We find, in a sample of 7581 merger offer announcements from 1990 to 2013, shareholders of 1283 (or 17%) target firms responded to the offer with negative market returns. These investors were disappointed at the offer, despite the price premium. To explain their disappointment, one must understand how target shareholders form expectations of premium to be received. We use a novel empirical design to find the relative weights of the rational vs. behavioral factors underlying the process of expectation formation. The estimated expected premiums are shown to have predictive power in the subsamples of both the positive and negative market responses. We also compare how the weights of the expectation factors change under different market conditions: hot vs. cold M&A regimes, bull vs. bear stock market, financial crisis vs. non-crisis periods, and dotcom bubble vs. no bubble.

We investigate the impact of debt covenants on acquisition characteristics. We find that acquirers with covenants pay lower merger premiums, make more focused acquisitions, and engage in acquisitions with higher synergy gains and higher acquirer returns around deal announcement, relative to those without. All these results are more pronounced with stricter debt covenants. Additionally, acquirers with covenants pay with a lower share fraction. In particular, capital covenants, which restrict debt issuance, are positively related to the share fraction, while performance covenants, which affect the stock of equity capital, result in a lower share fraction of payment. All our results hold only for acquirers who have not violated covenants, reemphasizing the importance of debt covenants and the threat they entail on corporate policies even before nearing violation states. Results also, generally, hold for badly governed firms, suggesting that creditors' monitoring role through debt covenants and borrower's effective corporate governance are substitutes.

We examine how capital structure considerations affect acquisition pricing and valuation. We find that debt capacity improvement is value-enhancing for all acquirers when they gradually reveal their growth opportunities to the market. This is reflected in the long-run stock market returns, both 12- and 24-months after acquisition announcement. While both overlevered and underlevered acquirers benefit from an increase in debt capacity resulting from the merger, only overlevered acquirers pay higher premiums to increase debt capacity. Underlevered acquirers do not pay a premium for it; instead they consider market timing opportunities. Results are robust for alternative definitions of leverage and debt capacity improvement.

Institutional investors tend to accumulate the shares of firms that announce acquisitions. The tendency to accumulate shares is stronger when the acquirer discloses synergy forecasts, and it is especially strong when the disclosed synergies are higher. This evidence is consistent with the idea that institutional investors are attracted to situations where their superior access to management and analysts provides an information advantage. Indeed, this tendency to accumulate information sensitive shares is especially strong for hedge funds, which tend to have the greatest information advantage. Moreover, stock prices respond favorably in the quarter following the acquisition announcement when higher institutional holdings are revealed.