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- - - - - - - - Chapter 8 - - - - - - - -. Empirical Tests of M&A Performance

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chapter 8
- - - - - - - - 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

issues in empirical studies
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

merger performance during the eighties
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%

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

slide4
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

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 4

slide5
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

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 5

slide6
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%

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 6

slide7
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%

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 7

slide8
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

slide9
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%

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 9

slide10
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

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 10

slide11
Bad bidders become good 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

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 11

slide12
Positive total returns vs. negative total returns
    • 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

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 12

slide13
Effects of tender offer regulation
    • 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

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 13

slide14
Runup vs. markup returns Schwert (1996)
    • Definitions
      • Runup — pre-announcement CAR
      • Markup — post-announcement CAR
    • Tender offers
      • Runup 16%
      • Markup 20%
    • Mergers
      • Runup 12%
      • Markup 5%

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 14

slide15
Successful deals — runup and markup both 15%
  • MBOs — runup and markup both 10%
  • Poison pills
    • Runup 12%
    • Markup 18%
  • Multiple bids
    • Runup 13%
    • Markup 18%

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 15

slide16
Insider trading cases
    • Runup 18.3%
    • Markup 21.2%
  • Runups vs. markups
    • Not correlated
    • Little substitution
    • Runup is added cost to bidder

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 16

slide17
Postmerger performance
    • 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

slide18
Investment variables
    • 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

slide19
Discussion and implications
    • 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

slide20
Agrawal, Jaffe, and Mandelker (1992)
    • 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

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 20

slide21
Franks, Harris, and Titman (1991)
    • 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

slide22
Industry influences on M&A activity
    • 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

slide23
Andrade and Strafford (1999)
    • 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

merger performance during the 1990s
Merger Performance During the 1990s
  • 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

slide25
Pooling versus purchase accounting
    • 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

slide26
Method of payment
    • 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

slide27
Taxability
    • 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

slide28
Premium paid
    • 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

slide29
Analysis of event returns
    • 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

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 29

slide30
Returns to shareholders (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

slide31
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

slide32
Merger performance in the 1990sSchwert (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

slide33
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

efficiency versus market power
Efficiency Versus Market Power
  • 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

slide35
Eckbo (1981)
    • 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

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 35

effects on concentration
Effects on Concentration
  • 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

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 36

slide37
Merger activity in recent years has not greatly affected aggregate concentration
    • High rate of divestitures
    • Rise of new firms and new industries — computers, Internet, etc.
  • If international competition is taken into account, share of top 200 companies would be smaller

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 37

slide38
Impact on microconcentration
    • 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