[We examine how managerial incentives affect acquisition decisions in the banking industry. We find that higher pay-for-performance sensitivity (PPS) leads to value-enhancing acquisitions. Banks whose CEOs have higher PPS have significantly better abnormal stock returns around the time of the acquisition announcements. On average, acquirers in the high-PPS group outperform their counterparts in the low-PPS group by 1.4% in a three-day window around the announcement. Higher PPS helps reduce the incentives for making value-destroying acquisitions, while at the same time promotes value-enhancing acquisitions. The positive market reaction can be rationalized by post-merger performance. Following acquisitions, banks with higher PPS experience greater improvements in their operating performance. We show that the effect of PPS is mainly evident in small and medium-sized banks, but is not present in large banks.]

We examine how managerial incentives affect acquisition decisions in the banking industry. We find that higher pay-for-performance sensitivity (PPS) leads to value-enhancing acquisitions. Banks whose CEOs have higher PPS have significantly better abnormal stock returns around the time of the acquisition announcements. On average, acquirers in the high-PPS group outperform their counterparts in the low-PPS group by 1.4% in a three-day window around the announcement. Higher PPS helps reduce the incentives for making value-destroying acquisitions, while at the same time promotes value-enhancing acquisitions. The positive market reaction can be rationalized by post-merger performance. Following acquisitions, banks with higher PPS experience greater improvements in their operating performance. We show that the effect of PPS is mainly evident in small and medium-sized banks, but is not present in large banks. The Author 2011. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: [email protected]., Oxford University Press.