Agency problems in stock market-driven acquisitions

Purpose – The purpose of this paper is to examine the ways in which stock market valuation and managerial incentives jointly affect merger and acquisition (M&A) decisions and post-M&A performance, and to provide new evidence on the agency implications where such acquisitions are driven by the stock market. Design/methodology/approach – Utilizing all publicly-traded US firms in the NYSE, AMEX and NASDAQ during the period from 1992 to 2005 (excluding financial and utility firms), obtained from COMPUSTAT, CRSP, I/B/E/S, and the M&A database provided by SDC Platinum, this paper adopts a two-stage approach: the first stage, predicts the probability of an M&A based on the market valuation variables; the second stage, regresses the post-M&A firm performance on the predicted probability of a merger or acquisition from the first stage and other control variables. Findings – Market valuation has a significant influence on corporate acquisition decisions, particularly for those firms whose compensation packages include less managerial equity ownership, more executive stock options and no long-term incentive plans, and in those firms where CEOs are serving on the board of directors. The value-destroying acquisitions made by these types of managers are likely to be financed using the firms' stocks, executed with high premiums and undertaken during periods of high market valuation. Originality/value – The main finding suggests that market-driven acquisitions could be value destroying when managers engage in opportunistic acquisitions for reasons of self-interest. Managerial myopia, overconfidence, misaligned incentives, empire-building motives and poor corporate governance can all exacerbate the agency problem of market-driven acquisitions.