Over the years, attention has focused on a firm’s 52-week high as a reference price. The 52-week
high is widely reported by a range of media on a daily basis, such as the Wall Street Journal, Yahoo
Finance, Financial Times, or the South China Morning Post, leading investors to gain full access to
information and may use it to assess the firm’s performance.
Prior research has identified the 52-week high’s salient role as the reference point in the decision-
making processes. Baker et al. (2012) applied the reference point theory in a comprehensive sample
of U.S. public acquisitions, documenting that the reference price measured with the target 52-week
high had a substantial impact on M&A decisions-making process. The target 52-week high is found
to be significantly positively related to the offer premium and bidders receive a negative market
reaction around the takeover announcement date when paying for acquisitions based on the target 52-
week high. The authors explained it with the reference point theory, reasoning that targets are less
likely to give up firms unless the offer premium can compensate target shareholders’ mental loss
relative to the reference price. Their statement implies the reason that bidders pay in accordance with
the target 52-week high is to avoid target shareholders’ loss-aversion, and thus increase the likelihood
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they believe paying based on the target 52-week high is too high. Baker et al’s findings (2012) are
consistent with the implications of prospect theory.
The 52-week high is significant in explaining investors’ behaviour in a variety of studies. Heath et al.
(1999), for example, found a relationship between individual stock option exercise decisions and the
reference point. Their study includes stock option exercise decisions made by over 50,000 employees
at seven publicly traded corporations and finds that the number of employee stock option exercise
activities nearly doubles when the stock price exceeds the maximum price of the previous year. The
authors reason that individual investors have a reference price relative to the maximum stock price
when exercising stock options.
Huddart et al. (2009) provided evidence in a large sample that there is high trading volume around
the past price extremes. Using the weekly observations of 2,000 firms spanning 24 years from 1982
to 2006, the authors found that the past price extremes are significantly related to the trading volume
at the 1% level. The results continue to hold after controlling for a series of variables that have
significant impact on the trading volume addressed in earlier studies. The authors attribute the
salience of the past price extremes to bounded rationality and attention hypotheses that individual
investors tend to rely heavily on past price extremes, since they are limited in obtaining and analysing
information. Their study complements evidence that the 52-week high has a strong effect on the
trading decisions of the investor.
In a similar vein, Burghof and Prothmann (2011) suggest that the 52-week high effect can be
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power when there is a high level of information uncertainty. Investors can obtain profits under a
greater level of information uncertainty by focusing on the 52-week high strategy. Their results
indicate significant reference point effect on the trading behaviour of the investor.
The use of a certain piece of information as a reference point has been well documented in Tversky
and Kahneman's work (1974). It has been well known that human minds are likely to focus on a single
event and overlook other events that lead to different consequences when making decisions. Their
concept has been put forwarded into various studies and the firm’s 52 week high has been widely
adopted as a reference point candidate for its simplicity. Following these studies, the investor’s
decisions in conjunction with the firm’s 52-week high were measured.
Following Tversky and Kahneman’s work (1974), Rau and Vermaelen (1998) suggest the over-
extrapolation hypothesis indicating that investors put considerable weight behind the past
performance of the firm and attribute a higher expectation to the firm’s M&A performance when it
achieves a decent past performance, whilst they may underreact to a firm with a worse past
performance. Their study suggests that investors have a tendency to make predictions by exploring
the firm’s past performance. Based on the assumption that the market is not efficient, investors’ biases
on the past price information are likely to come into play in estimating the firm’s future performance.
3.2.4. M&A offer premiums
M&A offer premiums are an important factor that have received great deal of attention from
shareholders, as it directly determines how the value of the deal is distributed between the bidder and
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their short-horizon shareholders that the firm is hard to generate wealth in the short run even though
it is possible for the firm to create value in the long term. On the other hand, target shareholders
benefit from high offer premiums. With this in mind, a higher offer premium is generally associated
with negative market reactions to the bidder firms but with positive market reactions to the target
firms. Prior literature on the offer premium has largely focused on the two completing hypotheses:
the synergy and the overpayment hypotheses. The synergy hypothesis tends to rationalise the motive
of bidders paying for the target firm as being to create value for the firm, suggesting that managers
serve the best interests of their shareholders should finding positive NPV projects, and premiums paid
for a target are in exchange for potential earnings to be created by a combined entity. The
overpayment hypothesis suggests that bidders are overconfident or the agency problems of the firm
are severe, leading managers to offer the target higher premiums in exchange for the control of the
target firm.
To justify the motive of offer premiums, Berkovitch and Narayanan (1993) tested three hypotheses
of M&A motives in a U.S. study. Their work provided a way of distinguishing synergy from
overpayment by looking at the correlation between target and total gains. It is suggested that
correlation should be positive if the bid is solely driven by synergy but negative if the bid is solely
driven by agency problem, and zero if the bid is solely driven by hubris. Their results indicate that
synergy and agency problem primarily explain the motives of U.S. M&As, with which Hodgkinson
and Partington (2008), agreed in their study of a sample of U.K. M&As over both the short- and long-
term windows, finding that bids are largely motivated by synergy and hubris, and that there is weak
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Re-addressing the offer premium in the U.K. market, Antoniou et al. (2008) found that the synergy
hypothesis has more explanatory power than the overpayment hypothesis. Their study is based on a
sample of 396 successful U.K. public acquisitions between 1985 and 2004. The authors divide the
bidder sample into the higher, medium, and lower offer premium sub-portfolios, and conduct both
the short- and long-term analysis for each sub-portfolio. It was found that the short-term combined
abnormal returns (i.e. synergy) were positively correlated with the offer premium, and the long-term
abnormal returns to bidders did not show any significant differences between the higher and the lower
offer premium sub-portfolios. It is therefore suggested that synergy is a more plausible motive than
overpayment in explaining the offer premium in the United Kingdom.
Another area of literature addresses the offer premium with the overpayment hypothesis. In earlier
research, Roll (1986) found that hubris-infected managers are engaged in value-destroying bids.
Reviewing a series of U.S. and U.K. studies, the author concludes that managers are accused of
overpaying targets. They tend to believe that they have better-than-average skills which lead them to
dominate the market. As a matter of fact, neither the bidder nor the target managers can make correct
predictions as to a firm’s performance around the takeover announcement date. Their results show
that the combined entity generates significantly negative abnormal returns following acquisitions,
reasoning that managers are irrational and the market is efficient, thus managers are unable to explore
mispricing of the market and thus overpaying for their targets due to an overestimation of the expected
synergies.
In the light of this, Hayward and Hambrick (1997) investigated a sample of 106 large acquisitions
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representing important decisions for the firms, tending to expose their CEOs to extensive risks. Their
study shows that bidders who achieve a decent performance in the recent past receive praise from the
media, together with higher salaries from their firms, which become the most important factors
leading them to believe that they are important in the firm. Thus, they are affected by hubris while
making major investment decisions. Their study suggests that the bidder’s recent performance, the
recent media praise for the CEOs, the CEO’s self-importance, and the composite index of these three
factors are positively correlated with the size of the offer premium, incurring negative market reaction.
Hayward and Hambrick's findings (1997) suggest that higher offer premiums are paid by hubris-
infected CEOs.
Using a comprehensive sample of U.S. M&As over the period of 1980-2001, Moeller et al. (2004)
established a positive relationship between the offer premium and the value of the bidder firm. The
authors provided various plausible reasons to explain why larger bidders tend to overpay for their
targets than their smaller bidders. First, larger firms generally have less concerned ownership than
smaller firms, leading to a weaker link in the interests between the manager and the shareholder.
Secondly, managers in a large firm are likely to be more overconfident as they are able to allocate
resources more easily, without any obstacles. Thirdly, larger firms are more constrained in finding
growth opportunities than smaller firms, thus managers are more likely to dissipate resources in
unnecessary projects, which destroy the wealth of their shareholders. Their findings indicate that
bidder managers of a larger firm, due to greater autonomy, are likely to be more overconfident than
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However, Alexandridis et al. (2013) found little evidence that value-destroying acquisitions are
caused by large M&A offer premiums to the target shareholders and reason that the negative source
of the firm’s value is the neglect of the M&A integration process. They find an overall negative
relationship between the target size and the offer premium. Their study reported that the mean
(median) premium for the larger target is 38% (32%), whereas the mean (median) premium for the
smaller target is 54% (45%). Though a lower offer premium is paid to the larger target, it does not
create value for the firm. The authors assert that larger targets are value destroying for bidders, due
to bidders’ neglect of the target post-merger integration.
Incorporating both the synergy and overpayment hypotheses into the M&A study and using the
quadric model for a sample of 49 banking industry M&As between 1995 and 2004, Díaz et al. (2009)
found both the synergy hypothesis and the overpayment hypothesis come into play in their M&A
sample. More specifically, the authors suggest a non-linear relationship between the offer premium
and bidder abnormal returns. The lower level of the offer premium paid to the target shareholders
tends to create synergies for the firm, whilst the value of the combined entity is destroyed when the
offer premium further increases. Based on these results, the authors suggest the synergy hypothesis
is able to explain the lower level of the offer premium and the overpayment hypothesis is able to
explain the higher level.
Many additional studies have largely explained the offer premium in relation to these two competing
hypotheses. Bowman and Richards (2013) suggest that a higher offer premium is used in exchange
for the market power of the bidder, which generates synergy following acquisitions. Soegiharto (2009)
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offer premium. By studying 81 European banking M&A over the period of 1994 to 2000, Diaz and
Azofra (2009) found that bidders tend to pay more for targets that have attractive characteristics, such
as it is larger size and has a decent recent performance. These authors argue that managers can have
substantial private benefits when acquiring another bank successfully, indicating that agency
problems are a source of overpayment. By contrast, Kim et al. (2011) argued that the offer premium
is to reflect upon the bank managers’ willingness for future growth. In that case, there are no conflicts
of interests between the manager and the shareholder and the primary purpose of paying M&A offer
premiums is to exchange for the control of the target firm.