Merger Announcements, Financial Performance and Stock Price: A Test of Market Efficiency

Abstract

Can investors earn above-normal risk-adjusted returns by acting on public information defined by merger announcements? This study tests the effect of a sample of 14 merger announcements on stock price returns using the risk-adjusted event-study methodology. Results show that an investor is not able to make abovenormal risk-adjusted returns on the announcement of mergers in support of semi-strong form market efficiency. Merger announcements stimulate significant positive returns around the merger announcement. Results show market over- and under-reaction around the merger announcement well documented in the behavioral finance literature. The evidence shows a significant stock price return reaction up to 1 day prior to the announcement consistent with the existence of insider trading (Ross and others, 2016). Do mergers strengthen companies’ financial performance? Results show that mergers are not value-increasing based on the pre-post-merger financial performance in support of the agency problem where large firm use excess free cash flow to get “bigger” not “better” by going shopping for other firms. In such cases, the firm’s merger maximizes size, not stockholder wealth, the goal of the firm.