Use caution when merging

Expectation management can be used opportunistically to drive down earnings forecasts
Graphic image of tall buildings with wheels merging onto a highway with cars.


  • Takeover bidders in stock-for-stock mergers have strong incentives to increase their own pre-merger stock prices to lower their acquisition costs.
  • Bidders try to guide analyst earnings forecasts down prior to earnings releases and stock merger announcements.
  • Analysts who have close relationships with bidders are more likely to participate in the practice, called expectation management.

Much like a package that arrives a day early or a flight that lands 30 minutes ahead of schedule, companies can deliver good news to investors by beating projected earnings before a merger or acquisition.

The practice, called expectation management, is an opportunistic behavior by takeover bidders that has become more prevalent since the early 2000s and one that regulators should pay attention to, according to Terry College of Business finance professors.

The research by associate professors Jie (Jack) He and Tao Shu and department head Jeff Netter, which was accepted for publication in Management Science, is novel because it bridges accounting and finance research by introducing the concept of expectation management into a major financial event: mergers and acquisitions.

Prior academic research and the business press have reported that some corporations are able to report higher-than-expected earnings by managing down analyst forecasts and market expectations before earnings announcements.

“Expectation management can boost a bidder’s pre-merger stock price and, in turn, gives it an edge in its takeover negotiations,” Jack He said.

The behavior is prevalent in stock mergers, in which bidders use their own stock to pay the acquisition price to shareholders of the target companies. Bidders have a strong and widely recognized incentive to increase their own stock prices prior to an acquisition: If successful, they will pay fewer shares and save acquisition costs, said Shu.

“If they can beat the earnings forecast, even by one cent sometimes, they see a big jump in the stock price on earnings announcement days,” said He.

Expectation management could present a conflict of interest if financial analysts, who tend to be overly optimistic at other times, act “strategically pessimistic” when they issue earnings forecasts before major events, He said. It’s more likely to happen when analysts have closer relations with stock bidders, the research found.

“This is a distortion of information disclosure that does impact mergers and acquisitions,” Shu said.

The method of payment – stock over cash – gives bidders more incentives for opportunistic behavior, although not all stock bidders use this practice. Expectation management is absent in cash mergers, where bidders pay the acquisition price to shareholders of the target companies in cash. They have much weaker incentives for boosting their own pre-merger stock prices.

The research raises a new concern for some of the players involved in merger deals, specifically target management, investment banks and regulators.

“We are calling attention to this practice so that the major stakeholders understand this type of potentially opportunistic behavior by takeover bidders,” said He.

The paper, “Expectation Management in Mergers and Acquisitions,” also was co-authored by Tingting Liu of Iowa State University.