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- - - - - - - - Chapter 8- - - - - - - -

Empirical Tests of M&A Performance

Note: When the statistical results are not significant, this is stated. If not so noted, the results are understood to be statistically significant at least at the 10% level or better. The empirical patterns described below represent our judgments. Individual samples for particular time periods with different combinations of variables will yield varying results.

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 1


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Issues in Empirical Studies

  • Tests of alternative theories

  • Determine whether or not social value is enhanced by mergers

    • Performance improvements

    • Relatedness to fundamental technological, economic, regulatory, and other forces taking place in individual industries

    • Effects on other firms in same industry

  • Guides to management for merger planning

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 2


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Merger Performance During the Eighties

  • Successful transactions

    • Targets earn substantial premiums

      • Mergers — likely to be friendly and for stock

        • Targets: Positive 20 to 25%

        • Buyers: Positive 1 to 2%

      • Tender offers — frequently hostile during the eighties and for cash

        • Targets: Positive 30 to 40%

        • Buyers: Negative 1 to 2%

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  • Time trend of returns to targets has been upward

    • Increase in government protection to targets

    • Development of sophisticated defensive tactics

    • Opportunity to find competing bidders

  • Event returns to bidding firms decreased over the decades

  • Total wealth increase from M&As has continued to be positive

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  • Unsuccessful takeovers

    • Target acquired within five years

      • Target — premiums higher than initial bids

      • Initial bidders — zero or negative returns if rival succeeds

    • Targets not acquired within five years

      • Target — stock prices return toward preoffer values

      • Bidders — negative returns

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  • Single bidder vs. multiple bidders

    • Mainly applicable to tender offers

    • Targets in tender offers

      • Single bidder: 25-30%

      • Multiple bidders: 35-40%

    • Bidders in tender offers

      • Single bidder: 0%

      • Multiple bidders: negative 2-4%

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  • Method of payment

    • Mergers — stock-for-stock, nontaxable

      • Targets: 20%

      • Bidders: negative 1-2%

    • Tender offers — cash-for-stock or assets, taxable

      • Targets: 35%

      • Bidders: positive 1-2%

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  • Resisted vs. nonresisted

    • Resisted — often multiple bidders

    • Nonresisted — usually single bidder

    • Impact of multiple bidders stronger than management resistance

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 8


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  • Methods of payment and managerial resistance (Huang and Walkling, 1987)

    • Controlling for form of payment and managerial resistance — difference between returns of tender offers and mergers disappeared

    • Controlling for type of acquisition and managerial resistance — difference between cash and stock offers remained strong

      • Average CARs to target

        • Cash offers: 29.3%

        • Stock offers: 14.4%

        • Mixed payments: 23.3%

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  • Reasons why use of cash may result in higher returns to targets

    • Cash transactions are taxable — require higher premiums to compensate for taxes

    • Information effect — bidder uses stock when it is overvalued

    • Signaling effect — use of cash indicates that target has better investment opportunities

    • Securities transactions involve regulatory approval and longer acquisition interval

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  • Bad bidders become good targets targetsMitchell and Lehn (1990)

    • Announcement of acquisitions

      • Negative returns — acquiring firms subsequently become targets

      • Positive returns — acquiring firms do not become targets

    • Divestitures

      • Negative returns — subsequent divestitures

      • Positive returns — no subsequent divestitures

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  • Positive total returns vs. negative total returns targets

    • Positive total returns

      • Targets — higher positive gains

      • Bidders — greater likelihood of significant positive gains

    • Negative total returns

      • Targets — gains not reduced

      • Bidders — greater likelihood of large negative returns

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  • Effects of tender offer regulation targets

    • Targets

      • Gains are higher

      • Premiums higher after adoption of Williams Act in 1968

    • Bidders

      • Losses more likely

      • Reduced returns due to:

        • Waiting period

        • Stronger target defenses

        • Increased bidder competition

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  • Runup vs. markup returns targetsSchwert (1996)

    • Definitions

      • Runup — pre-announcement CAR

      • Markup — post-announcement CAR

    • Tender offers

      • Runup 16%

      • Markup 20%

    • Mergers

      • Runup 12%

      • Markup 5%

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  • Insider trading cases targets

    • Runup 18.3%

    • Markup 21.2%

  • Runups vs. markups

    • Not correlated

    • Little substitution

    • Runup is added cost to bidder

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  • Postmerger performance targets

    • Healy, Palepu, and Ruback (1992)

      • Industry-adjusted operating variables

        • Ratio of cash flows to sales — no significant change

        • Ratio of sales to total assets — significant improvement

        • Ratio of cash flows to market value of assets — significant improvement

        • Annual percentage change in employment — declined significantly

        • Pension expenses per employee — reduction but not statistically significant

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 17


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  • Investment variables targets

    • Annual change in cash receipts from asset sales as a percentage of the market value of assets — no significant change

    • Annual change in the book value of asset sales as a percentage of the market value of assets — significant increase

    • Annual change in R&D expenditures as a percentage of the market value of assets — no significant reduction

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 18


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  • Discussion and implications targets

    • High correlation between event return measures and accounting measures of subsequent performance

    • Performance improvement from better asset management

    • Improved returns not from reductions in labor income

    • R&D and investment rates not significantly changed

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 19


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  • Agrawal, Jaffe, and Mandelker (1992) targets

    • Market or economy-wide benchmarks used for adjusted returns

    • Wealth loss to shareholders of acquiring firms of 10% over subsequent five years

    • Implication is that M&A activity takes place in industries depressed relative to the economy

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  • Franks, Harris, and Titman (1991) targets

    • Postmerger share-price performance sensitive to benchmark employed

    • Equally weighted benchmark — negative postmerger performance

    • Value-weighted index benchmark — positive postmerger performance

    • Multiportfolio benchmarks — no significant abnormal performance

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 21


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  • Industry influences on M&A activity targets

    • Mitchell and Mulherin (1996)

      • Significant differences in M&A activity by industry

      • M&A activity due to major shocks in relatively few industries

        • International competition — tires, steel, autos, shoes, machine tools

        • Technological change — information processing

        • Financial innovations — banks, S&Ls, brokerage firms

        • Deregulation — air transport, entertainment, trucking, health care

        • Price shocks — petroleum, air transport, trucking

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 22


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  • Andrade and Strafford (1999) targets

    • Evidence supports an impact of industry shocks on merger activity

    • Mergers, like internal investments, are a response to favorable growth potentials

      • Industries with excess capacity use own-industry mergers to achieve consolidation

      • In contracting industries, acquiring firms have better performance, lower capacity utilization, and lower leverage

    • Asset reallocation from mergers results in improved efficiency

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 23


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Merger Performance During the 1990s targets

  • Weston and Johnson (1999)

    • Sample

      • 364 transactions between 1992 and mid-1998

      • Sample of large transactions

        • Price paid for target:

          • Greater than $500 million for 1992-1996

          • Greater than $1 billion for 1997-1998

      • Accounted for 40 to 45% of total M&A deal value in most years, rising to 69% for first half of 1998

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 24


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  • Pooling versus purchase accounting targets

    • Full sample

      • 190 pooling transactions (52.2%)

      • 174 purchase transactions (47.8%)

    • Bank subsample

      • 60 pooling (80%)

      • 15 purchase (20%)

      • Strong preference for pooling - banks might be strongly averse to negative impact of goodwill write-offs on reported net income

    • Non-bank subsample

      • 130 pooling (45%)

      • 159 purchase (55%)

      • Lack of preference for pooling - economies or synergies sufficiently strong that increased earnings in new combined firm overcome goodwill write-offs

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 25


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  • Method of payment targets

    • Stock: 220 transactions (60.4%)

      • Bank mergers: 61 (81.3%)

      • Non-bank mergers: 159 (55%)

    • Cash: 80 transactions (21.7%)

    • Cash and stock: 64 transactions (17.6%)

    • Debt: 1 transaction (0.3%)

    • Big deals in the 1990s have been mainly stock for stock

    • Smaller transactions are mainly for cash

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 26


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  • Taxability targets

    • Taxable: 91 transactions (25%)

      • Bank mergers: 6 (8%), all were purchase accounting transactions

      • Nonbank mergers: 85 (29.4%), all were purchase accounting transactions

    • Nontaxable: 238 transactions (65.4%)

      • Bank mergers: 64 (85.3%), 4 were purchase accounting transactions

      • Nonbank mergers: 174 (60.2%), 44 were purchase accounting transactions

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 27


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  • Premium paid targets

    • Premium based on market price of seller stock 30 days before public announcement of deal

    • Non-taxable, non-bank deals: 33-40% premium

    • Taxable, non-bank deals: 36-44% premium

    • Non-bank, pooling transactions: 33% median premium

    • Non-bank, purchase transactions: 37% median premium

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 28


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  • Analysis of event returns targets

    • Sample of 309 transactions

    • Full sample

      • Positive total gains: 202 (65.4%)

      • Negative total gains: 107 (34.6%)

    • Bank subsample

      • Positive total gains: 41 (57.7%)

      • Negative total gains: 30 (42.3%)

    • Non-bank subsample

      • Positive total gains: 161 (67.6%)

      • Negative total gains: 77 (32.4%)

    • Good deals will have a favorable initial market response

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  • Returns to shareholders targets(Anslinger and Copeland, 1996)

    • In-depth study of 21 successful acquirers

    • These companies made 829 seemingly unrelated acquisitions from 1985-1994

    • 80% of the 829 transactions (611) earned their cost of capital

      • Corporate acquirers: averaged 18% per year in total returns to shareholders over a 10 year period

      • Financial buyers: averaged 35% per year in total returns

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 30


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  • Findings differ from previous McKinsey and Company studies for the 70s and 80s which found that two-thirds of all mergers did not earn their cost of capital

  • Successful acquirers focused on a common theme

    • Clayton, Dubilier & Rice — stockpiled management capabilities

    • Desai Capital Management — focused on retail-related businesses

    • Emerson Electric Company — looked for companies with core competence in component manufacturing to exploit cost-control capabilities

    • Sara Lee — focused on branding in retailing

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 31


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  • Merger performance in the 1990s for the 70s and 80s which found that two-thirds of all mergers did not earn their cost of capitalSchwert (1996)

    • On average abnormal returns to bidders for period 1973-1991 was not significantly different from zero

    • Highly competitive nature of takeovers continued through 1996 — suggests that abnormal returns to bidders continued at levels not significantly different from zero

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 32


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  • Total wealth change continued to be positive through 1996 since abnormal returns to targets were in the 35% to 40% range

  • Increased ability to make value-increasing mergers

    • Cisco Systems — high growth through acquisitions, high shareholder returns

    • Internet companies — considerable use of acquisitions to expand customer base, high shareholder returns

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 33


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Efficiency Versus Market Power since abnormal returns to targets were in the 35% to 40% range

  • Ellert (1975, 1976)

    • Supports efficiency basis for mergers

    • Acquiring firms had positive residuals in prior years, and acquired firms had negative residuals in prior years

  • Stillman (1983)

    • Rivals of firms did not benefit from announcement of proposed mergers

    • Inconsistent with concentration-collusion hypothesis

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 34


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  • Eckbo (1981) since abnormal returns to targets were in the 35% to 40% range

    • No negative effects on rivals when merger is likely to be blocked by antitrust authorities

    • Main effect of merger

      • Signal possibility of achieving economies for merging firms

      • Provide information to rivals that such economies may also be available to them

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Effects on Concentration since abnormal returns to targets were in the 35% to 40% range

  • Impact on macroconcentration

    • Share of assets of largest 200 U.S. corporations to assets of all nonfinancial corporations

      • Share was about 38% in 1970

      • Declined to 36% by 1980 and to 34% by 1984; remained stable at about 35% through 1996

      • Figures are biased upward since largest 200 firms in numerator are the ones that rank highest in each year of measurement

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  • Impact on microconcentration aggregate concentration

    • Individual industries concentration measure

      • Measures based on share of four largest firms

      • Weighted average level of concentration in individual industries using value added measure has stayed relatively constant at about 40% over recent decades

    • Industry concentration taking international factors into account — drops sharply

    • For most industries the HHI is below the critical 1,000 level

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 38


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