Informed Institutional Trading Around Merger and
Acquisition Announcements

Abstract

Merger and acquisition (M&A) activities are not well-anticipated corporate events in the equity market.Do institutional investors possess material non-public information before M&A announcements? Using a novel methodology that infers high frequency institutional trading, this article investigates the daily trading behavior of institutional investors in target firms before and after M&A announcements in the U.S. equity market from 1993 to 2004. The methodology is based on combining two publicly available datasets: the NYSE Trades and Quotes (TAQ) dataset and the institutional ownership report (13F). The author finds that all institutional investors start to accumulate net buying positions in target firms as far as 30 days before an announcement date. Institutional investors are not a homogeneous group in terms of trading strategies, regulations or information venues, but, surprisingly, they exhibit similar trading patterns prior to the event.This trading pattern indicates that institutional investors may possess material non-public information. On and after the announcement day, investment advisors tend to be merger arbitragers and buy more shares of target firm stocks to speculate on final deal consummation; while banks, insurance companies, and mutual funds immediately reverse their positions to cash in, a behavior consistent with the early informed traders acting as “shortterm profit takers.” The author rules out the possibility of a market-wide information leak prior to the event because prices of target firms do not show any significant price run-ups. Also, the fact that institutions are net sellers in rival firms of targets before the announcement, allows us to rule out the possibility that institutional investors have better models to predict possible takeovers, rather than inside information. Finally, the author shows that the trading by institutions before M&A announcements is associated with a higher probability of informed trading, for the firms they trade.