Abnormal Returns and Expected Managerial Performance of Target Firms

We argue that the association between abnormal returns and expected managerial performance of target firms reveals alternative motives behind acquisitions. We test for the disciplinary motive by regressing abnormal returns against the earnings forecast revisions of target firms. A negative slope coefficient is consistent with disciplinary acquisitions because gains from disciplinary actions are likely to be high when target firms’ managerial performance is expected to decline in the future as stand-alone firms. A positive coefficient is consistent with non-disciplinary acquisitions because unexpected increases in targets’ performance as stand-alone firms imply higher expected gains associated with better investment decisions. Our results indicating higher abnormal returns for targets with negative earnings forecast revisions suggest that investors are more optimistic about disciplinary rather than non-disciplinary acquisitions.