Mergers and The Market for “lemons”: Evidence from Changing Materiality Standards


We study the consequences of two landmark court rulings (IBP, Inc. v. Tyson Foods, Inc. and Hexion Specialty Chemicals, Inc. v. Huntsman Corp.) which clarified the scope of Material Adverse Event provisions in merger agreements and led to a tightening of materiality standards in New York and Delaware. Based on a sample of large mergers we provide four sets of results in that we find that the court rulings led to: (i) a lower likelihood of acquirer-initiated renegotiations and terminations and to narrower merger arbitrage spreads; (ii) to acquirers being less likely to select smaller, riskier targets; (iii) to a decline in deal premiums of mergers with smaller, riskier targets; and (iv) to a decline in post-acquisition returns following mergers with smaller, riskier targets. Taken together our results are consistent with the argument that the court rulings weakened acquirers’ ability to renegotiate and terminate deals which induces them to price protect. Price protection further truncates the merger activity in an asymmetric manner by turning the segment of mergers with smaller, riskier targets into a “lemons” market in the spirit of Akerlof (1970).