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Crackdown on M&A Leaks Makes Them More Rewarding

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It's Economics 101: When you diminish an item's supply, its price tends to go up.

It seems the law of supply and demand applies to inside information about mergers deals. A crackdown on leaks has resulted in a significant drop in "pre-announcement trading," according to a study by the Cass Business School in London.

But at the same time, the rewards for leaking deals—and trading on deals that will be leaked—have grown.


Jeffrey Goldfarb at Breaking Views explains
:

From 2008 to 2009, there was "significant pre-announcement trading" in the stock of a target company in 11 percent of cases. Over the following three years, the rate fell to 7 percent. Reduced merger activity over all may have played a part, but the British Takeover Panel's recent disclosure rules and closer scrutiny of market abuse in the United States also probably had an effect.

The report suggests the financial hazards of gossip have grown. In the boom years from 2004 to 2007, 88 percent of deals that were leaked, either accidentally or intentionally, went on to close. That was roughly on a par with non-leaked transactions. From 2010 to 2012, only 80 percent of tipped deals reached the finish line, while nearly nine out of 10 of the ones kept quiet made it.

The rewards of indiscretion, however, have increased. Five years ago, the researchers discovered little difference in the takeover premiums paid for the two sets of deals from 1994 to 2007. Over the last few years, leaked deals attracted a sharply larger premium—53 percent versus 30 percent. There's no indication of causality, especially as unauthorized disclosures can come from either sellers or buyers. Yet the implications won't be lost on advisers.

All else being equal, a $1 billion company being sold quietly would, according to the findings, fetch $1.3 billion. The price tag for a leaked deal would be $1.53 billion. Assuming a 3 percent fee, a banker would either have an 88 percent chance of pocketing $39 million or an 80 percent chance of $46 million. The second option yields $2.5 million more. Wall Street's collective ego will find that calculus enticing.

This is worth unpacking a bit. Goldfarb is focusing on the incentives for an investment banker leaking about a deal. Leaked deals garner a 53 percent takeover premium, versus a 30 percent premium for deals kept confidential. The leak, however, makes the deal 10 percent less likely to close.

The unleaked deal has an 88 percent chance of paying out $39 million, which translates into a pre-close option worth $34.32 million. The leaked deal has a 80 percent chance of paying out $46 million, which translates into a pre-close option worth $36.8 million. In other words, the leak produces an additional option value of $2.5 million.

That's a clear reason for deals to leak, so it's somewhat of a mystery why the market hasn't returned to a leaking equilibrium. If it creates so much in excess returns, why isn't there more of it?

One answer may be that the Cass study suffers from an aggregation error. Perhaps leaking was always vastly more rewarding for 7 percent of deals, while those represented by the missing four percentage points just didn't generate that much of a leak return. So when the costs of leaking increased, the marginal leaks went away.

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