Merger negotiations with stock market feedback

Merger negotiations routinely occur amidst economically significant a target stock price runups. Since the source of the runup is unobservable (is it a target stand-alone value change and/or deal anticipation?), feeding the runup back into the offer price risks "paying twice" for the target shares. We present a novel structural empirical analysis of this runup feedback hypothesis. We show that rational deal anticipation implies a nonlinear relationship between the runup and the offer price markup (offer price minus runup). Our large-sample tests confirm the existence of this nonlinearity and reject the feedback hypothesis for the portion of the runup not driven by the market return over the runup period. Also, rational bidding implies that bidder takeover gains are increasing in target runups, which our evidence supports. Bidder toehold acquisitions in the runup period are shown to fuel target runups, but lower rather than raise offer premiums. We conclude that the parties to merger negotiations interpret market-adjusted target runups as reflecting deal anticipation.