Boards, Uncertainty, and the Use of Fairness Opinions

Abstract

Manuscript Type: Empirical Research Question/Issue: We propose and test a new perspective on why the boards of some acquiring firms purchase a fairness opinion (FO). Specifically, we examine whether the board’s knowledge explains the use of a FO and the market reaction to the FO. Research Findings/Insights: We find that FOs are more likely to be purchased when the acquiring firm’s board feels uncertain about the deal Specifically, we find that boards with more outside directors are more likely to use a FO, while boards whose directors hold more outside appointments (busy boards) are less likely to seek a FO. Moreover, we find that although the market reacts negatively to the FO, board characteristics both moderate and exacerbate the reaction. When a FO is used by a busy board, the market reacts more negatively to the merger announcement. In contrast, board independence and the average service years for directors seem to moderate the market’s reaction to the FO. Theoretical/Academic Implications: The results of this study are consistent with the idea that a lack of knowledge and underlying transaction uncertainty motivates the board to purchase a FO. In addition, our empirical evidence supports a sophisticated market reaction, where the market recognizes the board’s knowledge when assessing the necessity of the FO.Practitioner/Policy Implications: This study provides a new perspective on why boards use FOs. A board with more outside directors may be strong on monitoring, but may lack knowledge on the deal. This essentially provides an example of a cost associated with an independent board. Further, we show that the market can differentiate the types of board that use a FO.