Uncertainty triggers overreaction: evidence from corporate takeovers

Behavioural finance models suggest that under uncertainty, investors overweight their private information and overreact to it. We test this theoretical prediction in an M&A framework. We find that under high information uncertainty, when investors are more likely to possess firm-specific information, acquiring firms generate highly positive and significant gains following the announcement of private stock and private cash acquisitions (positive news) while the market heavily punishes public stock (negative news) deals. On the other hand, under conditions of low information uncertainty, when investors do not possess private information, the market reaction is complete (i.e. zero abnormal returns) irrespective of the type of acquisition. Overall, we provide empirical evidence that shows that information uncertainty plays a significant role in explaining short-run acquirer abnormal returns.