See the Gap: Firm Returns and Shareholder Incentives

Firm return is widely used to infer shareholder incentives, yet this approach can be misleading when shareholders trade actively around corporate events. In mergers and acquisitions, we document that institutional investors strategically increase (decrease) their holdings of acquirers in deals that generate positive (negative) value. This trading creates a substantial gap between firm return and shareholder return: on average, institutional investors earn 2.4% from M&A while firm return is -0.9%. The gap grows with investors’ incentive and ability to trade. Importantly, institutions earning high return gaps are associated with weaker governance, emphasizing the need to account for shareholder turnover when evaluating governance incentives.