Information Asymmetries, Litigation Risk and the Demand for Fairness Opinions: Evidence from U.S. Mergers & Acquisitions, 1980-2002

In the market for corporate control, a potential market failure of asymmetric or inadequate information arises if any of the market participants (the acquiring or target firms’ management, boards of directors or shareholders) have insufficient knowledge about the real market value of a target firm. This failure may be mitigated by the market’s participants choosing to purchase additional information about the value of the target firm. An opinion by a third party regarding this value is known as a “fairness opinion.” Although it is often the case that at least one party to an acquisition obtains a fairness opinion, the issue of whether they provide any informational value is still debated. US court rulings have increased the potential costs to firms and their boards of directors of making merger and acquisition decisions without sufficient information, thus potentially raising the value of fairness opinions. The paper examines factors influencing the decisions of firms engaged in merger and acquisition activity during the 1980-2002 period to obtain or not to obtain fairness opinions. For each transaction information is available on the primary industry in which the acquiring and target firms operate and on the numbers and types of additional information, including fairness opinions, each of the parties to the transaction sought during the progress of the transaction. Our results show that for the acquiring firm in an acquisition, the likelihood of purchasing fairness opinions is influenced significantly by (1) the market values of the acquirer and the target firm, (2) the volatility of excess returns of both firms, (3) whether or not the transaction is a “cash” deal, (3) the degree of asymmetric information as measured by the similarity of the acquirer and target firms, (4) the amount of monopoly power the target firm has, (5) whether the acquisition is “hostile,” and (6) whether other financial advisory services have been purchased by either firm. Finally, strong evidence is found indicating that (7) the behavior of acquiring firms, whether incorporated in Delaware or not, has been significantly altered since the 1985 Van Gorkom v. Smith decision by a Delaware court regarding fairness opinions. Our results for target firms are not as strong as those for acquirers, nor are the results for financial advisory services more broadly defined.