Stock returns in mergers and acquisitions

This paper develops a real options framework to analyze the behavior of stock returns in mergers and acquisitions. In this framework, the timing and terms of takeovers are endogenous and result from value-maximizing decisions. The implications of the model for abnormal announcement returns are consistent with the available empirical evidence. In addition, the model generates new predictions regarding the dynamics of firm-level betas for the time period surrounding control transactions. Using a sample of 1090 takeovers of publicly traded US firms between 1985 and 2002, we present new evidence on the dynamics of firm-level betas, which is strongly supportive of the model's predictions.