The Persistence and Pricing of Merger-Related Transitory Growth and Its Implications for Growth Anomalies and Asset Pricing Models

Abstract

Prior literature in accounting and financial economics measures asset growth as year-over-year growth in total assets. Such growth estimates are upward biased when firms engage in mergers and acquisitions. We decompose asset growth into merger-related and organic growth components, and find that merger-related growth is less persistent than organic growth. The merger-related growth is positively associated with analysts’ optimism in earnings forecasts and stock recommendations, and is a strong predictor of future returns. Furthermore, such return predictability is exhibited by firms that do not transparently disclose the merger-related and organic growth components. This finding is consistent with investors with limited attention playing a role in mispricing. Portfolio asset pricing tests reveal that priced risk factors do not explain this growth pricing anomaly. Stocks with high merger-related growth tend to be associated with higher trading costs and arbitrage risk, which contributes to the persistence of this mispricing over time.

Keywords: Market Efficiency; Limited Attention; Asset Growth Anomaly; Asset Pricing Model; Factor Model; Mergers and Acquisitions; Persistence

JEL Classification: M41; G12; G14; G34