Manager Sentiment and Merger Activities

ABSTRACT This study investigates the ability of manager sentiment to predict corporate merger activity. Prior research suggests that during periods of high sentiment, managers tend to overestimate the future prospects of their firms. We thus hypothesize that, during such periods, managers may also overestimate the future cash flows from the mergers they undertake. Consistent with this, we find that higher manager sentiment predicts increased merger activities for up to four quarters ahead, and this predictive ability is driven primarily by cash mergers. The result holds at both the market level and the industry level. Additionally, managers finance these cash mergers by issuing debt rather than equity. Furthermore, we find that investors react negatively to mergers initiated during periods of high manager sentiment; however, this result is driven by stock mergers, suggesting that investors may not recognize manager sentiment as a factor driving the increase in cash merger activity. Finally, we demonstrate that the predictive power of manager sentiment on merger activities is distinct from that of manager overconfidence and investor sentiment. Our study contributes to research on behavioral finance and mergers and acquisitions (M&A).