Corporate Finance

Attached paper uses regression techniques to decompose the market to book ratio (M/B ratio) into components that track misvaluation at the firm and sector levels and a component that tracks long-run growth opportunities. The objective of the researchers is to test theories arguing that misvaluations have a significant influence on merger activitiy. Most findings are conventional wisdom. One finding is unexpected:

The researchers found evidence that firms which have a low M/B ratio for the long run tend to buy firms which have a high M/B ratio for the long run. This finding is surprising as probably most corporate finance professionals would think the opposite. Possible explanations given by the researchers are:

A possibility is that managers who face high short-run valuations acquire targets
with high long-run value to substantiate the market’s beliefs.

Another possibility could be that value-maximizing, but low-skilled, managers of low-valued firms acquire managerial talent from outside, and try to adapt their organization to the newly acquired talent.

Or that low-value managers acquire higher value targets as a way of further entrenching themselves.

Misvaluation and Merger Activity