Precision of Fairness Opinions: An Empirical Analysis

Abstract

Within the large market for mergers and acquisitions, fairness opinions are a de-facto standard in the United States of America to protect management from litigation risks by any of the involved parties. Previous court rulings have highlighted that management cannot rely on internally generated valuation reports to ensure the financial adequacy of a merger. However, fairness opinions created by a well-known financial advisor are able to deliver this protection function.

Researchers are debating whether fairness opinions (FOs) can have other functions as well. Legal researchers see the usability of FOs limited to the protection function, whereas the financial community assumes further functions of fairness opinions. These include an increased likelihood to successfully close the deal as well as lower/higher deal premia. With regards to cumulative abnormal returns (CARs) two different researches have found evidence that deals with FOs are accompanied by lower premiums paid by the acquiring shareholders to the target shareholders. The position of the legal community on the limited usefulness of FOs is supported by the fact that no standards for FOs do exist and that valuation ranges of FOs can be large. For example, one research found average valuation ranges of approximately 70%, which means that the fair price for a target can be between 100 billion USD and 170 billion USD. However, other fairness opinions are nearly as precise as a valuation appraisal. Therefore, the question on the precision of FOs arises and this area of research has not yet been analysed. In general it must be concluded that only a handful of researches has addressed the topic of fairness opinions at all so far.

The dissertation tries to close this research gap by identifying the different functions FOs have to fulfil and the conflicting interests they are torn between. FOs are influenced by principal-agent relations between the fairness opinion provider and the management board, but also by the diverging interests of shareholders and management. Consequently, the functions of the fairness opinions and the principal-agent relations are used to derive variables that might potentially influence the precision of fairness opinions with regards to the valuation range, the valuation accuracy and the known undervaluation of the target by the target’s advisor and the overvaluation of the acquirer’s advisor of the target. The question is if any of these variables leads to a higher precision. The three most commonly applied valuation models are considered as well. As the amount of existing research on FOs is limited, traditional M&A research is considered as well. These three sources are used to deduct hypotheses for the empirical research. The univariate and multivariate analyses have shown that the size of the target, a higher fraction of cash and multiple valuation models help to increase the precision. Hence, if a larger target is acquired with cash and different valuation models are used in the FO, the likelihood of a more precise fairness opinion is significantly higher.

The empirical analysis is also able to demonstrate that a previous relation does not influence the precision negatively; an argument which is often proposed by the legal community. Additionally, the changes in legislation, trying to make FOs more reliable, have not let to an increase in the precision. Criticism on the changes in legislation have highlighted that the best practice will only become officially binding and this argument is supported by the research results.

The variables considered in this dissertation have been limited to the information provided in the fairness opinion itself and, hence, further research should consider other variables to find further significant variables. The research is also limited to the US market and M&A transactions; however fairness opinions are also frequently used in other countries and for other financial transactions, e.g. spin-offs. Nonetheless, by providing some first insight into the precision of fairness opinions and finding significant variables, the dissertation is able to demonstrate that fairness opinions can be more than only an expensive legal protection for managers. It can provide insights to shareholders and lower the level of asymmetric information between the target and the acquirer as well as between the management and the shareholders.