Reputational risk and target selection: An evidence from China

Abstract Do bidders with pre‐deal lower (higher) reputational risk select targets with lower (higher) reputational risk in the existing and new markets? Past research on the role of reputation suggests that reputable firms make conservative investment decisions to maintain their reputation. Using data from the Chinese takeover market over the time period 2010 to 2018, we examine the effect of reputational risk similarity on target selection and bidder returns. The results show that bidders with pre‐deal lower (higher) reputational risk select targets with lower (higher) reputational risk and this pattern of target selection only holds in the existing market whilst bidders entering into the new markets select targets with different levels of reputational risk. We also find that bidders with lower reputational risk earn higher announcement returns in both existing and new markets and pay fairer premiums to win the bid auction.