The effect of stock misvaluation and investment opportunities on the method of payment in mergers

This paper tests the effect of firms' mispricing and investment opportunities on the method of payment in mergers. Using a new proxy for investment opportunities and a sample of 1187 mergers completed between 1990 and 2005 among US publicly traded firms, I find that acquirers lead the decision on the method of payment, thus exploiting short-term market mispricing (in line with both the Rhodes-Kropf and Viswanathan, 2004 and Shleifer and Vishny, 2003 models). However, target managers believe in the quality of the merger and care about the long-term value of the merged entity's shares (as predicted by Rhodes-Kropf and Viswanathan, 2004 and contrary to Shleifer and Vishny, 2003). I also find that better investment opportunities lead to greater use of stock.

► Acquirers lead the decision on the payment method in mergers. ► They exploit the overpricing of their stocks choosing stock as method of payment. ► Target managers believe in the quality of the merger and overestimate the synergies. ► Higher investment opportunities lead to greater use of stock as method of payment. ► Acquirers exploit stock mispricing also in the equity issues around the mergers.