Use of reference point theory to explain the price paid for private targets

We investigate whether reference points influence the price paid for private targets. Contrary to prior literature, we consider reference points of both target and bidder firms. Because market valuations of private targets are not available, we use comparable public firms and actual deals to derive an implied reference point for private targets. We find that when private firms have an implied valuation that is further from their implied reference points, they require a higher premium. In addition we find that the price paid for private targets is influenced by the bidder’s own reference point. We also show that the degree to which the target reference point influences the price paid for private targets is time-varying and affected by the prevailing economy. Private targets rely less heavily on their implied reference point to negotiate their takeover price when economic conditions are strong. Our findings confirm existing evidence that behavioral biases (reference points) are an important determinant of observed acquisition premiums.