Buyer Beware: Ethics, Adverse Selection, and Target Method of Sale Strategies

Abstract

Abstract: We examine the impact of ethical and acquisition dynamics related to whether the target initiates the sale of the firm on the method-of-sale decision (auctions vs. one-on-one negotiations), and on shareholder wealth creation. While we find a strong positive relationship between proxies of adverse selection risk and the likelihood of target initiation, robustness tests suggest target initiation itself is a unique indicator of information asymmetry in an acquisition environment. We also find that most target initiated transactions follow an auction as the method of sale. Regarding shareholder wealth, we find that the wealth accrued to both bidders and targets increases in auctions, especially in non-target initiated acquisitions. This benefit, however, disappears when the target initiates the acquisition, arguably due to higher unethical adverse selection risk concerns, which is consistent with Akerlof’s (1970) theory of the market for lemons. When adverse selection risk is lower, both the bidder’s and target’s combined gains from acquisitions are higher. The findings have noteworthy implications for managing the target’s ethical reputation.

Keywords: Acquisitions, Auction, Negotiation, Information-Asymmetries, Adverse Selection, Ethics

JEL Classification: G34, G14, L14, M40, D82