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It pays to analyze the typical patterns in investor psychology and respond accordingly.
"Investor irrationality is something that people tend to focus on when they think about investing in capital markets," he continues, "but there are also implications for corporate finance." For example, when investors hold onto stock they've received in an acquisitiontaking the path of least resistanceit keeps those shares off the open market and makes the price relatively higher than it would have been otherwise. "Normally, when a company sells its own stock in a follow-on offering, the price falls, in part because you're putting more supply on the market for a given level of demand," Baker says. "In the context of a merger, the acquiring company is often issuing shares to someone like me, who passively accepts them. The bottom line is that there's less of a negative impact on their stock price."
The payoff
As a result, the acquirer has a cheaper source of equity financing when pursuing growth opportunities, Baker explains, using the example of a hypothetical company with a fixed strategy that involves acquiring another companythe targetand building a new factory. If the target and the factory each cost $100, and debt can only be used to finance one