Relative reference prices and M&A misvaluations

Purpose The purpose of this paper is to examine the misvaluation hypothesis using a relative reference point (RRP) in mergers and acquisitions (M&A) market. Design/methodology/approach The paper studies 1,878 M&A deals in the US market announced between January 1985 and December 2014. Findings The paper finds that bidders prefer stock payments when the RRP increases. The RRP is positively related to the offer premium and the target announcement returns. Although the RRP is negatively related to the bidder announcement returns, it is positively related to the long-run performance of bidders who time the market with overvalued stocks. The results are consistent with the predictions of the misvaluation hypothesis and reference point (RP) theory. Originality/value The authors construct a dynamic valuation framework to explain the misvaluation hypothesis by linking M&As' misvaluation with RP theory. This paper provides direct evidence that the reference-dependence bias is prevalent for more experienced investors in major corporate investment decisions and offers fresh insights into the method of payment hypothesis.