Contrary to popular belief, investment banks do add value to M&As, new study shows

May 21, 2012

Investment bankers often are stereotyped as greedy, overpaid leeches who will say or do anything for a quick buck.

However, despite certain biases, do add value to and acquisitions and, in fact, produce important information for the M&A advisory process, according to new research by Matthew Cain, assistant professor of finance at the University of Notre Dame's Mendoza College of Business.

The lead author of "Information Production by Investment Banks: Evidence from Fairness Opinions," forthcoming in the Journal of Law and Economics, Cain analyzes a sample of more than 500 fairness opinion valuations that investment banks produce in relation to mergers and acquisitions, one of the primary business units of investment banking. Cain says the fairness opinion valuations they produce provide an objective product that can be analyzed to shed light on the motivations and value added by investment bankers.

"Investment banks do tend to produce valuations that are biased in a way that benefits their clients, which negatively affects their credibility," Cain says. "They produce overly optimistic valuations when hired by bidders in mergers, which can justify overbidding, and by some measures they produce pessimistic valuations when hired by targets in mergers, which can justify the acceptance of offers. Both actions tend to push their clients to consummate mergers; they have incentive to do this because they often earn advisory fees only after a given merger is completed."

However, Cain also finds that despite these potential , investment banks still produce new and valuable information through their valuations.

"They can be useful to boards of directors in evaluating merger proposals," he says. "And when the valuations are made public, the stock market reacts to the information contained in these valuations. Therefore, investment banks do produce information that has value as part of the M&A advisory process."

So, how can biased valuations be worth anything?

"Think of it this way." Cain says, "The absolute level is shifted too far in one direction, but the relative difference among valuations has meaning. Stock analyst recommendations are similar. They tend to be slightly optimistic in their buy recommendations, so to correct for this, you can subtract one notch and then compare the relative recommendations among different stocks. Boards of directors and investors should do the same thing when they consider valuations contained in fairness opinions."

Also the lead author of "Cleared for Takeoff? CEO Personal Risk-Taking and Corporate Policies," Cain's areas of specialty include mergers and acquisitions, corporate governance and financial contracting.

Explore further: 3 Qs: Economist makes the case for new quasi-experiments as a way of studying environmental issues

add to favorites email to friend print save as pdf

Related Stories

Study links personal, corporate risk-taking

Aug 10, 2011

(PhysOrg.com) -- A CEO who enjoys the adrenaline rush of flying a private airplane is more likely than other chief executives to exhibit similarly bold management characteristics, according to a new study by finance professors ...

Recommended for you

Which foods may cost you more due to Calif. drought

Apr 17, 2014

With California experiencing one of its worst droughts on record, grocery shoppers across the country can expect to see a short supply of certain fruits and vegetables in stores, and to pay higher prices ...

Performance measures for CEOs vary greatly, study finds

Apr 16, 2014

As companies file their annual proxy statements with the U.S. Securities and Exchange Commission (SEC) this spring, a new study by Rice University and Cornell University shows just how S&P 500 companies have ...

Investment helps keep transport up to speed

Apr 16, 2014

Greater investment in education and training for employees will be required to meet the future needs of the transport and logistics industry, according to recent reports by Monash University researchers.

User comments : 1

Adjust slider to filter visible comments by rank

Display comments: newest first

Caliban
1 / 5 (1) May 21, 2012

Here's your double tall coffee. It has half and half and sugar in it. Grip the cup firmly, and sip it slowly, because it's hot. Don't spill it on yourself, as it could result in scalding. It's really good coffee, though --shade grown, fair trade, and organic -so enjoy it and drink it all up. That'll be three fifty, please

There is some "new" M&A advice. However, no one is going to pay for it.

M&A advice is going to be -as was explicitly stated in the article- biased towards facilitating consummation of the transaction, and will ALWAYS be information --regardless of "novelty"-- which will encourage that end.

For that reason alone, any fool should be clearly aware of the fact that any and all presentation of facts --again, regardless of "novelty", or objective truth, for that matter-- is made with the purpose of suasion in mind, in order to complete the transaction, and therefore will never be "objective" in the commonly understood sense of the word.

Sales is Sales.

More news stories

Egypt archaeologists find ancient writer's tomb

Egypt's minister of antiquities says a team of Spanish archaeologists has discovered two tombs in the southern part of the country, one of them belonging to a writer and containing a trove of artifacts including reed pens ...

NASA's space station Robonaut finally getting legs

Robonaut, the first out-of-this-world humanoid, is finally getting its space legs. For three years, Robonaut has had to manage from the waist up. This new pair of legs means the experimental robot—now stuck ...

Ex-Apple chief plans mobile phone for India

Former Apple chief executive John Sculley, whose marketing skills helped bring the personal computer to desktops worldwide, says he plans to launch a mobile phone in India to exploit its still largely untapped ...

Filipino tests negative for Middle East virus

A Filipino nurse who tested positive for the Middle East virus has been found free of infection in a subsequent examination after he returned home, Philippine health officials said Saturday.

Airbnb rental site raises $450 mn

Online lodging listings website Airbnb inked a $450 million funding deal with investors led by TPG, a source close to the matter said Friday.