According to prospect theory, people tend to gauge gains and losses relative to a reference point, and
are unwilling to realise mental loss relative to this particular point. Since valuing a target is a difficult
task in M&As, the 52-week high is likely to be used for its simplicity. Burghof and Prothmann (2011)
suggest the use of a reference price increases with the level of information uncertainty. Moreover, the
52-week high reflects a firm’s recent best performance which provides predictions for the future
performance (George and Hwang, 2004). Finally, based on some experimental evidence from
Tversky and Kahneman (1974) and Kahneman and Tversky's works (1979), investors tend to rely on
a piece of information while deciding an atmosphere of risk and uncertainty. In the meantime, the 52-
week high as a reference price has been drawing the attention of the investor through a massive report
by the financial media.
The use of the reference point can be explained by the psychological influence of both the bidder and
the target. Target shareholders may find it hard to gauge managerial performance in M&A activity,
since they do not know for how much exactly their firm should be sold. Lacking information and time
in which to process the information related to the deal, target shareholders are likely to estimate their
firm based on a straightforward relevant price measure, such as the 52-week high. With a strong loss-
aversion tendency, they are not willing to see their firm, sold at a price significantly below their 52-
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The psychological influence among the target shareholders has a substantial impact on the decision-
making processes of their manager. If the target manager sells a firm at a price far below the 52-week
high without a rational motive, the shareholders must blame their managers by arguing that they
would have been better off if they had not sold the firm. Managers thus may incur legal risks. The
magnitude of the premium received by the target manager can be seen as a judgement of whether or
not the manager aims to protect the wealth of their shareholders. It has been shown that U.K. has a
high quality of corporate governance system, which leads to less severe conflicts of interests between
the managers and the shareholders. In this stringent legal environment and shareholder protection,
the wealth of the target shareholders is the first priority. Target managers would bargain for the
premium based on the 52-week high, which is a visible price for the market. Baker et al. (2012)
indicate that bidders tend to pay a price based on the target 52-week high if it is closer to the target
current price, arguing that it might be a true reflection of the real performance of the target. Together,
a positive correlation between offer premiums and the reference price measured by the target 52-
week high in the U.K. market is expected.
H1a: There is a positive correlation between offer premiums and the reference price in the U.K. market.
According to Erel et al. (2012) and Uysal et al. (2008), cross-border bidders have greater
disadvantages in gathering information than domestic bidders due to geographical distance. As the
level of information asymmetry increases, cross-border bidders are less likely to accurately estimate
Chapter 3. Reference Point Theory on Cross-Border and Domestic M&A Deals: U.K. Evidence
107
local social networks. In such a case, cross-border bidders are more likely to measure firm valuation
based on the target 52-week high.
In addition, a more competitive market environment tends to increase target bargaining power, thus
enhancing the reference point effect. Targets may find it easier to negotiate the offer premium based
on their 52-week high with the cross-border bidders than with the domestic bidders. In Edmister and
Walkling (1985), the offer premium is the outcome of negotiation. In the light of this, targets could
require higher premiums when they have greater bargaining power. Therefore, a stronger reference
point effect on cross-border acquisitions toward U.K. targets is expected.
H1b: There is a positive correlation between offer premiums and the reference price when cross- border bidders acquire U.K. targets.
Moeller et al. (2004) suggest that overpayment increases the wealth of the target shareholder and
decreases the wealth of the bidder shareholder. The target 52-week high is perceived as the recent
best performance of the firm. Bidder managers are expected to possibly a lower price so as to increase
the wealth of their shareholders. Bidder shareholders may simply believe their managers pay too
much if their payment is based on the target recent best performance. It is generally believed that an
overpayment leads to a negative market reaction since bidder shareholders may believe such
premiums paid to the target are hard to recover following acquisitions. There, bidders’ performance
around the announcement date are expected to be negatively correlated to the offer premium when
Chapter 3. Reference Point Theory on Cross-Border and Domestic M&A Deals: U.K. Evidence
108
H2: Bidder short-run performance is negatively correlated to offer premiums when deals are made with regard to the reference price.