Idiosyncratic Volatility, Takeover Premiums and Target Gains

We examine the relation between targets’ idiosyncratic volatility (sigma) with takeover premiums received and target’s acquisition announcement returns. We argue that sigma is a significant driving force of the premium difference and hence different returns enjoyed by target firm’s shareholders. The uncertainty in the market about a target’s value makes bidder manager to pay a relatively higher price, when she believes that the acquisition will increase her shareholders’ value, in favor of target’s shareholders. Our results support this argument as we find that high idiosyncratic volatility targets receive considerably larger premiums and gain significantly more than targets that are easier-to-value. This finding is robust to the method of payment effect and several other target and deal characteristics. Finally, our results have implications about the method of payment effect on target returns by idiosyncratic volatility. High idiosyncratic volatility targets acquired with cash realize the largest returns by great magnitude because the investors interpret this financing decision as the bidder has more favorable information than the market about target’s value and hence appreciate price at the benefit of target’s shareholders