Due Diligence on the Bidder and the Certification Effect

Target firm shareholder wealth in stock swap transactions depends on the value of the bidder’s shares, while the bidder has the incentives to inflate its stock price. This motivates the target to carry out a due diligence investigation that will certify the bidder’s value. We show that targets do perform such due diligence, and that bidders targeting firms with reputable due diligence accountants experience a positive certification effect manifested in higher excess returns at the announcement of stock swap transactions. This effect in turn spills over into higher target firm returns in such deals because the bidder’s value is certified. The certification effect is concentrated in settings with greater uncertainty about the bidder’s worth, and is not present when the due diligence provider cannot be deemed independent.