The Strategic Choice of Peers in M&A Valuations

Abstract

We examine the strategic choice of peer comparables in fairness opinions (FOs) used in M&A valuations. In contrast to prior research that focuses on the valuation and informational role of FOs with respect to deal premiums, we test the hypothesis that peer comparables are selected in order to mitigate appraisal lawsuit risk. Using a large sample of peer comparable analyses and a regulatory shock to appraisal lawsuit risk, we show that target-sought FO valuations employ lower valued peers when litigation risk is higher. Cross-sectionally, the bias towards lower-valued peers is stronger when the target CEO is retained by the merged firm and owns fewer shares in the target prior to the merger. Examining the consequences, we find that the strategic selection of downward-biased peers successfully reduces the likelihood of appraisal lawsuits, but is also associated with a lower premium received by the target. Our findings suggest that FO valuations are driven, at least in part, by the strategic motive to mitigate litigation risk.