PHILADELPHIA — Although banks are often privy to insider information as they help facilitate mergers and acquisitions, they are required to keep that information highly confidential, to the extent that inside information should not even be shared across departments within the same bank. New research from Thomas Jefferson University suggests that banks may not be protecting information effectively, instead using it to purchase merger-related stocks before their values jump. The results suggest that conflicts of interest can create powerful incentives even in the face of strict regulations.
“We were surprised to see just how frequently banks appear to be using pre-merger information for the benefit of certain clients,” says Tim Mooney, PhD, assistant professor and finance area coordinator at Jefferson. His research was recently published in Managerial Finance.
Company mergers and acquisitions bring the opportunity to earn highly positive stock returns. An acquiring firm pays a premium over the stock price of the firm they purchase (called the target). On the day a merger is announced, the stock price of a takeover target increases by 20% on average. Therefore, advance knowledge of a firm’s acquisition would be highly desirable for an investor.
Target firms generally hire an investment bank advisor in connection with being acquired, and in this role investment banks are privy to non-public information about a pending merger. Many investment banks also have investment management divisions that oversee mutual funds. A bank’s own mutual funds stand to gain from inside information about a takeover that their investment banking division is working on. Although information barriers are mandated to isolate non-public information within banks, anecdotal evidence in the financial press suggests these barriers are not always respected.
Dr. Mooney examined data on 3,846 mergers held across 10,803 mutual funds. Using a number of analytical methods, he identified affiliations between underwriters and mutual funds reported in annual funds, SEC filings and company websites.
The research shows evidence consistent with advance knowledge of takeovers being shared across divisions of a bank (investment banking and investment management). Mutual funds buy the stock of over 22% of target firms advised by the fund’s investment bank affiliate leading up to a merger announcement. By doing this, the mutual funds are able to earn the 20% average stock price increase around the merger announcement date. In contrast, mutual funds buy the stock of just 2% of takeover targets where they are not affiliated with the target’s advisor.
“This study adds to the conversation about conflicts of interest within banks and the effectiveness of regulations on the handling of non-public information,” says Dr. Mooney.
Further research in this area could provide insight into what factors drive information sharing between investment banking and mutual fund management divisions. It could also help policymakers and well-meaning investment bank and mutual fund managers mitigate the potential conflict of interest across divisions.
Dr. Mooney appreciates the support of the Thomas Jefferson University Faculty Research and Creative Scholarship Grant, and the Tony DiElsi Junior Faculty Research Grant.
Article Reference: Tim Mooney, “Pre-Announcement Merger Trading by Investment Bank-Affiliated Mutual Funds,” Managerial Finance, DOI: 10.1108/MF-08-2019-0407, 2020.
Media Contact: Edyta Zielinska, 215-955-7359, edyta.zielinska@jefferson.edu.
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