48 Corporate Governance: An International Review, 2010, 18(1): 4863

Boards, Uncertainty, and the Use of Fairness Opinions

Melissa B. Frye* and Weishen Wang
ABSTRACT Manuscript Type: Empirical Research Question/Issue: We propose and test a new perspective on why the boards of some acquiring rms purchase a fairness opinion (FO). Specically, we examine whether the boards knowledge explains the use of an FO and the market reaction to the FO. Research Findings/Insights: We nd that FOs are more likely to be purchased when the acquiring rms board feels uncertain about the deal. Specically, we nd that boards with more outside directors are more likely to use an FO, while boards whose directors hold more outside appointments (busy boards) are less likely to seek an FO. Moreover, we nd that although the market reacts negatively to the FO, board characteristics both moderate and exacerbate the reaction. When an FO is used by a busy board, the market reacts more negatively to the merger announcement. In contrast, board independence and the average service years for directors seem to moderate the markets reaction to the FO. Theoretical/Academic Implications: The results of this study are consistent with the idea that a lack of knowledge and underlying transaction uncertainty motivates the board to purchase an FO. In addition, our empirical evidence supports a sophisticated market reaction, where the market recognizes the boards knowledge when assessing the necessity of the FO. Practitioner/Policy Implications: This study provides a new perspective on why boards use FOs. A board with more outside directors may be strong on monitoring, but may lack knowledge on the deal. This essentially provides an example of a cost associated with an independent board. Further, we show that the market can differentiate the types of boards that use an FO. Keywords: Corporate Governance, Merger, Board Knowledge, Fairness Opinion, Market Reaction

INTRODUCTION
n mergers and acquisitions, the boards of acquiring rms and/or target rms often seek a fairness opinion (FO) from nancial advisors, usually investment banks. The FO indicates whether the deal, particularly the price, is fair to their shareholders. It is essentially a professional opinion based on collected data with an unambiguous indication of whether the deal is fair. FOs are not mandatory; however, Kisgen, Qian, and Song (2009) report that 80 per cent of targets and 37 per cent of acquirers are willing to pay substantial fees to obtain a third-party assessment of the merger. Some studies suggest that directors seek such opinions to provide legal protection as they may provide evidence of the boards due diligence (Bowers & Latham, 2006; Chen & Sami, 2007; Kisgen et al., 2009; Makhija & Narayanan,
*Address for correspondence: Department of Finance, College of Business Administration, University of Central Florida, Orlando, FL 32816-1400, USA. Tel: 407-823-3097; Fax: 407-823-6676; E-mail: melissa.frye@bus.ucf.edu

2007). However, Ohta and Yee (2008) stress that this legal protection or inoculation hypothesis cannot be the whole story. Specically, they question why all rms do not use them if they provide valuable protection as well as why they are not boilerplate across all transactions. They highlight that the use of FOs did not increase following the Smith versus Van Gorkum case in 1985, where the Delaware Supreme Court rebuked a board for failing to make an informed decision. Ohta and Yee (2008) further highlight that there are no cases where a board has been held liable for failing to obtain an FO. Moreover, extant studies that focus on the legal protection hypothesis often present inconclusive or even puzzling results as to why a board would use an FO. Kisgen et al. (2009) do consider an alternative to the legal protection hypothesis, which they label the transaction improvement hypothesis. Their results for acquirer FOs support both hypotheses. Specically, they nd that deal premiums are lower for acquirers using an FO (consistent with the transaction improvement hypothesis), while they also show that
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deals with acquirer FOs are more likely to be completed and are associated with greater wealth losses (consistent with the legal protection hypothesis). However, they assume that acquiring rm announcement returns provide a more comprehensive assessment, thus they conclude that FOs are used for legal protection. In addition to these mixed results, Kisgen et al. (2009) nd that smaller boards with more outside members are more likely to use an FO, seemingly indicating that rms with better corporate governance structures are more likely to use an FO. This raises the question as to why a rm with better governance would need more protection. In contrast, Bowers and Latham (2006) assume that rms with better governance (measured by the Gompers, Ishii and Metricks, 2003 governance index) would face lower litigation risk and thus would be less likely to obtain an FO. However, they nd no evidence that governance affects the demand for FOs. Makhija and Narayanan (2007) contend that captured boards with more insiders would seek the legal protection of an FO, but they nd no signicance in their empirical tests with acquirers. The inconclusiveness on this issue begs a new viewpoint. In this paper, we propose and test a fresh perspective on acquiring rms use of FOs. We focus on acquiring rms for several reasons. Kisgen et al. (2009) note that there is more variation in the use of FOs by acquiring rms, which raises the question as to why some rms purchase them while others do not. Second, most acquiring rms experience signicant losses in mergers, while targets often gain (Andrade, Mitchell, & Stafford, 2001). Moeller, Schlingemann, and Stulz (2005) stress the importance of understanding why announcement returns of acquirers are associated with large losses. Since an FO is an added expense to an event that, on average, destroys shareholder wealth, the motivation behind the purchase seems timely and relevant. Finally, the Kisgen et al. (2009) ndings on acquirer FOs are not always consistent with their legal protection hypothesis. In our paper, we contend that FOs are more likely to be purchased when the board has excessive uncertainty associated with the deal. We maintain that some boards are more knowledgeable about the value-creating potential of the deal than others. Such boards will feel more certain about the merits of the merger and will be less likely to ask investment bankers whether the deal price is fair. Coles, Daniel, and Naveen (2008) and Kroll, Walters, and Wright (2008) emphasize the importance of board knowledge in both the monitoring and advising functions of the board. Under this new perspective, we also expect the market to recognize the uncertainty of the underlying transaction as well as the knowledge of the board. We expect that the use of an FO will signal to the market that the board was unsure about the synergies of the deal (or that the transaction was complex). Thus, the market will react more negatively to deals with an FO. However, we expect the market to temper this reaction based on the underlying knowledge of the board. We note that prior studies have considered governance as a determinant of the use of an FO (Bowers & Latham, 2006; Kisgen et al., 2009), but they do not examine whether announcement returns are affected by characteristics of the board using the FO. Makhija and Narayanan (2007) examine the effect of low inside holdings and low

board independence only on target company announcement returns. Using multiple proxies for the boards knowledge as well as a matched sample to control for the deal uncertainty, our empirical results suggest that the boards uncertainty about the value of the deal is an important determinant of the use of an FO by an acquiring rm. We nd that larger boards, or more specically, those with more outside directors, are more likely to obtain an FO. Outsiders to the board may feel less informed about the merger valuation and thus obtain the FO as a means to gather information. We nd that boards with busy directors are less likely to use an FO. Serving on multiple boards may increase the directors knowledge base and thus decrease the need to seek an FO. We also nd evidence that boards are more likely to use an FO when there is more uncertainty about the underlying transaction. In general, our results are consistent with Ohta and Yee (2008) and suggest that the boards knowledge is important in explaining the use of an FO. In terms of market reactions, we nd that overall the market reacts negatively to the FO; however, board characteristics both moderate and exacerbate the reaction. Specically, we nd that when an FO is used by a board with a greater percentage or number of outside directors or by a board whose members have long tenures with the rm, the market reacts less negatively. Such boards are likely to have less knowledge and the market appears to recognize the necessity of the FO. However, when a busy board, which should be more knowledgeable, uses an FO, the market reacts more negatively. The contribution of our study is twofold. First, we provide a new perspective on why boards use FOs. We show that a board with more outside directors may be strong on monitoring, but may lack knowledge about the value-enhancing potentials of the deal. This essentially provides an example of a cost associated with an independent board. Our framework of uncertainty may provide a better explanation for the relation between board characteristics and the use of an FO than that offered by previous studies, which seemingly show better governed rms need more legal protection (Kisgen et al., 2009). Also, our framework and results provide an alternative explanation to the mixed ndings of Kisgen et al. (2009), where deal premiums are lower but announcement returns are negative for acquirers with an FO. The use of an FO may lead to a better transaction (lower deal premium), but may signal to the market the boards lack of knowledge. Thus, our ndings may reconcile the results in Kisgen et al. (2009). Second, we show that the market does consider the characteristics of the board that uses an FO. An FO may signal to the market that the board is unsure about the merger and subsequently the market reacts negatively to the FO. However, the market recognizes the necessity of an FO for boards lacking knowledge to perform their duciary duties.

BOARD KNOWLEDGE AND FAIRNESS OPINIONS (FOs)

The board has both an advisory and monitoring role, which require extensive knowledge about the rm and its strategic environment. In the case of mergers and acquisitions, the

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acquiring rms board needs to know not only their rm, but also about the target rm and the potential synergies from the merger. Variation in board knowledge may affect the boards decision making process. For a knowledgeable board, it is likely to be easier for the board to decide whether the merger ts the rms strategy and the value of the target rm to the acquiring rm. In this case, seeking an external opinion may be unnecessary. However, with a less knowledgeable board, purchasing an FO may be required for board members to feel comfortable with the transaction. We use several proxy variables to capture the boards knowledge, including the percentage and number of outside (independent) directors on the board, the size of the board, the average years of director service, and the busyness of the directors. When the board has more outside directors, these directors have less information about the rm simply because they are outsiders (Coles, Daniel, & Naveen, 2008). Fama and Jensen (1983) note that outsiders are independent of the CEO but are less informed about the rms projects. The literature generally contends that an independent board may be more effective at monitoring (e.g., John & Senbet 1998). Johnson, Hoskisson, and Hitt (1993) and Judge and Zeithaml (1992) indicate that boards that are more independent are more likely to exercise greater inuence over strategic decisions. However, a lack of knowledge about the rm coupled with a strong desire to monitor may persuade the independent board to collect more information to reduce their uncertainty about the deal. In Rahejas (2005) model, when the number of outsiders on the board is large, the costs to coordinate efforts and verify projects increase. She shows that outside directors can determine project quality only if they incur costly verication. Seeking an FO from an investment bank is an example of such costly verication. Thus, the percentage of outside directors on the board should be positively associated with the probability of obtaining an FO. With respect to a merger, internal knowledge about the rm may not be as important as the ability to assess the synergies between the two companies. The management literature often suggests that independent directors gain knowledge from their work outside the rm and become better advisors (McDonald, Westphall, & Graebner, 2008). While this may suggest that such directors would be more knowledgeable about acquisitions, McDonald et al. (2008) point out that outside directors must balance board duties with a variety of other professional responsibilities, suggesting time constraints may also make the FO more appealing as they may not have time to adequately research and understand the transaction. Likewise, Goodstein, Gautam, and Boekers (1994) arguments suggest that as the number of outsiders on the board increases, the chance of board factions and coalitions would also increase and thus reduce knowledge transfers among directors. If knowledge is not exchanged, the board as a whole will be less informed and knowledgeable. Thus, we expect boards with more outsiders to be more likely to seek an FO. Note that we consider both the proportion of outside directors as well as the interaction of the percentage of outside directors and board size, in other words the number of outside directors. This approach is consistent with Coles, Daniel, and Naveen (2008).

The size of the board may also measure of the boards knowledge, or more specically, the knowledge exchange among members. Prior literature contends that larger boards suffer from communication and coordination problems (Eisenberg, Sundgren, & Wells, 1998). This leads to less information dissemination between board members, resulting in a board that is less knowledgeable in an aggregate sense. In Goodstein, Gautam, and Boeker (1994), large boards become more factionalized into special interest groups as the strategic decision becomes more complex and ambiguous. This results in directors promoting their own agendas and a decreased interest in sharing expertise. Goodstein et al. (1994) argue that this less cohesive board essentially becomes a barrier to reaching a consensus on important decisions. Likewise, Jensen (1993) suggests that larger boards have less candid discussions among directors, again suggesting the aggregate knowledge of the board may be reduced. Thus, we expect larger boards to be more likely to purchase an FO. Our next proxy for board knowledge is the average directors years of service with the rm. Vafeas (2003) notes that long tenured directors may have important internal (not necessarily external) knowledge about the rm; however, such directors are more likely to be beholden to management and detrimental to shareholder interests.1 Anderson, Mansi, and Reeb (2004) nd that as board tenure increases, managers are better able to sway director opinion, suggesting less oversight by the board and less open discussions in the boardroom. Kaymak and Bektas (2008) conclude that long tenured directors have clouded judgment. Boone, DeBrabander, van Olffen, and van Witteloostuijn (2002) nd that increased board tenure leads to poor decision making because such directors rarely challenge managers. Katz (1982) shows that extended tenure reduces intra-group communication, and isolates groups from critical information sources both within and outside their organizations. Thus, a board with long-tenured directors may again suffer from a lack of communication, knowledge, and information sharing, resulting in a less knowledgeable board overall. Finally, Rutherford and Buchholtz (2007) associate long board tenure with a greater likelihood of proactively seeking information to reduce asymmetric information. Thus, we expect service years to be positively related to the use of an FO. The nal proxy for board knowledge is the busyness of the directors, captured by the number of other directorships held by the board. Several studies show that directors having additional appointments may provide benets to the rm. Harris and Shimizu (2004) nd that over-boarded directors are important sources of knowledge and enhance acquisition performances. Carpenter and Westphal (2001) show that additional directorships enhance the directors ability to contribute to strategic decision making. Thus, busy directors may be more knowledgeable about mergers and synergies, making them less likely to seek an FO.2 In addition to looking at the use of an FO, we also examine market reactions. The purchase of an FO likely indicates a lack of certainty on the part of the board and will result in a negative market reaction. However, we expect the degree of value loss to be moderated by board knowledge and the necessity of an FO. Broadly speaking, we expect that if the

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board needed an FO to overcome a lack of knowledge, the market should react less negatively to the FO. In contrast, if an FO is used by a board that essentially does not need the FO (or should already be knowledgeable), the market should react more negatively when an FO is used. Specically, we expect a less negative reaction when an FO is used by a larger, more independent board and by boards with long-tenured directors. Boards with more outside directors may need the costly verication to ensure project quality (Raheja, 2005), while larger boards may need to overcome communication problems that reduce information exchange and thus overall board knowledge. Likewise, a board with long-tenured directors may have less information sharing and less access to critical information (Katz, 1982). In a sense, the market should view the FO as necessary or justied under these conditions and thus react less negatively. In contrast, we expect the negative response to the use of an FO to be stronger when the FO is purchased by a busy board. Essentially, the market may view an FO even more negatively when purchased by a board that should not need an FO. In this case, the FO represents wasteful spending by a board that should have the expertise to evaluate the merger. In addition, a busy board, with presumably more knowledge, that purchases an FO may signal that the deal uncertainty is extremely high. If a board with members having expertise is looking for additional information that may indicate very high levels of ambiguity associated with the deal.

DATA AND METHODOLOGY

Data
To examine the role of board knowledge and the use of an FO, we start with director data maintained by the Investor Responsibility Research Center (IRRC). The data cover the years 19962003 and include 2,594 US rms and 11,579 rmyears. We obtain quarterly nancial and monthly stock return data for these rm-years from CRSP (Center for Research in Security Prices) and Compustat. We obtain the 4,103 merger deals that these 2,594 rms undertake as acquiring rms during the period from 1996 to 2004 from the Securities Data Corporation (SDC) on-line Merger and Corporate Transactions database. Finally, we merge the deal information with the acquiring rms nancial (stock) information from the month prior to the deal and the rms governance information. Our nal sample consists of 1,102 mergers.3 For each deal, SDC discloses whether the investment banks used by the acquiring rm provided an FO.4 However, as Kisgen et al. (2009) note, relying on SDC data may severely underestimate the actual incidence of FOs. To correct this potential bias, we manually search SEC lings for the 580 deals in which SDC indicated a nancial advisor was used. We nd 103 deals that use buy-side opinions.5 We also randomly check another 300 deals that SDC does not state that the acquiring rm used nancial advisors. We nd that this characterization is accurate. That is, when SDC states that there is no buy-side nancial advisor in the deal, we do not nd a buy-side opinion.

Consistent with Coles, Daniel, and Naveen (2008) and other studies, we use the natural logarithm of board size and the number of independent directors, as well as the percentage of independent outside directors.6 To compute the number of years of service, we use the average number of years that all directors have served on the board. Director busyness is the average number of other rm boards on which directors sit. All board characteristics are from IRRC. We also control for variables documented by prior studies on FOs, such as in Kisgen et al. (2009) and Bowers and Latham (2006). Board holdings are the total shareholdings of the directors on the board. Board holdings are often used as a measure of the rms internal governance or alignment of manager and shareholder interests. Firms with low inside ownership should be more likely to seek an FO. As Kisgen et al. (2009) suggest, managers of these rms may be more likely to pursue dubious acquisitions for their own private benet. We also use deal features that capture the underlying risk, including the transaction value (size), whether the acquiring rm and target rm conduct business in close industries, whether the acquiring rm uses its stock as currency, the attitude of target rm management to the deal (hostile or not), and whether the target is publicly traded (Public Target). Larger deals, deals paid for with stock, deals in different industries, and friendly mergers are more likely to be complex. Publicly traded targets may be more complex, but they are usually acquired to enter new businesses (Capron & Shen, 2007). In addition, we control for the acquiring rms size and performance before the deal announcement. In our market reaction analyses, we include a dummy variable equal to one if the target rm uses an FO (TFO). Makhija and Narayanan (2007) show that the market reacts less favorably to deals where the target company uses an FO. Controlling for this allows us to separate the effects of acquirer FOs and target FOs. While our models include deal characteristics, it is possible that our results are biased since a relatively large proportion of our sample does not use an FO and our controls may not adequately capture the notion that an FO is more likely to be used when uncertainty is high. To address this and provide a robustness check, we construct a matched sample. Specically, we match opinioned deals to nonopinioned deals based on industry (4-digit SIC code), size (acquirers market capitalization), and book-to-market ratio.7 We are able to match 103 opinioned acquirers to 185 non-opinioned rms. The board and deal characteristics of the sample are given in Table 1. In terms of board characteristics, the median board has 10 members, of which approximately six are independent. Directors on average have served on the acquiring rm board for 8.2 years. Acquiring rm directors serve on an average of .99 other boards. In terms of using an FO, there are about 9 per cent deals in which the acquiring rm uses an FO, and about 26 per cent target rms use an FO.8 The acquiring rms stock performance before the announcement (Pre-performance), computed as the average abnormal monthly return of the acquiring rm against the simple market model over the 24 months prior to the merger announcement, is 1 per cent. Same Industry is a

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TABLE 1 Summary Statistics for Acquiring Firm Variable % of Outsiders Board Size Number of Outsiders Service Years Busyness Board Holdings Acquirer Fairness Opinion Target Fairness Opinion Assets Pre-performance Transaction Value Same Industry Hostile Stock Pay Number of Bidders Public Target Premium Acquirer Market Cap Acquirer Book to Market CAR (-1, 0) N 1,102 1,102 1,102 862 862 998 1,102 1,102 1,072 1,102 946 1,102 1,102 1,102 1,102 1,102 529 1,102 1,102 1,102 Mean .63 10.53 6.76 8.20 .99 7.33 .09 .26 16,263.25 .01 1,358.96 .49 .02 .53 1.05 .59 55.23 20,047.40 .36 -.8% Median .67 10.00 6.00 7.92 .89 2.00 .00 .00 3,335.50 .01 215.98 .00 .00 1.00 1.00 1.00 44.44 3,689.78 .31 -.5% Std .18 3.81 3.35 3.35 .70 13.74 .29 .44 55,762.46 .03 4,770.13 .50 .13 .50 .25 .49 103.82 50,895.80 .26 4.9% Minimum .00 4.00 0 .88 .00 .00 .00 .00 92.10 -.09 .01 .00 .00 .00 1.00 .00 -86.28 44.90 -.23 -28.0% Maximum .92 25.00 22.00 23.17 3.56 93.20 1.00 1.00 1,057,657.00 .17 89,167.72 1.00 1.00 1.00 4.00 1.00 1,937.04 571,197.28 2.24 16.7%

This table reports summary statistics for the sample. % of Outsiders is the percentage of outside independent directors on the board. Board Size is the number of directors on the board. Number of Outsiders is the number of outside directors on the board. Service Years is the average years that directors have served the company. Busyness is the average other company boards on which acquiring rm directors sit. Board Holdings is the number of shares held by the board members divided by the rms total number of shares. AFO is a dummy variable taking a value of 1 if acquiring rm uses fairness opinion and 0 otherwise. TFO is a dummy variable taking a value of 1 if target rm uses fairness opinion and 0 otherwise. Assets are the acquiring rms total assets in deal announcement year. Pre-performance is the average abnormal monthly return of the acquiring rm against the simple market model over the 24 months prior to the merger announcement. Transaction Value is the transaction value of the merger. Same Industry is a dummy variable used to capture whether the deal is a simple expansion in the same industry or diversication across different industries for the acquiring rm. It takes a value of 1 if the acquiring rm and target rm share the same rst three digits of their main SIC, and 0 otherwise. Hostile is a dummy variable equal to 1 if the target rm opposes the deal and 0 otherwise. Stock Pay is a dummy variable taking a value of 1 if acquiring rm uses its stock as currency and 0 otherwise. Number of Bidders is the number of competitive bidders present before the result of the deal is disclosed (completed or withdrawn). Public Target is a dummy variable equal to 1 if target rm is a public rm and 0 otherwise. Premium is price paid for each target share relative to the targets stock price four weeks before the announcement. Acquirer Market Cap is the market capitalization of the acquiring rm. Acquirer Book to Market is the book to market ratio for the acquiring rm. CAR (-1, 0) is the cumulative daily abnormal returns over window (-1, 0) for the acquiring rms.

dummy variable used to capture whether the deal is a simple expansion in the same industry or diversication across different industries for the acquiring rm. In the sample, Same Industry has an average of .49, indicating that 49 per cent of deals in which the acquiring rm and target rm share the rst three digits of their main SIC. Hostile is a dummy variable used to capture whether the deal is hostile or is welcomed by the target rm. Only 2 per cent of deals are hostile. In 53 per cent of deals, the acquirer uses stock as currency. The number of competing bidders is 1.05 and the average premium paid by the acquiring rm (Premium) is 55 per cent in the sample. The abnormal returns of the acquiring rms are -.8 per cent for the two-day announcement window.

Methodology
We rst examine whether the boards knowledge and deal characteristics are associated with the use of opinions by estimating the following logistic choice model:

Prob ( AFO ) = + i Boardi + j Deal j + 1

(1)

where AFO is a binary variable equal to 1 if the acquiring rm obtains at least one opinion in the deal and 0 otherwise; Board variables include board size, the percentage of outside directors, the number of outside directors, the average number of service years for directors, board busyness, and board holdings; Deal includes Log(Assets), Pre-performance, Log(Tran Value), Same Industry, Hostile, Stock Pay, Number of Bidders, and Public Target.

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We use abnormal returns around merger announcements to capture short-term wealth effects. Abnormal returns are computed using a standard event study approach. The estimation period is the 255-day period ending 30 days prior to the announcement date. The market is the CRSP value weighted index of stocks traded on the New York Stock Exchange (NYSE), the American Stock Exchange (AMEX), and NASDAQ. Following Datta, Iskandar-Datta, and Raman (2001), we compute two-day (-1, 0) cumulative abnormal returns (CARs) for acquirers in response to merger announcements. We use the following regression model to investigate the wealth effects:

CAR = + 1 TFO + 2 AFO + i Boardi AFO + j Board j + k Dealk + 2

(2)

where CAR is cumulative abnormal return over (-1, 0) window. TFO in Equation (2) is a dummy variable, which has a value of 1 if the target rm uses an FO and 0 if it does not. AFO in Equation (2) is a dummy variable, which has a value of 1 if the acquiring rm uses an FO and 0 if it does not. If an acquirer who uses an FO is different from an acquirer that does not use an FO and the difference is not totally captured by presented variables, there will be a self-selection issue. Following Kisgen et al. (2009), we also compute a hazard rate l from the rst stage Probit model and add it to Equation (2) to address this problem.

RESULTS
Using an Fairness Opinion
Table 2 presents differences in board and deal characteristics for mergers with and without an FO. In Panel A, we use the entire sample. In Panel B, we use the matched sample. In terms of board characteristics, service years are lower for rms with an FO in Panel A (t = -1.63, p = .10), but the difference is only marginally signicant when using a Wilcoxon test (z = -1.65, p = .09). The signicance is lost using the matched sample. Other board characteristics are not statistically different in Panel A or B. For deal features, FOs are used in larger transactions and when stock is used to pay for the transaction. FOs are also more likely to be used when the target company is publicly traded. We nd that premiums and announcement returns are signicantly lower for deals with an FO, consistent with Kisgen et al. (2009). Table 3 presents the results from the logistic regressions predicting the likelihood that an acquiring rm uses an FO in a merger. We report several model specications. In particular, we include each of our proxies for board knowledge separately with control variables (Models 16). We include board holdings in all model specications to be consistent with Kisgen et al. (2009) and to control for the general alignment of shareholder and director interests. Also, we include two specications where board knowledge proxy variables are combined (Models 7 and 8). Several measures of board knowledge are signicantly associated with the use of an FO. For instance, larger boards,

where knowledge exchange may be inhibited, are more likely to use an FO. In Model 2, the natural log of board size has a coefcient of 1.24 (Wald = 12.13, p < .01). In Model 7, the coefcient is 1.07 (Wald = 7.03, p < .01). Interestingly, the percentage of outside directors is not statistically signicant; however, the number of outside directors on the board is positive and signicant. In Models 3 and 8, it has a coefcient of .54 (Wald = 6.13, p < .05) and .56 (Wald = 5.34, p < .05), respectively. This result conrms our prediction that boards with more outside directors may feel less informed or suffer from less knowledge exchange and are thus more likely to use FOs. We also note that the number of inside directors, which we include for completeness, is not statistically signicant (Models 4 and 8), so the number of outside directors is not simply capturing board size. The coefcient estimates for service years are insignicant at traditional levels. Models 6, 7, and 8 show that busy directors are less likely to obtain a costly FO (all signicant at the 10 per cent level). Busy directors should be more educated about mergers and valuation (Harris & Shimizu, 2004). Through their involvement on other boards, such directors should have gained more knowledge and thus have less need for an FO. While board holdings is generally insignicant, consistent with Makhija and Narayanan (2007), we nd that many of the deal features are important determinants of the use of an FO and suggest that the underlying risk of the transaction is an important determinant.9 Consistent with our hypothesis that FOs are more likely to be used when the deal is complex, the size of the transaction is positively associated with obtaining an FO (p < .01 in all models). A large merger may be difcult to integrate and therefore may have high risk. Smaller rms and those with poor performance prior to the merger are also more likely to obtain an FO. For larger rms, the transaction may be relatively less valuable in a strategic sense, thus reducing the need for the FO. Boards also seem more likely to purchase an FO when stock is used as currency, which may make the valuation more complex. While we have only a small number of hostile mergers in our sample, our ndings are consistent with Bowers and Latham (2006) and Kisgen et al. (2009). We nd that rms are more likely to seek an FO for friendly deals. Kisgen et al. (2009) contend that friendly deals are more complicated and thus boards will be more likely to seek an FO. Bowers and Latham (2006) assert that friendly transactions are more conducive to self-dealing and thus increased litigation risk. We also nd that FOs are more likely to be purchased when the target company is publicly traded. Capron and Shen (2007) show that rms acquire public targets to enter new businesses or businesses with high levels of intangible assets, suggesting greater risk. We also nd weak evidence that FOs are more likely to be used when the target is in a different industry.

Wealth Effects and Fairness Opinions

To examine the wealth effect of a buy-side FO, we rst conduct two-factor analyses of variance (anova) to examine whether FOs, board knowledge, and their interactions affect market reactions. Table 4 presents the results. Panels A, B, C, D, and E report how the percentage of outside directors,

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TABLE 2 Board and Deal Characteristics and the Use of an Fairness Opinion Variable Opinioned Non-opinioned t-statistic Z-statistic

Panel A: All opinioned and non-opinioned deals Board characteristics % of Outsiders Board Size Number of Outsiders Busyness Service Years Board Holdings Deal characteristics Assets Pre-performance Transaction Value Same Industry Hostile Stock Pay Number of Bidders Premium Public Target Acquirer Market Cap Acquirer Book to Market CAR(-1, 0) Panel B: Matched sample Board characteristics % of Outsiders Board Size # of Outsiders Busyness Service Years

.64 (.64) 10.49 (10.00) 6.80 (6.00) 1.03 (1.00) 7.61 (7.40) 6.60 (1.40)

.63 (.67) 10.53 (10.00) 6.76 (6.00) .99 (.89) 8.26 (8.00) 7.39 (2.00) 17,183.00 (3,352.00) .01 (.01) 911.64 (168.20) .49 (.00) .02 (.00) .49 (.00) 1.04 (1.00) 57.62 (45.27) .55 (1.00) 21,640.90 (4,018.30) .36 (.32) -.5% (-.4%)

.60 [.55] -.08 [.93] .12 [.901] .50 [.61] -1.63 [.10] -.52 [.60] -4.49** [.00] 1.08 [.28] 3.64** [.00] .19 [.85] -.62 [.53] 11.70** [.00] .89 [.37] -2.54* [.01] 11.90** [.00] -1.67 [.09] -.57 [.56] -7.21** [.00]

.37 [.71] .24 [.80] .69 [.49] .40 [.68] -1.65 [.09] -1.25 [.20] -1.20 [.23] 1.27 [.20] 10.67** [.00] .18 [.85] -.61 [.53] 7.79** [.00] .99 [.31] -1.95 [.05] 7.20** [.00] -.73 [.46] -.01 [.99] -5.42** [.00]

7,412.85 (3,218.8) .02 (.01) 5,060.31 (1,778.11) .49 (.00) .01 (.00) .89 (1.00) 1.08 (1.00) 41.44 (38.52) .92 (1.00) 12,370.90 (3,772.50) .35 (.32) -4.0% (-3.0%)

0.649 (0.64) 10.49 (10.00) 6.80 (6.00) 1.02 (1.00) 7.61 (7.40)

.61 (.63) 10.40 (10.00) 6.47 (6.00) .92 (.77) 8.21 (7.83)

1.31 [.19] .21 [.83] .88 [.37] .97 [.33] -1.28 [.20]

1.07 [.28] .30 [.76] 1.16 [.24] 1.00 [.31] -1.26 [.20]

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TABLE 2 Continued Variable Board Holdings Deal characteristics Assets Pre-performance Transaction Value Same Industry Hostile Stock Pay Num Bidders Premium Public Target Acquirer Market Cap Acquirer Book to Market CAR(-1, 0) Opinioned 6.60 (1.40) 7,412.85 (3218.80) 0.01 (0.01) 5,060.31 (1,778.11) .49 (.00) .01 (.00) .89 (1.00) 1.07 (1.00) 41.44 (38.52) .92 (1.00) 12,370.90 (3772.50) .34 (.31) -4.1% (3.5%) Non-opinioned 9.03 (2.10) 11,759.40 (2667.60) .01 (.01) 976.64 (168.78) .51 (1.00) .01 (.00) .45 (.00) 1.05 (1.00) 71.78 (47.62) .55 (1.00) 19,607.11 (3157.43) .39 (.32) -.3% (-.5%) t-statistic -1.18 [.24] -1.24 [.21] .89 [.37] 4.27** [.00] -.30 [.76] -.09 [.92] 8.10** [.00] .82 [.41] -1.27 [.20] 7.00** [.00] -1.22 [.22] -1.23 [.21] -5.47** [.00] Z-statistic -1.40 [.16] .03 [.98] 1.26 [.21] 8.40** [.00] -.30 [.76] -.08 [.93] 7.31** [.00] .57 [.57] -1.88* [.06] 6.48** [.00] .58 [.55] -.61 [.54] -4.73** [.00]

This table compares the board and deal characteristics for rms that use an FO (opinioned) with those that do not (non-opinioned). Panel A includes the entire sample, while Panel B includes a matched sample. The full sample consists of 1,102 deals of which 103 obtained an FO. For the matched sample, we match opinioned deals to non-opinioned deals based on industry (4-digit SIC code), size (acquirers market capitalization, and book-to-market ratio). We are able to match 103 opinioned acquirers to 185 non-opinioned rms. Variable denitions are provided in Table 1. The t-statistics are from difference in means tests and the z-statistics are from Wilcoxon two-sample tests. Medians are in parentheses. P-values are in brackets under the t- and z-statistic columns. p < .10 *p < .05 **p < .01.

board size, the number of outside directors, average service years, and board busyness interact with the use of an FO, respectively. In Panel A, the sample is equally divided into ve groups based on acquirer board independence. The F-test for the independence overall effect is 2.03, which is marginally signicant. The F-value of the FO overall effect is 55.50, signicant at 1 per cent level, indicating that the FO has a main effect on CAR (-1, 0). The F-value for the interaction effect is 2.23, signicant at the 10 per cent level, indicating that the FO interacts with the proportion of outside directors to affect the acquirers CAR (-1, 0). For instance, in Quintile 5, the group with highest percentage of outside directors, the average CAR for opinioned deals is -4.8 per cent. This is

lower than the average return of -.7 per cent for nonopinioned deals. In Quintile 1, the group with lowest board independence, the average CAR for opinioned deals is -6.5 per cent, which is lower than the average return of -.1 per cent for non-opinioned deals. Thus, 4.1 per cent (-4.8 per cent + .7 per cent) is the extra loss associated with an FO when the board is most independent while the extra loss is 6.4 per cent (-6.5 per cent + .1 per cent) when the board is least independent. Thus, the results in Panel A show that an FO used by a board with a larger percentage of outside directors is associated with less value loss for shareholders than when an FO is used by a less independent board. This provides evidence that the markets interpretation of the FO differs based on board characteristics. Boards with greater

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TABLE 3 Determinants of Using an Acquirer Fairness Opinion
% of outsiders (1) Board size (2) Number of outsiders (3) Number of insiders (4) Service years (5) Busyness (6) Pool (7) Pool (8) -3.29** (.79) -.80** (.11) -5.48 (2.88) -2.16** (.66) -.68** (.09) -5.87* (2.83) -1.72** (.62) -.61** (.08) -6.17* (2.79) -1.71* (.70) -.55** (.08) -6.71* (2.86) -1.96** (.68) -.54** (.08) -6.57* (2.88) -2.07** (.73) -.69** (.11) -6.57* (3.00) -2.05** (.72) -.58** (.08) -6.13* (2.79) .50 (.53) 1.24** (.36) .54* (.22) .18 (.16) -.03 (.03) -3.02** (.91) -.73** (.12) -6.29* (3.01) .11 (.59) 1.07** (.40) -.01 (.01) .72** (.08) -.29 (.16) -1.58* (.65) .88** (.23) -.36 (.36) .64* (.25) Yes 848 .43 Yes 848 .45 Yes 847 .44 -.01 (.01) .78** (.08) -.32 (.16) -1.75* (.71) .91** (.23) -.41 (.37) .72** (.27) -.00 (.00) .74** (.08) -.29 (.16) -1.67* (.67) .90** (.23) -.38 (.36) .66* (.25) -.01* (.01) .72** (.08) -.31 (.16) -1.57* (.66) .87** (.22) -.38 (.36) .66** (.25) Yes 847 .43 -.01 (.01) .69** (.08) -.21 (.17) -1.24 (.67) .86** (.24) -.47 (.38) .54* (.26) Yes 742 .44 -.28 (.16) -.01 (.01) .74** (.08) -.27 (.18) -1.27 (.67) .80** (.24) -.44 (.38) .53* (.26) Yes 742 .45 -.03 (.03) -.28 (.16) -.01 (.01) .79** (.09) -.32 (.18) -1.42* (.72) .82** (.25) -.48 (.40) .63* (.28) Yes 742 .47 .56* (.24) .32 (.19) -.04 (.03) -.29 (.16) -.01 (.01) .78** (.09) -.32 (.18) -1.41* (.71) .81** (.24) -.49 (.40) .62* (.28) Yes 742 .68

Intercept

Number 1

Log(Assets)

Pre-performance

% of Outsiders

January 2010

Log(Board Size)

Log (Number of Outsiders)

Log(Number of Insiders)

Service Years

Busyness

Board Holdings

Log(Tran Value)

Same Industry

Hostile

Stock Pay

Number of Bidders

Public Target

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This table reports results from logistic regression models predicting the likelihood of using an AFO. Board and deal characteristic variables are dened in Table 1. Standard errors appear in parentheses. p < .10 *p < .05 **p < .01.

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TABLE 4
ANOVA

Panel A Quintile 1 Opinioned Non-opinioned -Difference Quintile 2

% of outsiders Quintile 3 -4.3% -.7% -3.6% Quintile 4 -1.8% -.4% -1.4% Quintile 5 -4.8% -.7% -4.1%

-6.5% -3.7% -.1% -.5% -6.4% -3.2% F-value for % outsiders overall effect: 2.03 F-value for overall FO effect: 55.50** F-value for interaction: 2.23

Panel B Quintile 1 Opinioned Non-opinioned -Difference Quintile 2

Board size Quintile 3 -4.7% -.4% -4.3% Quintile 4 -3.5% -.3% -3.1% Quintile 5 -3.0% -.8% -2.1%

-5.5% -3.4% -.5% -.2% -4.9% -3.2% F-value for log (board size) overall effect: .43 F-value for overall FO effect: 51.84** F-value for interaction: .92

Panel C Quintile 1 Opinioned Non-opinioned -Difference Quintile 2

Number of outsiders Quintile 3 -3.1% -.2% -2.9% Quintile 4 -3.1% -.5% -2.6% Quintile 5 -4.5% -.9% -3.6%

-9.9% -2.6% -.4% -.5% -9.5% -2.1% F-value for independence overall effect: 1.03 F-value for overall FO effect: 52.76** F-value for interaction: 5.22**

Panel D Quintile 1 Opinioned Non-opinioned -Difference Quintile 2

Service years Quintile 3 Quintile 4 -4.3% -1.1% -3.2% Quintile 5 -2.6% -.7% -1.9%

-7.1% -5.2% -3.1% -.8% .1% -.7% -6.3% -5.3% -2.4% F-value for numbers of service years overall effect: .00 F-value for overall FO effect: 45.76** F-value for interaction: 7.85** Busyness Quintile 1 Quintile 2 Quintile 3 -2.3% -.2% -2.1%

Panel E

Quintile 4 -4.6% -.9% -3.7%

Quintile 5 -7.3% -.9% -6.4%

Opinioned Non-opinioned -Difference

-5.2% -2.8% -.4% -.7% -4.8% -2.1% F-value for busyness overall effect: .79 F-value for overall FO effect: 45.71** F-value for interaction: 2.27*

This table presents two-factor analysis of variance (ANOVA), examining how FOs and several board characteristics interactively affect the acquirers CAR (-1, 0) for the merger announcement. Panel A, B, C, D, E, and F examine how the percentage of outside directors, board size, number of outside directors, average service years, and busyness interact with an FO respectively. p < .10 *p < .05 **p < .01.

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proportions of outside directors may require costly verication to ensure the quality of the project (Raheja, 2005). The market recognizes that the FO may be necessary for such boards to overcome their knowledge decit to perform their duciary duties. In other words, the FO may be necessary, but it represents a cost of board independence. We nd similar results with greater statistical signicance using the number of outside directors (Panel C). In similar analyses, Panel D shows that an FO used by a board whose directors have more service years is associated with less loss than the FO used by a board whose directors have less average service years. A board with long-tenured directors may have less access to important information and less information sharing (Katz, 1982). Thus, the market views the FO as necessary to overcome this lack of knowledge and reacts less negatively. Panel E indicates that an FO used by busier boards is associated with more value loss than an FO used by less busy boards (6.4 per cent loss versus 4.8 per cent). The market reacts less favorably when a board with greater knowledge purchases a costly external opinion. However, in Table 3, we note that busy boards are less likely to use an FO. Panel B shows no difference in the market reaction based on board size. Table 5 includes several model specications to test the wealth impact of an FO, using two-day cumulative abnormal return around the deal announcement date as the dependent variable (Equation 2). Models 15 examine the effect of a buy-side FO (AFO) and its interaction with our proxy variables for board knowledge. Models 6 and 7 correct for the self-selection issue by including the hazard ratio. Specically, we use a two-stage procedure, where the rst stage is estimated using Model 7 from Table 3 (includes all board knowledge proxy variables).10 Consistent with Kisgen et al. (2009) and others, the use of an acquirer FO is negative and statistically signicant in all but one model specication. In Model 7, for instance, the AFO has a coefcient of -.19 (t = -4.14, p < .01). This indicates that the market reacts more negatively to the announcement of a merger with an FO. This is consistent with our assertion that the use of an FO signals that the board is unsure about the deal. Likewise, the use of an FO by a target rm is also viewed more negatively by the market, which is consistent with Makhija and Narayanan (2007). These ndings are robust to including controls for board and deal characteristics as well as controlling for the possible self-selection bias. Table 5 shows that the markets reaction differs when the FO is accompanied by certain board characteristics. In other words, while the reaction to the acquirer FO is negative, this negative reaction may be alleviated or exacerbated by the underlying board knowledge. In Models 1 and 7, the interaction between the acquirer FO and the percentage of outsiders on the board has coefcients of .06 (t = 1.79, p < .10) and .11 (t = 2.76, p < .01), respectively. Similarly, the interaction between the number of outside directors and acquirer FO has coefcients of .02 (t = 2.09, p < .05) and .04 (t = 3.54, p < .01) in Models 3 and 6, respectively. These results indicate that the value loss associated with an FO is signicantly reduced if the FO is accompanied by a board with more (percentage or number of) outside directors. Rahejas (2005) model shows that outside directors require costly verica-

tion to overcome information or knowledge problems. Thus, the market views the purchase of an FO in these cases less negatively as the FO is needed. Hence, the market may perceive the FO as a way for the board to increase its understanding of the deal. Table 5 shows that the interaction between an FO and years of director service is positive and signicant. Its coefcient has a minimum t-statistic of 2.00 and p < .10 in Models 4, 6, and 7. The market reacts less negatively to an FO used by a board with high average director service years. Katz (1982) shows that lengthy tenure reduces group communication and access to critical information sources. Thus, the market again recognizes that a less knowledgeable group may need the FO. Table 5 also shows a negative and signicant interaction between the use of an FO and board busyness. The interaction has coefcients with a minimum t-statistic of 2.00 and p < .05 in Models 5, 6, and 7. Multiple boards can be seen as a proxy for the knowledge base of the board and should be benecial to the acquirer (Ferris, Jagannathan, and Pritchard, 2003; Harris and Shimizu 2004). Busy boards should be less likely to need an FO because they have extra knowledge. However, when a board with knowledgeable directors purchases an FO, the market reacts more negatively. Essentially, the FO may be viewed as wasteful spending, or the deal uncertainty is extremely high.

Robustness
To explore the robustness of our results, we use the matched sample. We report results in Table 6 for both the likelihood of using an FO (Models 1 and 2) and the market reaction to the FO (Models 3 and 4).11 We continue to nd that larger boards with more outside directors are more likely to use an FO. Board size has a coefcient of 1.45 (Wald = 5.09, p < .05) in Model 1 and the number of outside directors has a coefcient of .76 (Wald = 4.99, p < .05) in Model 2. In terms of the market reaction, the interaction between service years and AFO has a coefcient of .01, signicant with p < .05 in both Models 3 and 4. The interaction between the number of outsiders and AFO has a coefcient of .04 (t = 2.00, p < .05) in Model 3. The interaction between busyness and AFO has coefcient of -.03 (t = -3.00, p < .05) in Model 3. These results continue to show that director service years and the number of outsiders on the board mitigates the negative reaction to the FO, while busyness exacerbates the negative reaction. In addition to the matched sample, we also introduce target-level control variable to address the underlying risk of the transaction (Models 5 and 6). Data availability becomes problematic since our target rms include both public and private rms. We are able to obtain market capitalization and book-to-market ratios for about 283 public companies in our sample. For this reduced subsample, we repeat our analyses on the use of an FO (as in Table 3) and the market reaction (as in Table 5). Our main results continue to hold. Specically, the number of outside directors is an important determinant of the use of an FO (coefcient = .67, p < .05 in Model 5). We still nd a negative market reaction to an AFO (coefcient = -.15, p < .01). Also, we nd that the interaction between AFO and number of outsiders has a coefcient of

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TABLE 5 Fairness Opinions and the Short-term Market Reaction

% of outsiders (1) Intercept TFO AFO % Outsiders Log(Board Size) Log(Number of Outsiders) Log(Number of Insiders) Service Years Busyness AFO*% Outsiders AFO*log(Board Size) AFO*log(Number of Outsiders) AFO*Service Years AFO*Busyness Board Holdings Log(Assets) Pre-performance Log(Tran Value) Same Industry Hostile Stock Pay Number of Bidders Public Target l Year Dummies N R-square Yes 742 .10 Yes 742 .10 Yes 742 .11 Yes 742 .10 Yes 742 .11 .00 (.00) -.00 (.00) -.08 (.06) -.00* (.00) -.00 (.00) -.00 (.01) -.01 (.00) -.01 (.01) -.01 (.01) .00 (.00) -.00 (.00) -.06 (.06) -.00* (.00) -.00 (.00) -.00 (.01) -.01 (.00) -.01 (.01) -.01 (.01) -.00 (.00) -.00 (.00) -.07 (.06) -.00* (.00) -.00 (.00) -.01 (.01) -.01 (.00) -.01 (.01) -.01 (.00) -.00 (.00) -.00 (.00) -.07 (.06) -.00* (.00) -.00 (.00) -.01 (.02) -.01 (.00) -.01 (.01) -.01 (.01) .06 (.03) .03 (.02) .02* (.01) .00* (.00) -.02* (.01) -.00 (.00) -.00 (.00) -.08 (.06) -.00* (.00) -.00 (.00) -.01 (.01) -.01 (.00) -.01 (.01) -.01 (.01) .04** (.01) .00* (.00) -.03** (.01) -.00 (.00) -.01** (.00) -.09 (.06) .00 (.00) -.00 (.00) -.02 (.01) -.00 (.00) -.01 (.01) -.00 (.00) .04** (.01) Yes 742 .14 .04** (.01) -.01 (.00) -.06** (.02) .00 (.01) Board size (2) .03* (.01) -.01 (.00) -.08* (.04) Number of outsiders (3) .04** (.01) -.01 (.00) -.07** (.02) Service years (4) .04** (.01) -.01 (.00) -.05** (.02) Busyness (5) .03** (.01) -.01* (.00) -.01 (.01) Pool 2-stage (6) .04** (.01) -.01* (.00) -.15** (.03) Pool 2-stage (7) .05* (.02) -.01* (.00) -.19** (.04) -.00 (.01) .01 (.01)

.01 (.01) .00 (.00) .00 (.00) -.00 (.00) .00 (.00) .01 (.00) .00 (.00) -.00 (.00) .00 (.00)

.00 (.00) .00 (.00) .11** (.03) .02 (.02)

.00* (.00) -.03** (.01) .00 (.00) -.01** (.00) -.08 (.06) .00 (.00) -.00 (.00) -.01 (.01) -.00 (.00) -.01 (.01) -.00 (.00) .03** (.01) Yes 742 .14

This table reports results from ordinary least squares and hazard rate enhanced models for the market reaction to the deal announcement. The data used in all models are after exercising the rst-stage of the Heckman (1979) method based on Model (7) in Table 3. The dependent variable is the cumulative abnormal return over the two-day window prior to the deal announcement (-1, 0). l is the hazard rate. Standard errors appear in parentheses. p < .10 *p < .05 **p < .01.

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TABLE 6 Robustness Tests

Matched sample: Logistic (1) Intercept Log(Assets) Pre-performance % Outsiders Log(Board Size) Log(Number of Outsiders) Log(Insiders) Service Years Busyness TFO AFO AFO*% Outsiders AFO*log(Board Size) AFO*log(Number of Outsiders) AFO*Service Years AFO*Busyness Board Holdings Log(Tran Value) Same Industry Stock Pay Num Bidders Public Target Log(Target Cap) Target Book-to-Market l Year Dummies N R-square Yes 188 .57 Yes 185 .57 .02 (.02) Yes 188 .16 .03* (.01) Yes 185 .17 Yes 283 .43 -.02 (.01) .85** (.14) -.13 (.29) 1.59** (.37) -1.41 (.80) .88* (.42) -.00 (.01) 1.03** (.17) -.31 (.29) 1.24** (.40) -.26 (.84) 1.07* (.45) .01* (.00) -.03* (.01) .00 (.00) .00 (.00) .01 (.01) .00 (.01) .01 (.02) -.01 (.01) .02 (.04) .11 (.27) -2.77* (1.41) -.85** (.17) -7.38 (4.89) -.44 (.93) 1.45* (.64) (2) -1.09 (1.36) -.86** (.19) -10.68 (5.69) Matched sample: Market reaction (3) -.03 (.05) -.00 (.01) -.09 (.16) .02 (.03) .02 (.02) (4) .01 (.04) -.01 (.01) -.04 (.15) Public targets: Logistic (5) -3.56 (2.59) -.72** (.15) -10.64* (4.56) Public targets: Market reaction (6) -.10 (.06) -.01 (.00) .04 (.12)

.76* (.34) -.14 (.32) .04 (.05) -.37 (.25)

-.00 (.00) .00 (.01) -.01 (.01) -.12 (.08) .08 (.05) .00 (.03)

.01 (.01) -.01 (.01) -.00 (.00) -.00 (.01) -.02 (.01) -.16** (.04)

.67* (.34) .36 (.27) -.04 (.03) .02 (.21)

.01 (.01) .00 (.00) -.00 (.00) .00 (.01) -.01 (.01) -.15** (.04)

.04* (.02) .01* (.00) -.02 (.01) .00 (.00) .00 (.00) -.00 (.01) .01 (.01) .03 (.02) -.00 (.01)

-.01 (.01) .43 (.35) -.21 (.24) 1.09** (.35) -1.18* (.53) .35 (.36) .21 (.39)

.03* (.01) .00 (.00) -.00 (.01) .00 (.00) -.02** (.01) -.00 (.00) -.00 (.01) .00 (.01) .02* (.01) -.01 (.01) .03* (.01) Yes 283 .22

This table reports results for a matched sample (Models 14) and a sample with publicly traded targets (Models 56). We match opinioned deals to non-opinioned deals based on industry (4-digit SIC code), size (acquirers market capitalization), and book-to-market ratio). We are able to match 103 opinioned acquirers to 185 non-opinioned rms. Models 1 and 2 are logistic regressions on the likelihood of using an FO. Models 3 and 4 are hazard rate enhanced models for the market reaction to the deal announcement (as in Table 5). Models 5 and 6 include only publicly traded target rms, where Model 5 is the likelihood of using an FO and Model 6 is market reaction. Standard errors appear in parentheses. p < .10 *p < .05 **p < .01.

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.03 (t = 3.00, p < .05) in Model 6. That is, the negative market reaction is mitigated when the board is perceived as being less knowledgeable (more outside directors). While service years and busyness decrease in signicance with this smaller sample, we do note they continue to have the same signs as previous results. Finally, in unreported results we examine the use of multiple FOs and an unafliated FO. Specically, we use a logistic regression where the dependent variable is the use of an unafliated investment bank as well as a regression model and a multinomial logit model on the number of FOs. Our board variables are not statistically signicant. Interestingly, this may suggest that board knowledge only affects the decision to obtain an FO. Our results are consistent with Kisgen et al. (2009).

CONCLUSIONS
In this paper, we examine whether the underlying knowledge of the board directors motivates them to seek an FO from an investment bank. We nd that larger boards and boards with more outside directors are more likely to obtain an FO, suggesting such directors may feel less informed about the merger valuation and thus obtain the FO as a means to gather information. In addition, we nd that boards with busy directors are less likely to use an FO. Serving on multiple boards may increase the directors knowledge base and reduce the need for an FO. Overall, these results suggest that the boards knowledge is important in explaining the use of an FO. Moreover, we consider the market reaction to the use of an FO in conjunction with the boards knowledge and the necessity of an FO. We nd a negative market reaction to the use of an FO, which suggests the market recognizes the boards uncertainty about the deal. However, we also nd evidence that the uncertainty may be understood by the market. We nd that when an FO is used by a board with more outside directors or used by a board whose members have long tenures with rm, the market reacts less negatively. Both groups would be expected to have less knowledge about the merger. However, when an FO is used by a busy board, which should be more knowledgeable, the penalty for using an FO is increased. Several limitations apply to our study. First, we study only US rms. It would be interesting to see whether the results hold internationally. Second, our study relies on several proxies to capture board knowledge, none of which is a perfect measure of the boards comprehension or understanding. In fact, many of our variables have been used to capture agency problems. For instance, the number of outside directors may also measure board independence and thus alignment of interests between shareholders and managers. From an agency perspective, it is also reasonable to interpret our market reaction results as suggesting that the market responds less negatively to an independent board using an FO because such a board is more likely to act in good faith. For board busyness, the market may perceive the use of an FO as evidence of director shirking, and therefore react more negatively. While we cannot reject these alternative agency perspective arguments, we believe

the combined evidence we present is more consistent with board knowledge as the underlying determinant. Future research may explore how best to combine the measures to truly capture board knowledge. Third, we do not observe when an FO was sought but not given. The lack of an FO can indicate that one was never sought or that it was sought but not granted. It is also possible that the deal was revised until the investment banker could opine that the offer was fair. Fourth, our study is also limited by our inability to observe boardroom discussions on why FOs are purchased by the board. A direct observation and analysis of boardroom discussions may shed light on the true underlying motivation of directors. Future research may also investigate the interactions between the board and the investment bank with respect to the development and issuance of an FO. Despite these limitations, we believe our paper makes an important contribution. Specically, we consider a new perspective on why an acquiring rms board may purchase an FO. While we cannot eliminate or reject the legal protection hypothesis of Kisgen et al. (2009), our ndings provide an alternative explanation that may be more agreeable in terms of describing the role boards and governance play with respect to the use of an FO. A board with more outside directors may be strong on monitoring, but may lack knowledge on the deal. This essentially provides an example of a cost associated with an independent board. Further, we show that the market can differentiate the types of board that use an FO. The markets reaction is sophisticated and it considers the necessity of the FO based on the boards understanding of the deal.

ACKNOWLEDGEMENTS
We thank the associate editor, the anonymous referees, William Judge, Ann Marie Whyte, Honghui Chen, Richard Hoer, Xiaorong Zhang, David Becher, Jie Wei, and Dolly King, as well as seminar participants at the 2008 Financial Management Association annual meetings, 2008 Eastern Finance Association annual meetings, University of Central Florida, and Marshall University for helpful comments and suggestions.

NOTES
1. For example, Hermalin and Weisbach (1988) show a negative relation between board tenure and rm value, while Mishra and Nielson (1999) nd banks with long tenured boards have lower growth opportunities. Kaymak and Bektas (2008) nd similar results with board tenure and ROA. 2. Board busyness may also capture the boards monitoring potential. Cotter, Shivdasani, and Zenner (1997) suggest that busy directors will be better monitors. Ferris et al. (2003) nd no evidence that multiple directors shirk their responsibilities. However, there are also studies that show that busy boards are less likely to monitor (Ahn, Jiraporn, & Kim, 2009; Fich & Shivdasani, 2006). Busy directors may not have the time to thoroughly research a merger proposal making them less knowledgeable, suggesting they would be more likely to purchase an FO. However, our empirical results do not support this alternative hypothesis.

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3. The loss in observations is related largely to merging unbalanced panel data for both governance and nancial data. 4. Note that we do not observe when an FO was sought but not given. The lack of an FO can indicate that one was never sought or that it was sought but not granted. It is also possible that the deal was revised until the investment banker could opine that the offer was fair. However, the severity of the issue seems to be somewhat mitigated by our ndings. We show that opinioned mergers perform worse than non-opinioned mergers. Ex ante, we would expect mergers where an FO was sought but not provided to also be poor performers. 5. SDC reports that only 57 of the 1,213 deals used an FO. 6. The log transformation reduces the effects of possible outliers and captures non-linear relations. We also run the analyses with actual board size and obtain qualitatively similar results. 7. Specically, we sort all the observations in the sample based on acquiring rm SIC code, market capitalization, and book-tomarket ratio. The non-opinioned deals immediately before and after an opinioned one are selected as its matching deals. We also change the order of sorting to market capitalization, SIC, and book to market, the results are similar. 8. In Kisgen et al. (2009), the percentage is 37 per cent for acquirers. Several reasons contribute to the difference with our sample. First, they exclude merger deals which have transaction values of less than $5 million, but we do not. Transaction size is positively associated with the use of an opinion. For transaction values larger than $5 million, the percentage of acquiring rms using an FO is 40.5 per cent in our sample. Our ndings are robust to limiting our sample in this subset of rms. Second, Kisgen et al. (2009) start with all public acquiring rms in SDC. We start with public rms that are in the IRRC Director and match these to deals in SDC. 9. For robustness, we also examine Gompers et al.s (2003) governance index. Like board holdings, this may provide a measure of the rms overall governance structure. We nd no evidence that it affects the likelihood of using an FO or the market reaction to the FO. 10. Results are robust to using Model 8 from Table 3 in the rst stage. Also, results are qualitatively similar if we pool observations and use OLS. In addition, all results are robust to including the deal premium. However, this variable is missing for many observations. 11. Hostile is dropped because of a lack of observations in the reduced sample.

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Melissa B. Frye is an associate professor of nance at the University of Central Florida. Her primary research area is corporate governance. She received her B.S. from Florida State University and her Ph.D. from the Georgia Institute of Technology. Weishen Wang is an assistant professor of nance at Marshall University. He received his Ph.D. from the University of Central Florida. He holds strong research interests in corporate governance, investments, real estate, and risk management. Before joining academia, Weishen worked in the banking sector for four years advising borrowers in nancial distress on asset sales, mergers, and security issuance.

2009 Blackwell Publishing Ltd

Volume 18

Number 1

January 2010