Research

Publications

• The Cost of Equity: Evidence from Investment Banking Valuations with Gregory W. Eaton, Tingting Liu, and Feng Guo

  • Accepted,  Journal of Financial and Quantitative Analysis

• Abstract: Using manually compiled cost of equity (COE) estimates disclosed in takeover regulatory filings, this paper provides novel evidence on how discount rates are constructed in practice by investment banks. Bank COE estimates have a positive but relatively low correlation with rates implied from the CAPM or Fama-French models. Banks include industry effects, beta, size, illiquidity, ownership structure, financial distress, and volatility in their COE calculations, but do not emphasize M/B, profitability, investment, or past returns. Incentives appear to impact bank COE estimates. We find evidence suggesting strategic tradeoffs between two most common approaches (i.e., comparable company analysis and the discounted cash flow analysis) to balance the overall valuation estimates. Banks use significantly higher COE values in management buyout deals, which potentially underestimates target value to make the proposed bid more attractive for target shareholder approval.

• Neglected Peers in Merger Valuation with Feng Guo and Tingting Liu

  • 2023, Review of Financial Studies, 36(8), 3257-3310. 

  • Presented at Cavalcade North America 2022, Midwest Finance Association 2022, The University of Tennessee, Northern Finance Association 2021, Financial Management Association Annual Meeting 2021 and Academy of Behavioral Finance & Economics 2021, The University of Iowa, The University of South Carolina, The University of Illinois at Chicago, Baruch College, and Iowa State University 

  • Abstract: Using merger documents filed with the SEC from 1994 to 2018, we show that being selected by investment banks as “comparable peers” are more than twice as likely to become a target themselves in the future compared to control firms matched for industry and size. They also experience an increase in analyst coverage and institutional ownership. Investment banks’ informational advantage as well as their ability to facilitate future takeover transactions, appear to contribute to peers’ significantly higher probability of becoming targets. Investors and equity analysts largely ignore the rich information contained in merger filings. A portfolio that longs peers and shorts non-peers matched for industry and size earns up to 15.6% alpha in the subsequent year. Alphas come entirely from the long-leg, which cannot be explained by short-sale constraints. 

• Earnings Growth and Acquisition Returns: Do Investors Gamble in the Takeover Market? with Tingting Liu

  • 2023, Journal of Financial and Quantitative Analysis, 58(3), 1326-1358.

  • Media Coverage: The FinReg Blog, Global Financial Markets Center at Duke University School of Law

  • Presented at Southern Finance Association Annual Meeting 2021, American Accounting Association Annual Meeting 2021, Financial Accounting and Reporting Section 2021, Eastern Finance Association 2021, and Iowa State University 

  • Abstract: We document a strong positive initial market reaction to merger announcements by bidders with either large earnings growth or significant earnings decline, relative to those with neutral earnings change, reflecting a U-shaped pattern between bidders’ earnings growth and announcement returns. However, the higher initial returns for bidders with earnings decline subsequently reverse, while the higher returns for bidders with high growth do not. We further show that short-sale constraints limit the ability of arbitrageurs to correct this short-term mispricing for bidders with large earnings decline. Additional analysis suggests a tendency for retail investors to gamble that mergers and acquisition (M&A) deals initiated by poorly performing bidders will generate high synergies.

Working Papers

• Negotiation, Auction, or Negotiauction?! Evidence from the Field with Tingting Liu and Micah S. Officer

  • Presented at China International Conference in Finance (CICF) 2024, Financial Intermediation Research Society (FIRS) Conference 2024, the American Finance Association Annual Meeting 2024, Eastern Finance Association Annual Meeting 2023, and University of Tennessee

  • Abstract: We connect the extensive theoretical negotiation and auction literature to real-world practice using a rich, hand-collected data set offering a comprehensive picture of high-stake merger and acquisition (M&A) negotiations for 322 deals that aggregate more than $2.4 trillion in deal value. We find that a full-scale auction is not a common way to sell a firm, and about 75% of our sample deals switch to negotiating with only one buyer in the final stage of the sale process. Moreover, the majority of our sample involves a fluid deal process that changes the nature of the deal (negotiation or auction) as the process proceeds. Most initiating bidders have higher valuations for the target and are the eventual winning bidders. On average, it takes two to three months for the merging parties to reach an agreement on offer prices, and the delay is related to information asymmetry, valuation uncertainty, and potential outside options. Most bidders experiment with offers, but the final premiums are largely similar regardless of the number of offers made by the bidder. About half of the target firms make counteroffers during negotiation; most of the time, the target and the bidder split the price differences. The empirical patterns we document challenge some common assumptions on which much of auction theory is based. Our findings call for further developments in theories that consider the inherent interconnectedness between auctions and negotiations as in the real world.

• The Real Effects of Reference-dependent Preferences: Evidence from Mergers & Acquisitions with Tingting Liu

  • Presented at Financial Management Association Annual Meeting Doctoral Consortium 2021, The Academy of Behavioral Finance & Economics 2021, Asian Finance Association Annual Meeting 2021, Silicon Prairie Finance Conference 2021, and Iowa State University 

  • Abstract: We investigate whether and how reference-dependent preferences affect acquisitions. We find that managers pursue risky and low-quality acquisitions when investors are in the loss domain. Bidder announcement returns are higher when investors are deep in the gain or loss domain. High returns to deals with investors in the loss (gain) domain are followed by reversals (upward drifts). Investor reference-dependent preferences appear to not only cause stock mispricing around mergers but also have a real effect in shaping managers’ acquisition decisions due to catering to investors’ risk appetite. Moreover, changes in analysts’ forecasts around mergers, but not announcement returns, predict post-merger performances. 

• Long Term Institutions, Short Term Institutions, and Market Anomalies with Ferhat Akbas and Paul Koch

  • Presented at The University of Kansas and Iowa State University

  • Abstract: An emerging literature shows that institutional investors puzzlingly tend to trade against well-known anomalies [Edelen, Ince, and Kadlec (2016)]. We show that while more sophisticated short term institutions correctly trade around short term anomalies, the puzzling finding is driven by the trading activity of relatively less sophisticated long-term institutions on long term anomalies. Long term institutions exhibit a trend chasing behavior that is negatively related to the long term anomaly characteristics. By following this strategy, long term investors inadvertently happen to trade on the wrong side of the long-horizon anomalies which explains the puzzling finding in the literature. 

Research Papers In Progress

• The Information Content When Managers Decide Not to Manage Earnings 

  • Preliminary results are obtained

• Learning from Capital Market: Evidence from M&A Decisions, with Zongrui Hu

  • Draft in progress