Stock market misvaluation and corporate investment payout

Stock market misvaluation and corporate investment payout

The behavioral catering theory suggests that stock market misvaluation can have a first-order impact on major corporate investment and payout decisions while corporate incumbents cater to peculiar investor preferences (such as dividend initiations or omissions, local dividend clienteles, and short-term overinvestments).

 

Relative market misvaluation between the bidder and target firms drives most waves of mergers and acquisitions (Loughran and Vijh, JF 1997; Shleifer and Vishny, JFE 2003). Highly valued bidder firms are more inclined to use stock rather than cash as consideration in mergers and acquisitions (Dong, Hirshleifer, Richardson, and Wong, JFE 2006).

 

Dong, Hirshleifer, Richardson, and Wong (JFE 2006) and Masulis, Wang, and Xie (JF 2007) confirm Loughran and Vijh's (JF 1997) empirical evidence on cash and stock acquisitions. Cash tender offers attract significantly positive cumulative abnormal returns around the acquisition announcement date. Stock acquisitions attract significantly negative cumulative abnormal returns around the acquisition announcement date.

 

Polk and Sapienza (RFS 2009) find a significantly positive relationship between abnormal investment and discretionary accrual (the latter of which is a proxy for the degree of market misvaluation). This pattern is more pronounced for firms with greater opacity (low asset tangibility or high R&D intensity) and investor short-termism (high share turnover). The post-acquisition abnormal return predictability increases with the relative price premium. In this light, corporate incumbents steer major corporate investment decisions to cater to the preferences of myopic investors who seek to secure short-term profits.

 

Baker, Pan, and Wurgler (JFE 2012) empirically find that the 52-week high stock prices serve as salient reference points for senior managers, executive directors, and other stakeholders in the M&A announcement period (Tversky and Kahneman, SCI 1974; Kahneman and Tversky, ECMT 1979). These salient reference points anchor the takeover-premium expectations of corporate incumbents of both the bidder and target firms. Bidder-firm boards can cater to the preferences of the target firm's shareholders by anchoring the M&A transaction price to the 52-week peak stock price. Ceteris paribus, a 10% increase in the 52-week high stock price correlates with a 3% increase in the takeover premium. Target-firm boards that discourage an M&A deal often emphasize that the bid is below the 52-week high stock price, whereas, target-firm boards that encourage an M&A deal note when the bid compares favorably with the 52-week high stock price. Merger waves coincide with higher recent stock returns and stock market values. The market's 52-week high stock price relative to its current value is inversely related to the number of mergers and acquisitions. The preponderance of Baker, Pan, and Wurgler's (JFE 2012) results echoes the market-timing thesis first proposed by Shleifer and Vishny (JFE 2003). These results further lend credence to the catering theory that sheds fresh light on the determination of M&A deal prices.

 

Baker and Wurgler (JF 2004, HEF 2012) argue that corporations often cater to investor preferences for cash dividend initiation or omission. When dividend-paying firms trade at a premium relative to non-payers, many firms are inclined to initiate cash dividend payments. When dividend-paying firms trade at a discount relative to non-payers, many firms are inclined to omit cash dividend payments. This catering theory of dividend payout predicts the initiation and omission of cash dividend payments but not their magnitude.

 

Becker, Ivkovic, and Weisbenner (JF 2011) further find evidence in support of local dividend clienteles. Incumbents cater to the demand for cash dividends if the firm's headquarters are in an American state where seniors constitute a large fraction of the local population. Demographic changes can have a first-order impact on corporate dividend payout decisions in response to senior investor preferences.

 

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