Practitioners and academics have long assumed that markets value the deal-specific legal terms of merger agreements yet have failed to subject this premise to empirical scrutiny. Mergers are high-stakes events, so it is unsurprising that the conventional wisdom posits that value is at stake in drafting acquisition agreements and negotiating conditions, “fiduciary out” clauses, and deal protection provisions. The question is whether financial markets price the highly negotiated legal terms of acquisition agreements or only value the financial terms forged by management and bankers. The challenge in answering this question is the difficulty in separating the market impact of the merger announcement (and disclosure of financial terms) from the disclosure of the legal terms, since these events occur in close proximity.
We conduct an empirical study that shows that markets do not respond in an economically significant way to the deal-specific legal terms of M&A agreements. We collected a data set of public company cash mergers spanning the decade from 2002 to 2011 and applied a modified event study to test statistically whether the market reacted to the disclosure of merger agreements. We analyze market reactions by exploiting the (small) temporal gap between the announcement of pending mergers (which lays out their financial terms) and the disclosure of acquisition agreements (which delineate the legal terms) typically one to four trading days later. We find that markets react almost exclusively to the initial merger announcement, and there is no economically consequential market reaction to the disclosure of the acquisition agreement. This finding implies that the extensive negotiations over deal-specific legal terms are not priced into financial market valuation.