Anticipated vs. realized stock price reactions to M&A announcements: The effect of investor beliefs on abnormal returns and event study inferences

Abstract

This paper investigates how investors’ anticipation of future mergers and acquisitions (M&A), and their prior beliefs about the potential wealth effects of such deals, influence acquirors’ abnormal returns around M&A announcement dates. Based on firm-level and industry-specific information, we construct a measure of prior beliefs by estimating the probability that a company will engage in value-enhancing or value-destroying M&A deals. When comparing predicted deal probabilities and value impacts with actual deal occurrence, we find that our model is effective in predicting future M&A activity. In addition, we demonstrate that it can more accurately predict the value implications of deals initiated by acquirors with higher deal probabilities. Despite this predictive ability, there is mixed evidence regarding whether investors trade on positive prior beliefs before the announcement of a deal, and no evidence of pre-announcement trading activity associated with negative prior beliefs. However, we find asymmetric belief adjustments upon announcement. Investors exhibit a significantly stronger reaction to unexpected value-destroying deals, while underreacting to unexpected value-enhancing deals. These findings are in line with prospect theory, suggesting that loss aversion and reference point dependence shape investor reactions to anticipated M&A activity. In this regard, our study highlights a behavioural channel through which deal anticipation and prior beliefs may introduce systematic bias in short-term event studies, with important implications for the interpretation of abnormal returns and the design of empirical tests in corporate finance research.