Financial versus strategic bidders and underpricing as an acquisition motive

Abstract

We examine the difference between financial and strategic bidders in exploiting target underpricing. To isolate underpricing from other sources of acquisition gain, we estimate the target revaluation of bids that fail to be completed. We document larger revaluations for targets of financial bidders, precisely private equity bidders than for those of strategic bidders when targets are most likely to be underpriced, that is, when they are small. This differential effect between financial and strategic bidders in target revaluation is robust after controlling for differential sorting into deal failure, future takeover activity and anticipated operational changes and therefore indicates that it is greater target underpricing before bid announcements that financial bidders reveal to the market than strategic bidders do. This suggests that financial bidders and private equity firms attempting to buy smaller firms are more likely associated with underpriced targets than strategic bidders.