Divergence of investors’ opinion and takeovers: the impact on announcement returns, bid success and merger arbitrage investment strategies

We examine three aspects of investors’ divergence of opinion in the context of takeovers.First we examine the effect of divergence of opinion and short sale constraints on merger announcement returns. To our knowledge, no study has analysed this combined effect for acquirers and targets. Using a sample of 565 Australian acquirers and 442 targets we find that relative spread and order imbalance (proxies for divergence of opinion), significantly affect acquirer returns. This provides information to investors wanting to assess the impact on bidder returns of an impending merger. The evidence of an impact on target returns is weak. Neither of our proxies for short sale constraints (level of institutional ownership or short selling ban), present a significant relationship with acquirer returns. The relationship with target returns is very weak. Second, we examine the effect of the market reaction to a takeover announcement in conjunction with divergence of opinion on deal success. To our knowledge, no study has analysed this joint effect. We apply logistic regressions using a sample of 774 Australian acquirers and 584 targets and find some evidence that managers in takeover negotiations listen to the acquirer market reaction to the announcement when deciding whether to complete a deal or withdraw from it. We do not find evidence of managers listening to the target market reaction. Additionally, we find that deal success has a significant positive relationship with relative spread and a significant negative relationship with order imbalance, variables which proxy for divergence of opinion.Third, we examine the impact of divergence of opinion on merger arbitrage investment strategies. To our knowledge, no study has analysed this mpact. We find that by using divergence of opinion to predict takeover success, we can build a merger arbitrage portfolio that earns higher Fama and French (1993) adjusted excess returns than a typical portfolio where arbitrageurs invest in all announced deals. However, the portfolio is small and its performance sensitive to the window used to calculate the returns and the divergence of opinion proxies. The models that provide the highest merger arbitrage returns use relative spread or order imbalance to proxy for divergence of opinion