Belief asymmetry and gains from acquisitions

The divergence of opinion ‘premium hypothesis’, developed by Miller [Miller, E., 1977. Risk, uncertainty, and divergence of opinion. Journal of Finance 32, 1151–1168], predicts that the price of a stock is set by optimistic investors when belief asymmetry about its value is high. We examine whether this hypothesis can explain gains to acquiring firms. We find a significant positive relation between belief asymmetry and announcement returns to acquiring firms bidding for unlisted targets after accounting for various firm and deal characteristics. Yet, acquirers subject to high (low) belief asymmetry experience negative (no) abnormal returns in the post-acquisition period. Our evidence suggests that, in the presence of high belief asymmetry, optimistic investors overreact around acquisition announcements involving private targets that on average signal strong potential for value creation. This leads acquiring firms’ prices to overshoot in the short-run and experience sharp corrections subsequently.