The Adaption Option and Market Responses to Acquisition Announcements by Loss Firms

Prior research suggests that losses are less persistent than profits because loss firms are more likely to exercise real options to adapt their current business resources. We examine whether investors respond favorably when loss firms exercise the adaption option by acquiring other business entities. We find that loss-reporting acquirers have average three-day announcement abnormal returns that are 97 basis points higher than profit-reporting acquirers and that there is a non-linear relation between earnings and acquirer announcement returns. Further analysis finds that our result is stronger in acquisitions of privately held targets using all stock or mixed payments of cash and stock. Consistent with the market response analysis, loss firms that make acquisitions subsequently experience significantly greater improvement in operating performance than loss firms that do not make acquisitions.