Cosmetic Mergers: The Effect of Style Investing on the Market for Corporate Control

We study the impact of style investing on the market for corporate control. We argue that a firm may choose to boost its market value by merging with a firm that belongs to a style that is more favored by the market. By using data on the flows in mutual funds, we construct a measure of neglectedness, which relies directly on the identification of sentiment-induced investor demand, rather than being a direct transformation of stock market data. We show that bidders tend to pair with targets that are relatively less neglected. The merger with a less neglected target generates a halo effect from the target to the bidder that induces the market to evaluate the assets of the more neglected bidder at the (inflated) market value of the less neglected target. Both bidder and target premia are positively related to the difference in neglectedness between bidder and target. However, the target’s ability to appropriate the gain is reduced by the fact that its bargaining position is weaker when the bidder’s potential for asset appreciation is higher. We document a better medium-term performance of more neglected firms taking over less neglected firms. The bidder managers engaging in these cosmetic mergers take advantage of the window of opportunity created by the higher stock price induced by the M&A deal to reduce their stake in the firm under convenient conditions. JEL Classification: G34; G23; G32