Olga Ihl Devive

Conclusion

5.1.

A pre-requisite for a sound investment or a firm acquisition is the accurate estimation of a firm’s value so that investors or companies do not overpay (Damodaran, 2008). However, valuation has become more complex over the years. This is partially due to an excessive level of information available to market participants. The vast amount of information sources, which often provide conflicting information, might lead to incorrect choices of valuation inputs, resulting in poor valuation estimates, and ultimately wealth losses for investors. In this dissertation, I explore the relation between several factors, including the nature of valuation inputs, corporate governance and institutional factors, and the precision and accuracy of valuation estimates.

In the first study (chapter two), I examine whether valuation performance improves if street earnings, as opposed to GAAP earnings, are used as a basis for peer selection in a multiple valuation framework. If street earnings represent a better reflection of the true economic performance of a firm, then they should also serve as a better basis for selecting comparable benchmark firms. Thus, I benchmark the use of street earnings versus GAAP numbers and examine whether multiple valuation using peers identified based on street earnings outperforms multiple valuation using peers identified based on GAAP numbers. To compare the performance of these peer valuations, I examine the predictive ability and valuation accuracy of peer-based multiple estimates.

I find that street earnings lead to a different set of selected peers compared to GAAP, which is not surprising given the fundamental differences in the derivation of these two sets of earnings. However, it is interesting to note that this different peer selection does not automatically lead to a superior peer-based valuation. On average, I do not find support for the relative superiority of street peers compared to GAAP peers. It is only when significantly different peers are selected that street-earnings based multiples outperform their GAAP counterparts. In addition, I explore whether the difference between the predicted and actual multiple signals potential mispricing, and hence is correlated with future returns. My findings reveal that while the use of street earnings indeed has the potential for identifying mispricing, no such evidence is found in the case of GAAP earnings. My analyses further show that street earnings are particularly superior in terms of valuation performance and identification of mispricing when target firms are volatile, R&D intense, or internationally active. Lastly, I find that the peers identified using street earnings are more comparable to the target firm than peers identified using GAAP numbers.

In the second study (chapter three), I focus on target-sought valuations provided in a fairness opinion in the setting of tender offers. Target valuations are not only valuable to the acquiring firm to avoid overpayment, but also to the target firm to ensure that it is not sold at a discount. Therefore, fairness opinions have successfully established themselves in the merger and acquisition arena and are widely used by acquirees and acquirers. Despite the prevalence of fairness opinions, prior research so far provides inconclusive evidence on the value of these opinions. I argue that the value of a fairness opinion to shareholders depends on the properties of valuation analyses underlying the opinion. Anecdotal evidence reveals that there is a large heterogeneity in the properties of valuations disclosed. Hence, this study sheds more light on the determinants and consequences of valuation properties. Considering the prominent role of the target board of directors in the takeover setting, I particularly focus on the characteristics and incentives of a target board as the primary determinant.

My findings reveal that firm-specific knowledge and incentives of the board are strong predictors of the precision of fairness opinion valuations. Specifically, it is the firm-specific knowledge of the board that is crucial for the precision of valuations. In addition, I find that it is not only the knowledge of the board that is reflected in the precision of a fairness opinion, but also the board’s and CEO’s financial incentives to complete the deal. The stronger these incentives, the greater the likelihood that imprecise valuations are disclosed, potentially to facilitate the justification of the fairness of the offer price. I also find that these financial incentives are strong determinants of the fairness of a fairness opinion. Another main finding of this study is that, in line with my expectations, valuation properties in a fairness opinion matter to target shareholders. I find that target shareholders are more likely to initiate class action lawsuits specifically addressing fairness opinions if these are imprecise or unfair. This suggests that target shareholders use fairness opinions to decide on their tendering decisions, and that they consider valuation properties when assessing the usefulness of a fairness opinion.

In the third study (chapter four), I extend our understanding of the determinants and consequences of valuation properties in fairness opinion. The target board of directors and, ultimately, financial advisers are the two key players responsible for the disclosure of a fairness opinion. Therefore, to obtain a more complete picture of the sources of variation in valuation properties, I focus on the role of financial advisers. In particular, I focus on boutique advisers since these have gained in popularity and demand in recent years. Yet, despite their growing popularity, the evidence regarding the benefits of hiring boutique advisers versus their competitors is still scarce, especially in the context of fairness opinions. Boutique advisers have a different nature and focus as compared to large investment banks because they are independent, often industry specialists and focus exclusively on providing M&A advice. This makes it interesting to investigate whether they provide different fairness opinions as compared to their counterparts.

I find that boutique advisers provide more precise fairness opinion valuations as compared to their counterparts. The recent popularity of boutique advisers seems to be warranted in terms of the precision of their valuation estimates. In general, I find that target advisers with prior ties with the acquirer provide less precise valuations, yet the opposite is true for boutique advisers. They tend to provide more precise valuations if they have prior ties with the acquirer potentially to increase their chances that the acquirer rehires them in the future. Another important finding of the study is that valuation properties are not only associated with shareholder class action lawsuits (see Chapter 3), but also with shareholders’ general assessment of fairness opinions’ credibility. My findings reveal that less precise fairness opinions tend to delay the completion of the tender offer. This suggests that target shareholders need more time to decide whether to tender their shares if a fairness opinion contains less precise valuation estimates. Altogether, my study shows that target firms benefit from hiring boutique advisers since they provide more precise valuations in a fairness opinion, which in turn facilitates a timely deal completion.

5.2. Contributions and Future Research

Overall, the three studies in my dissertation enhance our understanding of the role of various explicit and implicit factors that are relevant for the properties of valuation outcomes. My dissertation provides several important contributions to the body of knowledge and research about drivers of valuation performance. The insights from the research questions examined in this dissertation are relevant to market participants of different nature, ranging from individual investors, firms engaged in acquisitions, regulators and standard-setters to the investment community in general.

The results of the first study (chapter two) contribute to the research on the role of alternative performance metrics, in particular street earnings, for forecasting and valuation purposes. Prior research has extensively examined the persistence and informativeness of street earnings in general as well as the individual adjustments made by analysts to arrive at street earnings. Compared to prior studies, I focus explicitly on the valuation angle and examine the performance of street earnings as direct valuation inputs into a multiple-based model. This is motivated by two important observations. First, anecdotal evidence reveals that a substantial portion of investors still relies to a large extent on GAAP earnings. A proprietary survey by Clermont Partners in 2017 reveals that nearly 30% of active investors rely on GAAP reporting more than non-GAAP when analyzing a company’s performance or making a buy or sell decision. This figure might even be higher for passive investors with a long-term oriented buy-and-hold mentality. Second, multiple sources show that multiple-based valuations are widely used by both sophisticated and non-sophisticated market participants. For instance, almost 85% of equity research reports rely on multiple-based valuation, and more than 50% of all acquisition valuation analyses are based on multiples. Altogether, this emphasizes the relevance of my study on the role of street earnings in the multiple-based valuation framework. My finding that street earnings are not unconditionally superior to GAAP earnings in terms of valuation performance, but predominantly when the firm-to-value is complex and difficult to forecast, should be of interest to all types of investors.

The second study (chapter three) of this dissertation provides important contributions to the acquisition literature and, more importantly, the role of the target board of directors for valuations obtained in the course of an acquisition. Prior studies examined the relation between various characteristics of the board, such as its financial expertise or acquisition experience and acquisition outcomes, often captured by announcement or post-acquisition returns (e.g., Field and Mkrtchyan, 2017; Güner et al., 2008). Most of these studies, however, focus on acquiring firms and their boards to examine the relation between their characteristics and the value they create for acquiring firm shareholders. Hence, little is known about the target side and the target firms’ board of directors, which are equally important in an acquisition. My study is one of the few studies to explore the interplay between characteristics and incentives of the target board and the value they create for target shareholders. Whether a negotiated merger or a hostile tender offer, target shareholders rely on the target board of directors to provide its recommendation towards the offer. Thus, the target board of directors creates value for target shareholders essentially by issuing its recommendation towards the proposed offer, and valuations that support the board’s conclusion. Despite the central role of valuations underlying the target board’s recommendation, evidence on the factors affecting these valuations is rather scarce. Moreover, while shareholder class action lawsuits are often initiated in the acquisition process to express shareholders’ dissatisfaction with disclosures made by the boards of directors, so far little is known on the relation between class action lawsuits and the properties of such disclosures. I fill these research gaps and provide insights on how the target board’s characteristics and incentives shape the valuations provided in the board’s recommendation and, then in turn, how target shareholders perceive these valuations. The findings in this chapter are not only of interest to firms engaged in acquisitions, but also to regulators as recent studies show that valuations supporting the board's recommendation are closely monitored by regulators. Most of the SEC comment letters for merger and acquisition transactions revolve around fairness opinions and their valuations (Liu et al., 2019).

The third study (chapter four) contributes to the body of research on financial advisers, i.e., investment banks in merger and acquisitions. There is a considerable amount of research on the role of investment banks’ attributes, degree and type of involvement, incentives and compensation structure and M&A outcomes. This study focuses on two angles that so far have been unexplored. First, prior literature mainly uses market share league tables to proxy for financial advisers’ reputation. In these league tables, investment banks are ranked based on the value of the target companies in all M&A deals that they advised during a specified period. The market share league tables are widely publicized by both the media and investment banks themselves and are often used by both academics and practitioners as a measure of expertise (Bao and Edmans, 2011). However, the rise of independent and specialized investment banks, the so-called boutique advisers, has shaken up the M&A landscape and, thus, challenges the traditional definition of reputation and quality of financial advisers. The acquisition of LinkedIn by Microsoft in 2016 is said to mark the rise of boutique investment banks. One of the largest tech deals in history with a transaction value of $26 billion involved boutique investment banks as advisers. Most M&A transactions close to this transaction value typically involve the well-established giants in the investment banking industry such as J.P. Morgan or Goldman Sachs. Yet LinkedIn decided to hire two much smaller boutique investment banks, Qatalyst and Allen Co., to assist in the acquisition. Considering the growing importance of and interest in boutique advisers, there is a need for a more detailed understanding on the benefits of hiring a boutique adviser. Second, while prior research examined the relation between boutique advisers and some direct deal outcomes, such as deal premium, my study focuses on a more understudied value creation source of boutique advisers. This is the first study to investigate the role of boutique advisers for valuations underlying a fairness opinion. Since fairness opinion valuations are of great importance to target shareholders, this study provides important insights into the relation between the different types of advisers and the properties of valuations they disclose. This enhances our understanding on when the investment in fairness opinions actually pays off with regard to the precision of the valuation information disclosed by a fairness opinion provider.

The studies in this dissertation are subject to certain limitations, which at the same time can be viewed as possible avenues for future research. The first study uses industry membership based on two-digit SIC codes for the selection of peers. Given the existence and emergence of new alternatives to identify related peer firms, future research could extend the first study and incorporate alternative membership classifications. For instance, Lee, Ma and Wang (2015) propose a new way to identify economically related peers by using a ‘‘co-search’’ algorithm applied to EDGAR’s website traffic. Hence, it is interesting to investigate the role of street earnings for alternative groupings and benchmarking of firms. Additionally, future research could examine the role of non-GAAP earnings issued by managers, either in addition to or instead of street earnings, for peer selection in a multiple valuation framework.

In the second study, I focus on the characteristics and incentives of board members in the setting of an acquisition. While I do capture some of the relevant attributes of the board, future research can explore additional factors such as age, industry experience or busyness of the board members. In addition to the financial incentives examined in the study, career concerns can also be examined since mergers represent serious setbacks to target CEOs’ and board members’ careers. Prior research shows that acquiring firms are more likely to target firms with retirement-age CEOs, likely due to these CEOs’ greater willingness to accept a takeover bid (Jenter and Lewellen, 2015). Future research can delve into a potentially disciplining role of career concerns by examining whether young target boards are more likely to provide precise valuations in a fairness opinion as opposed to a board dominated by retirement-age directors. Moreover, while I do focus on class action lawsuits explicitly addressing fairness opinions, I do not explicitly examine the content and grounds of these lawsuits and complaints. Hence, future research can provide some additional insights into the specific valuation aspects of a fairness opinion that shareholders most frequently complain about in their class action lawsuit complaints.

In the third study of this dissertation, I examine the role of boutique advisers in the context of fairness opinions. As prior studies provide support for the industry specialization of boutique advisers, I do not explicitly integrate industry specialization in my study. Therefore, future research could more closely inspect the role of industry specialization of boutique advisers for the precision of fairness opinion valuations. In addition, future research could explore the variation within the market of boutique advisers. Considering that boutique banks vary substantially in their size and reputation, it is interesting to analyze if top-tier boutique advisers provide more precise fairness opinions as compared to lower tier boutique banks. Overall, in both studies (study two and three) I focus on a setting where I expect fairness opinions to be of great importance, namely tender offers. The relevance of the setting, however, comes at a cost of a relatively small sample size. Future research could, therefore, investigate the examined research questions in a setting of mergers and acquisitions to increase the statistical power of the tests.