Opinion

Felix Salmon

Where the efficient markets hypothesis never took hold

By Felix Salmon
September 8, 2009
M&A

In the wake of Justin’s book and Cadbury’s rejection of Kraft’s takeover offer, it’s probably worth noting that the one place the efficient markets hypothesis never took hold was in corporate boardrooms. It’s commonplace for boards to say that offers significantly above the stock-market valuation “significantly undervalue the company”, or somesuch — with the clear implication that the market is not rational at all. At least when it’s your own company on the line.

Comments
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I am just reading Galbraith’s Affluent Society and he highlights the dissonance between a person’s generalised view of what is good for humanity, and their refined view what is good for them on a personal level. Your example above is a nice addition to the list.

Posted by Tom | Report as abusive
 

I always assumed that such statements were merely negotiating tactics. Also, it may sometimes to be true that the value of a firm to a certain prospective purchaser is much greater than its book value, because such an acquisition would give the purchaser a strategic advantage.

 

In fairness, there are many reasons why the market valuation of the marginal share bought/sold can’t just be extrapolated linearly to a large block, especially a controlling block.

Posted by axg | Report as abusive
 

Seconding AXG here (I’ve been corrected on that, as well). The ‘share price’ for a traded company is derived from only a certain number of traded shared; there could be several times that number being held by people who want more than the ‘share price’ to part with their shares.

Posted by Barry | Report as abusive
 

Endowment Effect?

Posted by Aaron | Report as abusive
 

In the absence of more information — and almost always with more information — bet on the market in this situation, not the board.

 

Felix,

Any particular reason why you think that an (open) market hypothesis should apply to a (closed) boardroom negotiation?

And…

Inasmuch as both processes yield the same result – an equilibrium price – aren’t they merely two paths to the same destination?

Posted by zeem | Report as abusive
 

“In fairness, there are many reasons why the market valuation of the marginal share bought/sold can’t just be extrapolated linearly to a large block, especially a controlling block.”

If so, then market capitalization for firm is a meaningless statistic and shouldn’t be reported.

Posted by Jon H | Report as abusive
 

“If so, then market capitalization for firm is a meaningless statistic and shouldn’t be reported”.

It certainly doesn’t mean you could buy the company if you only had $MARKET-CAP at your disposal. Nor (a related error) does it mean that if you owned x% of a company for some very high x, your wealth is x% of $MARKET-CAP. But it’s going to be impossible to come up with an unambiguous “right” number in either case, partly because this right number is so dependent on the actual transaction details.

On the other hand, market cap is easy to compute, assumption-free, and is going to be _roughly_ indicative of how these transactions would go. I guess it would take a rather unusual situation for it to mislead you by more than a factor of 2 either way. MSFT really is a vastly more valuable company than, say, RHT, and market cap is sufficient and clear in revealing this basic point.

Posted by axg | Report as abusive
 

Schoolboy error Felix, as pointed out by Sterling.

CBRY was worth £5.70 standalone last Friday, but when you add the potential revenue and cost synergies to that you see a value up to £9-10.
Kraft wanted to keep some of the value-creating synergies for themselves so offered roughly the mid-point: £7.45.

CBRY board is simply stating that Kraft has undervalued the CBRY within Kraft entity, not CBRY standalone.
Without Kraft, CBRY is still worth just £5.70 or so.
By rejecting the offer, the board is hoping to take more than 50% of value of the synergies for their shareholders. i.e. They are negotiating, as is their fiduciary duty.

Posted by Tiny Tim | Report as abusive
 

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