More "Efficient Markets" Nonsense?
At a reader’s suggestion, I checked out the Fama/French website, which is a neat set of Q&A on the implications of the “efficient markets hypothesis” (EMH) way of viewing the world. This particular question–and French’s answer–threw me:
Question: Firms often pay a substantial premium to the market price when making acquisitions. Does their willingness to pay a premium suggest the shares of target firms were mispriced?
Now here’s Fama’s answer, which is perfectly reasonable from an EMH point of view:
FAMA: The empirical evidence says that all the gains from mergers are eaten up in the premiums paid to acquire firms. On average, the acquiring firm gets nothing. This doesn’t necessarily imply that the shares of the acquired firm were mispriced since there can be synergies (real business gains) from mergers.
So to translate into an example, suppose Jim’s Wooden Sticks (ticker JWS) right now is selling for $25 per share. They get acquired by Jane’s Icy Sugar Cyclinders (ticker JIC) for $30 per share. The newly merged corporation can now crank out popsicles at a much lower cost than before, and so JIC has higher earnings as a result. However, after taking into account the $5 per share premium they paid to the original shareholders of JWS, it’s a wash.
I think that’s the kind of thing Fama has in mind. It still seems that “the market” made a pricing mistake, in the sense that a shareholder of JWS would have been furious had he liquidated his position the day before the announcement. But you can at least see where Fama is coming from, and why he thought his answer was a good one. In other words, Fama was trying to explain why JWS shouldn’t have been viewed as free money waiting to be snatched up, since the costs of acquisition exhausted the gains from the merger.
Now if Fama’s above response seems a little incomplete, French’s response (to the same question) is downright incomprehensible to me at least:
FRENCH: Takeover premiums do not imply that the target firms were mispriced. Since we do not expect the market to accurately forecast every acquisition that will create value, we should not be surprised that prices rise when tender offers and mergers are announced.
Help me out here, fans of the EMH. It sure sounds like French is saying, “We don’t expect the market to accurately price everything, so that’s why we shouldn’t conclude that a given stock is mispriced.”
