The Wealth Effects of Fairness Opinions in Takeovers

AuthorTingting Liu
Date01 August 2018
DOIhttp://doi.org/10.1111/fire.12168
Published date01 August 2018
The Financial Review 53 (2018) 533–568
The Wealth Effects of Fairness Opinions
in Takeovers
Tingting Liu
Creighton University
Abstract
This paper explores the wealth effects associated with a bidder’s decision to solicit a
fairness opinion in a takeover transaction. Using a hand-collected sample with bidders’ filing
proxy statements, this paper finds that the use of fairness opinions does not negatively affect
bidder shareholders’ wealth, a finding that contradicts prior studies’ findings. In addition, I
find a positive wealth effect associated with bidder use of fairness opinions in the post-Rule
2290 period. Collectively, these results are consistent with a fairness opinion being used by
bidder management as a means to facilitate transactions rather than a mechanism to entrench
management.
Corresponding author: Heider College of Business, Creighton University, Omaha, NE 68178; Phone:
(402) 280–4806; E-mail: tingtingliu@creighton.edu.
I am particularly grateful to my dissertation chair, Harold Mulherin, as well as Srinivasan Krishnamurthy
(the Editor), one anonymous reviewer,Chris Anderson, Scott Atkinson, David Becher, Seong Byun, Erik
Devos, Stuart Gillan, Jack He, Sara Holland, Eric Kelley,Felix Meschke, Jeffry Netter, David Offenberg,
Micah Officer, Bradley Paye, Annette Poulsen, Andy Puckett, Tao Shu, Joshua Spizman, Bonnie Van
Ness, Robert VanNess, Oscar Varela, William Vogt,Eddie Wei, Jide Wintoki, Tracie Woidtke,Julie Wu,
and conference participants at the 2015 Eastern Finance Association Annual Meetings, the 2013 Financial
Management Association Meetings, the 2013 Southern Financial Association Meetings, and seminar
participants at the University of Georgia, University of Tennessee, University of Kansas, University of
Wyoming, University of Mississippi, University of Texas at El Paso, Creighton University, and Loyola
Marymount University for comments and suggestions. I am also grateful to WRDS and EFA 2015 for
sponsoring and selecting this paper for the Wharton School-WRDS Outstanding Paper in Empirical
Research. I am responsible for any remaining errors or omissions.
C2018 The Eastern Finance Association 533
534 T. Liu/The Financial Review 53 (2018) 533–568
Keywords: mergers and acquisitions, fairness opinions, bidder abnormal returns, Rule 2290
JEL Classifications: G24, G34, J33
1. Introduction
Public company boards of directors are obligated to fulfill their fiduciary duty
in important corporate transactions such as mergers and acquisitions (M&As). A
central question is how equity exchange values are determined in M&As because
the process of determining exchange values not only reflects the efforts of boards
of directors to perform due diligence but, more importantly, can also significantly
affect shareholders’ wealth. Seeking a fairness opinion from a financial adviser who
evaluates whether the consideration to be paid or received is “fair from a financial
point of view” is a common practice in M&As. This paper investigates the value
effects of fairness opinions sought by bidders.
Conceptually, two discrete—albeit not mutually exclusive—views interpret the
potential effects of the use of fairness opinions. One view posits that fairness opin-
ions can facilitate transactions because a range of fair prices outlined in the opin-
ions imposes impartial, external constraints on equity exchange values (DeAngelo,
1990). The valuation analysis provided in fairness opinions thus mitigates informa-
tion risks and enhances communications between bidder boards of directors and their
shareholders. I refer to this first hypothesis as the shareholder interest/transaction
facilitation hypothesis, which suggests that management acts in the best interests of
shareholders and that the use of a fairness opinion by management will benefit their
shareholders.
An alternative view suggests that the main motivation for a board of directors
to obtain a fairness opinion is to entrench management by mitigating litigation risks
when management behaves opportunistically at the expense of shareholders. Prior
studies show that litigation risks as an institutional factor mitigate agency problems,
and argue that a reduction in the expected legal liability entrenches management, ex-
acerbates agency problems, and encourages managerial opportunism (Leuz, Nanda
and Wysocki, 2003; Burgstahler, Hail and Leuz, 2006). I refer to this second hy-
pothesis as the management interest/entrenchment hypothesis, which predicts a high
degree of managerial opportunism when a fairness opinion is sought, and that the use
of this opinion will result in significant shareholder wealth destruction.
Admittedly, the two potential explanations might not be mutually exclusive
because boards of directors may have a variety of reasons for obtaining fairness
opinions in takeover transactions.
This paper investigates which explanation has the dominant effect by testing
market reactions to the use of fairness opinions. If the entrenchment explanation has
the dominant effect, then market reactions to the use of fairness opinions should be
T. Liu/The Financial Review 53 (2018) 533–568 535
significantly negative. In contrast, if the transaction facilitation viewdominates, then
market reactions should be either nonnegative or positive.
Existing empirical evidence on the use of fairness opinions by bidder manage-
ment largely favorsthe entrenchment view. Table1, Panel A, summarizes prior studies
that examine the wealth effects of fairness opinions obtained by bidders. The use of
fairness opinions by bidders has consistently been found to be significantly nega-
tively associated with bidder abnormal returns around merger announcements. Prior
studies interpret this negative association as being consistent with the entrenchment
hypothesis (e.g., Kisgen, Qian and Song, 2009). In this paper, I provide new empir-
ical evidence suggesting that the use of fairness opinions does not have a negative
impact on shareholders’ wealth. The negative association between fairness opinions
and bidder announcement returns documented in prior studies is likely due to a severe
sample selection bias.
I start by identifying a sample that requires a bidder shareholder vote. This
sample criterion is crucial, as pointed out by Cain and Denis (2013), who note that
the use of fairness opinions is disclosed only if bidders are required to file proxy
statements to solicit a shareholder vote. Listing rules of the NYSE, Amex, and
NASDAQ require a bidder shareholder vote only when the bidder plans to issue 20%
or more new equity to finance a deal. In other words, as long as the bidder uses cash
or issues less than 20% new equity, a bidder shareholder vote is not required; neither
is the disclosure of a fairness opinion (even if the bidder obtained such an opinion in
the transaction). A major limitation of existing studies that examine abnormal returns
associated with whether or not a bidder obtained a fairness opinion is that the authors
assume no fairness opinion was used if none was observed. This assumption is very
strong, as pointed out by Ferro, Messina and Benoit (2015), who suggest that a bidder
might seek a fairness opinion in larger transactions—even when those transactions
are financed by cash—to help fulfill the fiduciary obligation due to the amount of
cash required. In these cases, fairness opinions are used but not observable. On the
other hand, if we do not observe a fairness opinion disclosed in a proxy statement,
then we can safely conclude that the bidder did not obtain such an opinion, because
the proxy rule requires the disclosure of all material information, including the details
of fairness opinions.
After identifying a sample of deals requiring a bidder shareholder vote, I man-
ually collect the information on the number of fairness opinions obtained by bidders
from the proxy statements through the Secutity and Exchange Commission (SEC)
EDGAR Web site. Consistent with Kisgen, Qian and Song (2009), who point out
that the fairness opinion data provided by the Securities Data Corporation (SDC)
are inaccurate, I find that SDC underreports the use of fairness opinions by bidders,
especially in the early sample period.
To test which hypothesis has the dominant effect, I examine how the use of
fairness opinions affects bidder abnormal returns around merger announcements.
The ordinary least squares (OLS) regression results suggest that the use of fair-
ness opinions does not have a significantly negative impact on shareholders’ wealth

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