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

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

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

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  1. - - - - - - - - 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

  2. 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

  3. 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

  4. 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

  5. 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

  6. 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

  7. 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

  8. 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

  9. 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

  10. 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

  11. 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

  12. 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

  13. 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

  14. 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

  15. 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

  16. 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

  17. 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

  18. 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

  19. 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

  20. 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

  21. 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

  22. 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

  23. 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

  24. 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

  25. 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

  26. 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

  27. 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

  28. 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

  29. 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

  30. 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

  31. 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

  32. 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

  33. 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

  34. 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

  35. 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

  36. 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

  37. 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

  38. 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

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