial advisors appears to benefit the shareholders. Bowers and Miller (1990) detail that total combined returns are higher when either party (target or bidder) hires a top-tier investment bank.3 Kale, Kini, and Ryan (2003) document that shareholders gain a higher portion of merger synergies when their financial advisors have higher reputation relative to the counter party.4 Bao and Edmans (2009) find that stock returns from an investment bank’s prior deal predict returns on future deals advised by the same investment bank.


–  –  –

  While financial advisors may create value, conflicts of interests may help to explain why numerous studies document non-positive acquirer shareholder returns around mergers. McLaughlin (1990, 1992) argues that contingent fee payment contracts may lead to financial advisors’ conflicts of interest. Rau (2000) finds that a higher proportion of top tier investment banks’ advisory fees are contingent and that acquirers advised by these advisors are more likely to complete a deal, but pay higher premiums. Further, financial advisors’ conflict of interest may affect their affiliated analysts’ recommendations. Kolasinski and Kothari (2008) detail that analysts affiliated with advisors provide biased recommendations to maximize financial advisors’ expected fee revenue. Becher and Juergens (2010) provide evidence advisors’ affiliated analysts issue biased recommendations to ensure deal completion. Collectively, this evidence suggests that financial advisors may face conflicts in mergers and provide biased opinions to maximize their own benefit at a cost to shareholders.

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