Pre-announcement merger trading by investment bank-affiliated mutual funds

Abstract

PurposeThis study examines whether mutual funds buy or sell the stock of merger targets advised by their investment bank affiliates in advance of merger announcements and withdrawals. Existing literature finds mixed evidence on whether financial conglomerates act on conflicts of interest across divisions.Design/methodology/approachAffiliations between investment banks and mutual funds are identified, and the incidence and characteristics of mergers where funds trade the stock of targets advised by affiliates are examined.FindingsMutual funds buy or increase holdings of merger targets advised by their investment bank affiliate in advance of merger announcements, capturing highly positive abnormal returns. Mergers with this pre-announcement trading by affiliates are more likely to be completed successfully. Furthermore, mutual funds are more likely to liquidate holdings of a target in advance of a merger withdrawal if the fund is affiliated with the target's investment bank advisor, thus avoiding negative abnormal returns surrounding merger withdrawals. Results are robust after controlling for potential sample selection bias.Originality/valueThese findings contribute to the literature on affiliations between investment banking and mutual fund management, M&A outcomes, and to the discussion of potential conflicts of interest within banks. Also, this study is the first to examine trading activities by mutual funds affiliated with merger investment bank advisors during value-sensitive periods beyond the pre-announcement phase, such as the time period leading up to merger withdrawals.