The Effects of the Cross-Correlation of Stock Returns on Post Merger Stock Performance

In this paper, we examine the effects of the cross-correlation of stock returns on the long-run post merger stock performance of UK acquiring firms over the period 1985-2001. We show that, in general, the widely documented anomaly of long-run underperformance following mergers is not due to various stylised merger effects but rather due to the cross-correlation of stock returns, which compromises the 'independence of observations' assumption, thus yielding overstated test statistics. We test, in particular, the method of payment, diversification, book-to-market, and size effects in mergers. We find that these documented long-run effects simply disappear after accounting for the cross-sectional dependence of sample returns. Our results highlight the importance of controlling for the cross-correlation of stock returns in long-run post merger event studies