Market sentiment and the choice of payment method in mergers and acquisitions

• Published date: 01 July 2021
• Author: Pei‐Su Tsai,Tze‐Yu Yen,Chia‐Cheng Ho,Pei‐Jung Tsai
• Date: 01 July 2021
• DOI: http://doi.org/10.1002/jcaf.22501

Received:  October  Revised:  April  Accepted:  April 

DOI: ./jcaf.

RESEARCH ARTICLE

Market sentiment and the choice of payment method in

mergers and acquisitions

Pei-Su Tsai Tze-Yu Yen Chia-Cheng Ho Pei-Jung Tsai

Department of Finance, National Chung

Cheng University, Chai-Yi ,Taiwan

Correspondence

Tze-YuYen, Department of Finance,

NationalChung Cheng University, 

UniversityRoad, Min-Hsiung, Chia-Yi,

Taiwan.

Email:f intyy@ccu.edu.tw

Abstract

The study contributes to the literature that pre-merger market sentiment playsa

significant role in the choice of payment method in M&As and further impacts

the market reactions to such related deals around the deal announcement date.

Stock is more likely to be overvalued and chosen as the medium of exchange

when the market is in the bullish periods. The higher investor sentiment prior

to the deals setting under the cash payment, the better abnormal stock returns

of such deals around the deal announcement date. The two commonly used sen-

timent indexes, BWI and CSI, are both representative for the market sentiment

in relation to the choice of M&A payment methods, but the investor sentiment

index, BWI, is more powerful on explaining the relationship with market reac-

tions.

KEYWORDS

acquisition performance, market sentiment, mergers and acquisitions, payment method

JEL CLASSIFICATION

G, G

1 INTRODUCTION

Numerous researchers in the past several decades have

investigated factors influencing the payment choice of

Merger and Acquisition (M&A) transactions. Typical fac-

tors that have been considered in the literature include:

firm features of both parties such as corporate control con-

cern, debt capacity, growth opportunities, tax effects, etc.

(Amihud et al., ; Brown and Ryngaert, ; Faccio &

Masulis, ; Ghosh & Ruland, ; Harford et al., ;

Jung et al., ; Karampatsas et al., ; Martin, ;

Stulz, ); and deal characteristics such as tender offers,

deal size, offer premium, contract renegotiation costs, etc.

(Boone et al., ; Dong et al., ; Houston & Ryngaert,

; Hubertde La Bruslerie, ; Karampatsas et al., ;

Officer, ; Rhodes-Kropf et al., ; Shleifer & Vishny,

).

However, most of above factors are discussed from the

perspective of the decision makers of acquiring firms. Prior

researchers also observe that the acquirer’s stock tends to

be the payment medium of exchange when its stock price

is relatively high (Andrade et al., ; Ben-David et al.,

; Dong et al., ; Faccio & Masulis, ; Golubov

et al., ; Holmstrom & Kaplan, ; Ismail & Krause,

; Karampatsas et al., ). This raises the question

as to why the target is willing to accept the deal even

when the acquirer’s stock is under concern. Two plausi-

ble explanations have been proposed by Shleifer & Vishny

(, henceforth SV) and Rhodes-Kropf & Viswanathan

(, henceforth RKV) respectively. According to the SV

model, target managers are motivated by self-interest to

agree on the share exchange in the hope of cashing out for

a short-run gain. In this sense, target managers attempt to

take advantage of the overvalued stock but empirically, the

J Corp Account Finance. ;:–. ©  Wiley PeriodicalsLLC 139wileyonlinelibrary.com/journal/jcaf

140 TSAI  .

short-term announcement effect brought by share M&A

transactions is generally not good (Alexandridis et al., ,

,; Andrade et al., ; Boone et al., ; Bouw-

man et al., ; Faccio et al., ; Golubov et al., ;

Moeller et al., ). In the RKV world, acquirer’s stock

is more likely to be overvalued when the sentiment of the

capital market is optimistic. In this sense, target managers

place high expectations for the future synergy and there-

fore accept M&A deals in the form of stock payments. Mar-

ket sentiment seems to play a role in the decisions of pay-

ment method but it has received relatively little attention

in the M&A literature.

Baker and Wurgler () assert that sentiment-based

demands have relatively profound effects on stock valua-

tion, especially those are highly speculative and difficult

to value. They further define investor sentiment as a belief

that future cash flows and investment risks are not justi-

fied by the fact at hand (Baker & Wurgler, ). Baker

et al. () further provide international evidence that the

BWI, tailored for individual markets, is negatively related

to future returns on stocks that are relatively difficult to

value and arbitrage. These arguments reinforce the view

that market sentiment is crucial to M&A deals, because

M&As are widely regarded as speculative investments in

nature, and such investments would become more specu-

lative when these deals are settled by stock payments. Fur-

thermore, sentiment-based demands can be contagious

among investors. Therefore, it is reasonable to expect that

sentiment-based demands due to factors unrelated to the

acquirer may still spill over into the acquirer’s stock.It fol-

lows that high investor sentiment is likely to encourage

shareholders of the target to accept a stock payment in

anticipation of a huge demand for the stocks from outside

investors.

ThelineofreasoningbasedonBakerandWurgler

(,), coupled with the speculative characteristics

of acquisition events, hence motivates us to examine if

market sentiment can affect the choice of payment method

on its own, rather than through its effect on the valuationof

the acquirer’sstock (the SV model) or on the target’s expec-

tation of the acquisition synergy (the RKV model). Fur-

thermore, whether the relationship between market senti-

ment and deal payment methods can be used as a reference

for investors to respond to such M&A deals. In this way,

an easily accessible and representative sentiment indicator

becomes extremely important.

Based on individual investor sentiment, Baker and Wur-

gler (, henceforth, BWI) constructed a representative

market sentiment index, which allows subsequent studies

to provide empirical evidence on the link between investor

sentiment and market valuation of stock prices (Baker

& Wurgler, ,; Cornelli et al., ;Dorn,;

Huangetal.,). In addition to the BWI, another well-

known market sentiment index is the Consumer Senti-

ment Index (henceforth, CSI), which is based on the Uni-

versity of Michigan’s household survey of the economy.

However, as noted by previous studies (Alimov & Mikkel-

son, ; Huang et al., ; Lemmon & Portniaguina,

; Sibley et al., ), the BWI and CSI include the

intrinsic component of the market and consequently might

be a noisy proxy for market sentiment. To obtain a better

proxy, we might need torely on a specif ic model topursue

a “pure” market sentiment measure, however, this would

result in a model-dependent measure, limiting the public’s

access to the information as compared to the easy availabil-

ity of the BWI and CSI. Therefore, the BWI and CSI in the

original formulation are used as a proxy for market senti-

ment in this study, and a measure of the market intrinsic

component proxied by the Dow Jones Industrial Average

(DJIA) is added into the models to control the potential

confounding problems.

With , U.S. M&A completed deals from April 

to December , this study contributes to the literature

with two major points. First, we concede that previous

studies (e.g., Di Giuli, ; Dong et al., ; Rhodes-

Kropf & Viswanathan, ; Shleifer & Vishny,)have

already focused on the relationship between the choice of

the M&A payment method and the misvaluation of the

acquirer’s stock. However, we extend the cause–effect link

by studying whether pre-merger market sentiment (rather

than complex valuation) is directly related to the choice of

payment method and how the cross effect between mar-

ket sentiment and payment method impacts the short-

term market reaction to deal announcements. Second,

prior studies (e.g., Baker et al, ; Cornelli et al., ;

Dorn, ; Huang et al., ; Sibley et al., )have

attempted to further decompose the sentiment measures

into fundamental-related and -unrelated components. The

residual component then is taken as the proxy for the

“pure” market sentiment. Focusingon the merger context,

Regarding the appropriateness of using the Dow Jones Industrial Aver-

age (DJIA) as a proxy for fundamental-related components, we adopt Di

Giuli () as a reference. Di Giuli () takes an approach that does not

need to measure misvaluation to examinewhether the choice of payment

method is related to individual stock mis-valuation. The author first cal-

culates the average capital expenditure of the merged entity during the

four-year period after the merger to measure investment opportunities.

The investment opportunity proxy,along with the combined P/B ratio of

the acquirer and the target right before the merger,is added to the right-

hand side of the regression to control for the effect of the fundamental-

related component of P/B. The P/B ratiocan now serve as a proxy for mis-

valuation. Followinga similar approach used in Di Giuli (), we added

a measure of intrinsic market value into the model to controlfor the con-

founding effect of the fundamental-related component. Specifically, the

DJIA is taken as a proxyfor the intrinsic market value. This is because the

DJIA is comprised of blue-chip companies whose share prices are hard to

manipulate and hence could be a fair reflection of the intrinsic value.