Run‐up of Acquirer's Stock in Public and Private Acquisitions

• Date: 01 May 2011
• Author: Douglas Cumming,Dan Li
• Published date: 01 May 2011
• DOI: http://doi.org/10.1111/j.1467-8683.2010.00838.x

Run-up of Acquirer’s Stock in Public and

Private Acquisitionscorg_838210..239

Douglas Cumming* and Dan Li**

ABSTRACT

Manuscript Type: Empirical

Research Question/Issue: This paper empirically examines whether there is pre-announcement movement of an acquirer’s

share price and trading volume prior to the announcement of acquisitions in ways consistent with insider trading. Prior

papers focus on insider trading of a target’s stock; our paper differs by examining for the f‌irst time run-up of acquirer’s

stock, and considers both public and private acquisitions, including private-equity backed acquisitions.

Research Findings/Insights: Acquisition announcements generate predictable movements in the price of the acquirer’s

stock. Pre-announcement trading in acquirer’s stock is more likely to be attributable to insider trading when the pre-

announcement price changes match the expected post-announcement acquirer returns. Based on a sample of Canadian

acquirers and public and private acquisition targets from Canada, the US and 31 other countries over the years 1991–2008,

we f‌ind evidence consistent with insider trading of acquirer’s stock.

Theoretical/Academic Implications: The evidence consistent with insider trading in this paper is limited to specif‌ic

situations and is far from generalizable to all types of acquisition announcements. Post-announcement returns are typically

negative for high Tobin’s q acquirers, stock transactions, and foreign targets, but positive for private equity-backed private

targets. We f‌ind economically and statistically signif‌icant evidence that pre-announcement run-ups move in ways that match

these expected post-announcement effects. Pre-announcement movement in acquirer’s stock largelydepends on the type of

acquisition announcement.

Practitioner/Policy Implications: Our f‌indings have signif‌icant policy implications for the allocation of surveillance efforts

for initiating insider trading investigations.

Keywords: Corporate Governance, Acquisitions, Private Equity, Insider Trading

INTRODUCTION

Abnormal returns prior to the announcement of an

acquisition do not by themselves imply the existence

of insider trading. Detecting insider trading prior to an

acquisition is a diff‌icult task, rendering surveillance of

insider trading and enforcement of insider trading laws

problematic. In fact, empirical evidence has shown that

insider trading laws by themselves without effective sur-

veillance or enforcement can have the perverse effects of

increasing the acquisition costs and making the market

reaction to acquisition announcements stronger, thereby

increasing the prof‌its to, and hence prevalence of, insider

trading (Bhattacharya & Daouk, 2009; Bris, 2005). Empirical

studies have shown that even some developed countries,

such as Canada, appear to be among the worst in the world

for the prevalence of insider trading (Bris, 2005). Other

papers suggest that the pre-announcement price run-up is

actually due to the investors’ ability to correctly predict the

pending takeover bid instead of insider trading (Pound &

Zeckhauser, 1990).

In light of the diff‌icult task of detecting insider trading

(and distinguishing it from market timing) and enforcing

prohibitions against illegal insider trading, it is worthwhile

examining situations when price movements prior to the

announcement of an acquisition are consistent with insider

trading and warrant further investigation. The price

response to the announcement of an acquisition generates

predictable movements in acquirer’s stock depending on

the characteristics of the acquisition. For instance, post-

announcement returns are typically smaller or even nega-

tive for acquirers of foreign f‌irms due to transactional

completion risks, information asymmetries and transaction

costs (Eckbo & Thorburn, 2000). Post-announcementreturns

Address for correspondence:

*Douglas Cumming, Schulich School of Business, York University, 4700 Keele Street,

Toronto,Ontario, Canada M3J 1P3. E-mail: douglas.cumming@gmail.com

**Dan Li, Schulich School of Business, York University, 4700 Keele Street, Toronto,

Ontario, Canada M3J 1P3. E-mail: dli06@schulich.yorku.ca

210

Corporate Governance: An International Review, 2011, 19(3): 210–239

© 2011 Blackwell Publishing Ltd

doi:10.1111/j.1467-8683.2010.00838.x

are typically negative when the acquirer pays in shares

and has a high Tobin’s q because the market inference is that

the acquirer’s equity is overvalued (Myers & Majluf, 1984).

By contrast, announcement returns are positive for acquirers

that purchase private equity (PE)-backed private companies

due to the governance and value-added provided by

the PE investors (Masulis & Nahata, 2009). Taken together,

this body of evidence shows the announcement effects

of acquisitions on acquirer’s stock are predictable. Cases

where the pre-announcement run-up matches expected

post-announcement acquirer returns warrant further inves-

tigation for possible insider trading.

In this paper we consider pre-announcement stock price

and transaction dynamicsof Canadian acquirers that acquire

private and public domestic and international targets. To

the best of our knowledge, our paper is the f‌irst one which

focuses on the pre-announcement price run-up of acquiring

f‌irms that acquire domestic and international public and

private targets. Moreover, our paper contributes to the lit-

erature on insider trading by showing that insider trading

prior to M&A announcement is not limited to target f‌irms’

stocks and there is actually evidence consistent with insider

trading in acquirers’ stocks. Our work is the f‌irst one to

explore the pre-announcement run-up of the acquirer in

response to public versus private acquisitions, domestic

versus international acquisitions, method of payment, PE

f‌inancing and other pre-observed factors. In this paper, we

make use of detailed data that enables the analysis of pre-

announcement run-ups in relation to predictable post-

announcement returns.

Canada offers an interesting institutional setting to study

insider trading of acquirer’s stock for a number of reasons.

First, targets are not just public companies; a signif‌icant

number of acquisitions also involve private f‌irms. Second, a

signif‌icant number of targets are not based in Canada, but

rather, they are based in the US and many other countries

around the world. This type of heterogeneity in the data

enables assessment of different types of target f‌irms and

associated pre-bid announcement of the dynamics of prices

and transactions. Third, while Canadian legal systems are

similar to the US, there appears to be a comparative dearth

of enforcement in Canada relativeto the US, thereby leading

prior international empirical studies of insider trading to

rank Canada as the most prevalent insider trading nation in

the world (Bris, 2005).

We consider a sample of 736 Canadian acquisition

announcements of public and private targets based in

Canada, the US and 31 other countries over the years 1991–

2008. The data consistently indicate that pre-bid announce-

ment run-ups in cumulative abnormal returns (hereafter

“run-up CARs”) vary in predictable ways. It is noteworthy

that these run-ups are not apparent in aggregate; rather, one

must investigate the specif‌ic characteristics of the acquisi-

tion and compare announcement returns for acquisitions

with similar characteristics, and then compare the expected

announcement effect with the CARs over the run-up period.

Specif‌ically, the data indicate run-up CARs are lower for

acquisitions when the bidder has a higher Tobin’s q and

exhibits greater information asymmetry as measured by

the standard deviation of the market model, which is used

to estimate the abnormal return. Run-up CARs are lower

for foreign targets, but higher for PE-backed private targets

(consistent with Nikoskelainen & Wright, 2007; Wright,

Amess, Weir & Girma, 2009). These f‌indings are consistent

with studies of announcement effects of foreign acquisi-

tions in Eckbo and Thorburn (2000) and announcement of

PE-backed acquisitions. For non-PE-backed acquisitions,

run-up CARs are on average negative, but there is signif‌i-

cant heterogeneity across quintiles. Finally, run-up CARs

are lower for share payments, consistent with theory in

Myers and Majluf (1984) showing negative performance

associated with signals from insiders that their equity is

overvalued. These f‌indings are both statistically and eco-

nomically signif‌icant and robust to a number of robustness

checks, such as 2-step treatment regressions for the non-

random choice to target a private f‌irm, alternative explana-

tory variables, different event window lengths, and subsets

of the data. Further, we analyze different market bench-

marks for generating CARs, and examine cumulative abnor-

mal volume, transactions and turnover.

Our f‌indings have policy implicationsfor guiding surveil-

lance authorities in terms of optimizing insider trading

investigations. We demonstrate the importance of directing

more resources to the monitoring of the abnormal price

movement and trading activities in acquirer’s stock, espe-

cially in countries with less strict enforcement of regula-

tion. The data and f‌indings enable regulators to examine

announcement of different types of acquisition transaction

more eff‌iciently. That is, the data and empirics provide

guidance as to where insider trading is more likely to be

observed, and as such, where surveillance and enforcement

could be more eff‌iciently directed. Specif‌ically, the regula-

tory oversight should be concentrated on transactions that

generate predictable movements in acquirers’ share prices,

based on the f‌irm and deal characteristics, such as acquisi-

tion involving a private target, or a foreign target or a target

f‌inanced by private equity. Therefore, surveillance and

enforcement could be more eff‌iciently directed.

This paper is organized as follows. The next section

reviews the prior literature and the following session sum-

marizes stylized facts for the post-announcement returns.

Thereafter we introduce the data and provide summary sta-

tistics. Multivariate regression analyses are presented after

describing the data. Concluding remarks follow in the last

section.

RELATED LITERATURE

Our paper is related to the literature that studies price

run-up before takeover announcements. This literature

focuses on the price dynamics of target f‌irms and not the

acquirer. These studies f‌ind that, in general, target f‌irms

experience signif‌icant price increases prior to the public

announcement of the takeover event.1For example, Keown

and Pinkerton (1981) examine a sample of 194 f‌irms

involved in takeover bids and f‌ind that approximately half of

the market reaction occurs before the f‌irst public announce-

ment date. The substantial price increase in target shares is

interpreted as preliminary evidence of insider trading on

non-public material information, and thereby followed up

with an examination of the trading activities of corporate

RUN-UP OF ACQUIRER’S STOCK 211

Volume 19 Number 3 May 2011© 2011 Blackwell Publishing Ltd