ARBITRAGE OPPORTUNITIES IN CORPORATE TAKEOVERS: AN EFFICIENT MARKETS ANALYSIS (MERGERS, INVESTMENTS, ACQUISITIONS)

This study examines the merger arbitrage opportunities accompanying corporate takeovers. The two empirical issues addressed are: (1) whether merger arbitrage investments yield average profits in excess of their forecasted returns; and (2) whether the results are sensitive to various methodologies of capital market event studies.; The sample of proposed corporate acquisitions, either by merger or tender offer, shows that the most successful merger arbitrage opportunities occur during the preevent period. The null hypothesis of no abnormal returns of merger arbitrage hedge portfolios formed in the period prior to the initial public disclosure is rejected at a high probability level in favor of positive returns. Smaller, but still statistically significant positive returns in excess of their forecasted value are available to arbitrageurs who invest immediately after the public announcement. These postannouncement portfolio returns apparently stem from a positive capital market reaction as the likelihood of a successful outcome increases. When observations are segmented according to actual outcome, the distinction between successful and unsuccessful bids is very noticeable and stresses the arbitrageur's ability to invest consistently in successful takeovers.; With regard to the second research issue, sensitivity analysis indicates that the initial conclusions should be cautiously interpreted. While non-synchronous trading of sample firm securities or a size anomaly do not affect performance statistics, applications of alternative return-generating models, index proxies, and significance statistics generally temper the previous assessments of merger arbitrage returns. Most importantly, after full application of the trading frictions, the null hypothesis cannot be rejected during the earlier postannouncement holding period. These results support the semi-strong form of the efficient market hypothesis and infer that investors cannot systematically earn abnormally positive gains from available public information (i.e. takeover proposals).