hen Bank of America (BofA) announced in
October 2003 that it would acquire FleetBoston
Financial, the total value of BofA's outstanding
stocks fell from $122 billion to $113 billion one week after
the announcement while the value of FleetBoston's stocks
rose by about the same amount from $33.5 billion to $42.5
billion. It is not unusual for shareholders of firms acquiring
other companies to lose money after such plans are made
public. Previous studies suggest that the value of an acquiring
firm goes down because the market thinks the company
is engaged in so-called empire-building or its managers are
too confident in their ability to run vast companies.
These studies, however, do not explain why an acquiring
company's shareholders would allow managers to take
on a transaction that gives shareholders a bad return. Even
though BofA's 10 largest investors owned about a quarter of
the company, they did not stop the merger and eventually
lost 10 percent of the value of their holdings—about $2 billion—
in the week following the announcement.
The answer, according to a recent study titled "Crossownership,
Returns, and Voting in Mergers" by University of
Chicago Booth School of Business professor Gregor Matvos
and Michael Ostrovsky of Stanford University, is that many
of BofA's biggest investors also owned substantial stakes
in FleetBoston. Because a buyer normally pays a premium
to acquire a company, it is possible for shareholders of the
acquiring firm to make up for their loss if they also own
shares of the target company.
In fact, the 10 largest shareholders of BofA and FleetBoston
had eight names in common. "They lost money in one
pocket as Bank of America shareholders but made money in
the other as shareholders of FleetBoston," says Matvos. As a
result, instead of losing $2 billion, BofA's 10 largest investors
as a group gained more than $300 million after the
merger was announced.
The BofA-FleetBoston deal is not an exception. Analyzing
a large sample of mergers between publicly traded firms
in the United States from 1981 to 2003, Matvos and Ostrovsky
find that institutional investors with stocks in both the
acquiring and target companies gain from a merger while
those who hold only the acquiring firm's stocks lose.
The difference in expected payoffs means that these two
groups of shareholders will probably vote very differently
when management proposes to acquire a company.
Returns to Cross-Ownership
The study estimates the average returns earned by a particular
group of shareholders—institutional investors—around
the time that a merger is announced. Institutional shareholders
are often a company's biggest investors and also
have the biggest voice in terms of voting for or against a
Turning first to the BofA-FleetBoston merger, Matvos
and Ostrovsky estimate that BofA's institutional shareholders
lost about 7.5 percent of the value of their equity holdings
one week after the announcement of the merger. However,
many of them also owned FleetBoston's stock. After taking
cross-ownership into account, it appears that BofA's institutional
investors did not lose money but actually earned 0.3
percent. The gains were even larger—about 0.7 percent—for
the subset of institutional shareholders who owned stocks in
both the acquiring and target firms.
The authors find similar results when they extend the
analysis to their entire sample. Taking cross-ownership of
stocks into account, institutional investors as a group do not
perform worse than the stock market during the five days
before and five days after the announcement of a merger.
However, institutional investors who own stock only in the
acquiring company lose about 1.5 percent relative to the
performance of the stock market. By contrast, investors who
hold stocks on both sides of a merger increase the value of
their portfolio by 2.5 percent. Thus, cross-owners earn about
four percentage points more than other institutional investors
who hold shares only in the acquiring firm.
The difference in average returns is even larger when the
authors restrict their analysis to the 100 largest mergers in
terms of the size of the target company. In this case, institutional
investors who own both the acquiring and target companies'
stock earn about five percentage points more than
those who hold only the acquiring firm's shares.
This significant difference highlights a potential conflict
of interest between shareholders who lose and those
who gain. Investors who are diversified in both companies'
stocks, for instance, are less likely to vote against a merger
than investors who will potentially bear the full loss when a
merger is announced.
Cross-Ownership and Voting in Mergers
To see how the difference in potential payoffs to institutional
shareholders affects voting behavior, Matvos and Ostrovsky
analyze how a particular group of institutional investors—
mutual funds—tends to vote on mergers. Beginning in 2003,
the Securities and Exchange Commission (SEC) required all
mutual funds to disclose how they
vote as company shareholders.
The authors collected this information
from filings submitted
by the funds to the SEC between
August 2004 and December 2006.
They find that mutual funds
that do not hold shares in the target
company are more than twice
as likely to vote against a merger as those that own shares in
both the acquirer and the target. The authors then restrict
their analysis to only "responsive funds," or those funds that
opposed a merger at least once during the sample period,
because a large number of mutual funds never oppose a proposal
by management. The results are more striking. Among
responsive funds, mutual funds that hold only the acquirer's
stocks are six times more likely to vote against a merger as
The authors also test whether this disparity in voting
behavior only arises when markets expect a poor outlook
for a merger. If investors believe that a proposed merger
is a bad one, investors who own stocks in the acquiring
company alone will more likely oppose the merger than
those who own stocks in both the acquirer and target. It
also follows that there should be no difference in voting
behavior if the merger is widely expected to be good for the
company, such that all shareholders are expected to vote in
favor of the merger. The authors divide the sample by using
the change in the acquiring company's stock price after a
merger announcement as a proxy for a good or bad merger.
A merger is considered bad if the value of the acquiring company's stocks falls, while a good merger is one that
yields a positive return.
Matvos and Ostrovsky find that when it comes to bad
mergers, mutual funds that hold shares in both the acquiring
and target companies are 14 percent more likely to agree to a
merger than mutual funds with shares only in the acquiring
firm. In other words, investors do not mind bad mergers as
long as they own sufficiently large stakes in the target company.
This discrepancy disappears when a merger is predicted
to increase the value of an acquiring company's stocks. As
expected, both groups tend to vote in favor of the merger.
The study highlights an often-ignored area of corporate
governance in the United States. "When we think about
corporate governance, we mostly think about the conflict
of interest between shareholders and managers rather than
between groups of shareholders," says Matvos. Discussions
about conflicts that arise between investor groups usually
focus on emerging markets, such as Korea's predominantly
family-owned and managed conglomerates and India's
pyramid structure of corporate ownership and control. The
study by Matvos and Ostrovsky shows that even in the United
States, it is important to understand how motives and incentives
may differ among shareholders.
However, it is unclear how such conflicts should be
addressed, if at all. A merger announcement that causes the
price of an acquiring firm's stock to fall might signal a bad
merger, but as the study shows, what may be a bad merger
to one group of shareholders may be considered worthwhile
by other investors. Institutional shareholders cannot be
expected to always look out for what is best for the company
because they have a responsibility toward their own
investors, such as the investors of a mutual fund. "The job
of institutional shareholders is not to maximize the value
of a particular firm but to maximize the value for their own
investors," says Matvos.
An interesting area for future research is to examine why
investors with stocks in the acquiring company alone still
vote for a merger about 83 percent of the time, even if the
value of their holdings would clearly fall. One possible reason
is that shareholders may believe that these mergers are
good for the company in the long term so they do not mind if
the value of their investment falls in the short run.
Another reason is that shareholders such as mutual funds
may not want to disagree with management if doing so would
adversely affect their current and future business relationships—
for instance, in managing a company's pension funds.
The cost of disagreeing is especially higher if most shareholders
vote in favor of the merger because it would be easier
for management to retaliate against the one fund that votes
"Cross-ownership, Returns, and Voting in Mergers." Gregor Matvos
and Michael Ostrovsky. Journal of Financial Economics, September