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Enclosure:
1. Synopsis

Page 1

SYNOPSIS
TITLE
Effect of reference price bias on merger and acquisition in India

INTRODUCTION
Mergers and acquisitions have been of interest to researchers for decades.
A particular aspect, attracting much attention, is that the value, created
by combining the assets of two firms, has often not been able to justify the
offer premium paid (Moeller, 2005).
Classical finance theory as well as behavioural finance theory has
contributed with explanations. In classical finance theory, the appropriate
offer premium should be determined as the fundamental value of those
operational and financial synergies that arises from combining assets. The
fundamental value of such synergies is simply found by discounting the
expected cash flows, achieved by combining assets, by a rate reflecting
the risks involved with these cash flows (Miller and Modigliani, 1958).
However, the distribution of the fundamental value of synergies between
acquiring and target shareholders is the result of a negotiation process.
The outcome of this negotiation process is determined by the relative
bargaining power of the acquirer and the target. Thus, in classical finance
theory, relative bargaining power is the cause of unjustified offer
premiums.
In behavioural finance theory, two prevalent arguments have, until
recently, been presented. First, the hubris theory, introduced by Roll
(1986), suggests that it is the management of the acquirer who, motivated
by personal ambition, are willing to overpay for a target. Second, Shleifer
and Vishny (2003) argue that mergers and acquisitions are driven by the
intention of management to exploit mispricing in financial markets.
The ability to do so relates to the private information held by the acquiring
management against investors in the market. Both of these explanations
suggest that offer premiums are driven by the acquisition side. In recent

years, convincing evidence suggests that the target side of a deal may
also add to the understanding of the way offer prices are formed (Baker et
al, 2012; Bugeja et al, 2011). This evidence builds upon concepts from
prospect theory (Kahneman and Tversky, 1979; 1992) and indicates that
target shareholders hold a reference price bias in their subjective
valuation of the target firm. The underlying assumption is that
shareholders in targets as well as in acquirers behave rationally (Simon,
1955).
In practice, the reference price bias impacts the negotiation process
around mergers and acquisitions as target shareholders, concerned with
their relative change in utility, attempts to justify an offer premium, which
cause the offer price to surpass their reference price. This paper aims to
detect the impact of a reference price bias in Japanese mergers and
acquisitions by constructing and testing models that explain the offer
premium along with deal success and market reaction.
In decision making, the concept of a psychological reference point is
described as a belief formation process of anchoring and adjustment
(Tversky and Kahneman, 1974) where individuals use an initial piece of
information (or anchor) to make judgements and adjust the final value
based on other considerations.
In the context of mergers and acquisitions (M&A), Baker, Pan and Wurgler
(2012) examine the role of the peak stock market prices of the target
company as a psychological reference point while determining the offer
price.
The study of reference price bias is relevant as well as interesting in Indian
mergers and acquisition as the market regulator, the Securities and
Exchange Board of India (SEBI), mandates a minimum offer price for M&A
deals taking into account various relevant parameters, which also includes
the targets historical market prices. Particularly, the SEBI Regulation 3
(Substantial Acquisition of Shares and Takeovers (SAST) 1997 with
amendments in 2002 and 2011) makes a reference to the targets twenty
six week high price in SAST 2002, which is amended to sixty day high
price in SAST 2011.

OBJECTIVES

The objective of this study was to determine factor of the target firm
which are significantly related to the offer price.

To identify the relevance of anchoring and to graphically establish

the relationship between the offer price and the stock market peak
prices.

To examine the influence of characteristics of the proposed

transaction - whether it is for cash, stock, hostile, a tender, or a
financial bidder.

To investigate how the bidders shareholders react to the news of

the offer premium, particularly the component of the offer premium
that reflects the targets 52-week high.

HYPOTHESIS

H1: The reference effect may be stronger for those cases where the
offer price is higher than the 52-week high price than in the cases
where it is lower than the 52-week high price?

H2: The targets 52-week high price influences the determination of

the offer price in case of merger and acquisition?

H3: 26-week stock market peak prices of the target firm are
significantly factor in determining the offer price of Merger and
Acquisition.

H4: The likelihood of a deal being completed increase disproportionately

when the offer price, at announcement, exceeds the 52-week average
share price?

Data and Methodology

In this research, the source for M&A is Bloomberg. All unique deals (unique
bids) in which the announcement date is between January 1, 2005 and July
31, 2016, where the target is a public company, in which the offer price is
not missing, and where the bidder starts with less than 50% of the target
firm shares outstanding and ends with 100% or else the percentage
acquired is unknown.
The targets 52-week high price from the (BSE- Sensex) and Prowess for a
final sample., the Dataset comprise of important variables of target firms
like open offer and its characteristics, the stock market prices and
financial characteristics of the target firms, and the data related to the
market index (i.e., BSE-Sensex).
The data relating to the market prices of the stock and the financial
characteristics of the firms will be taken from CMIE Prowess.
Analysis is divided into two parts. One is used to present the descriptive
statistics of the dependent and independent variables to derive testable
Hypotheses and second is to use an econometric analysis to examine the
hypotheses presented in the paper as to model the determinants of the
offer premium.

The offer premium as the total consideration offered scaled by the targets
price as of 30 days prior to the announcement.
Similarly, the 52-week target (market index) high is the 52-week high
stock price (market index) over the 335 calendar days (2-year window)
ending 30 days prior to the announcement date expressed as a
percentage difference from the BSE stock price (market index) 30 calendar
days prior to the announcement date.

References

LANGEVOORT*, D. C. (2011, aug). THE BEHAVIORAL ECONOMICS OF

MERGERS AND Acquisition. Retrieved from
http://trace.tennessee.edu/cgi/viewcontent.cgi?
article=1201&context=transactions

Malcolm Baker, X. b. (2012). The effect of reference point prices on

mergers and acquisitions. Journal of Financial Economics, 23.

Nielsen, S. T. (2013, aug). Retrieved from The Reference Price Bias in

Japanese Mergers and Acquisitions: http://pure.au.dk/portal-asbstudent

Ranganathan, K. (2014, march). Reference Price Bias and

Regulations in Indian. Retrieved from NSE.