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Transcript
Corporate Control I This material is a summary of the papers by M. Jensen and R. Ruback, The market for corporate control: The scientific evidence, J F E 1983, Weston, Chung and Siu “Takeovers, Restructuring and Corporate Governance (1997) M. Bradley, A. Desai, and H. Kim, The rationale behind interfirm tender offers: Information or synergy? Journal of Financial Economics, 11 (1983) 141-153; M. Bagnoli and B. Lipman, Successful takeovers without exclusion, R F S (Spring 1988), 89-110, Grossman and Hart (1980), Bradley (1980) and Bradley and ‘Kim (1984), Healy, Palepu and Ruback (1992), Franks, Harris and Tiiman (1991), Berger, Philip G. and Eli Ofek, JFE 1995, Chandler (1977), Weston (1970), Stulz (1990) Lewellen, 1971. Rumelt (1974), Jensen’s (1986), Meyer, Milgrom, and Roberts (1992), Agency Problems, Equity Ownership, and Corporate Diversification, Amihud and Lev (1981), Denis, Denis, Sarin Journal of Finance, 1997, Chang, 1998, Journal of Finance The market was regarded by Adam Smith as an invisible hand that distributes resources to its most efficient use. Private and public companies are acquired on a daily basis. We could regard this activity as a means to control the rights to determine the management of corporate resources. In the market for corporate control, also referred as takeover market, alternative managerial teams compete for the right to manage corporate resources. A recent WSJ article states that the value of the merger activity in the late 90’s exceeded $1 trillion dollars per year. Takeovers (I will refer to this activity with the general term of M&A) can occur through merger, tender offer, or proxy contest, and sometimes elements of all three are involved. 1. In mergers and tender offers the bidding firm offers to buy the common stock of the target at prices in excess of the target’s previous market value. Mergers are negotiated directly with target’s managers and approved by the board of directors before going to the target’s shareholders for approval. 2. Tender offer are offers to buy shares directly from target shareholders who decide individually whether to tender their shares. 1 3. Proxy contests occur when an insurgent group, often led by a dissatisfied former manager of a large stockholder, attempts to gain controlling seats on the board of directors. 2 Will M&A ever take place? Before attacking the empirical evidence, let us think about the process in which firms acquire firms from current shareholders. Suppose that stockholders have rational expectations and that no stockholder can affect the outcome of the takeover bid. If the bid is going to succeed, no stockholder will sell unless he is offered at least the post-takeover value of his stock. Consequently, the raider cannot purchase a share unless he pays at least what the share is worth to him if the bid succeeds. The idea behind exclusionary mechanisms is that the only way to create proper incentives for the production of a public good [i.e., guaranteeing that the firm is efficiently run] is to exclude non-payers [minority stockholders] from enjoying the benefits of the public good. There are several different exclusionary devices: 1. Prior to a takeover, the shareholders voluntarily accept a dilution of their property rights in the event of a takeover by adopting rules that allow the raider to exclude them from some of the increase in the value of a share. 2. A second device focuses on front-loaded two-tier bids. These bids specify two prices, the front-end and back-end prices. The raider offers to pay the front-end price for controlling interest in the firm. If he takes over, then the minority stockholders are forced to sell their shares for the back-end price. As long as the back-end price is less than the value of a share under the raider’s management, this is a form of exclusion. 3. When there is a finite number of stockholders, some stockholders must be pivotal in the sense that they recognize they may affect the outcome. Making some 3 stockholders pivotal is crucial because it forces them to choose whether or not the bid succeeds. Hence, they cannot free ride, so exclusion is not necessary for successful takeovers. These views suggest that to make the target’s shareholder tender, the bidder company has to offer a price superior to the current market price. Thus, the empirical evidence should indicate an increase in the price of its shares when the announcement of the M&A takes place. Why do M&A take place? A firm willing to expand its current production or enter in a new line of business could develop its current capacity without acquiring another firm. There are transaction cost in acquiring firms: Out of pocket fees to investment banks; lawyers and advisers; time and resources expended during the acquisition period; cultural and managerial problems or adaptation of the acquired firm to the culture and structure of the organization. Why do firms decide to acquire another firm? If managers are acting in the shareholders interest, we expect that bidder and target firms should experience an increase in share value when the transaction is announced. Value can be created because M&A are an attempt by the bidding firm to exploit some specialized resource by gaining control of the target and implementing a higher valued operating strategy. The revised operating strategy may involve: 1. More efficient management 4 2. Economies of scale 3. Improved production techniques 4. The complementary resources 5. Increased market power 6. The redeployment of assets to more profitable uses, or any number of value-creating mechanisms (synergies) An alternative hypothesis of why value might be created is the release of information during the tender process. There are two forms of this information hypothesis: 1. The target was previously undervalued (“sitting on a gold mine” hypothesis) 2. The bidder management will implement a higher valued strategy (“kick in the pants” hypothesis) It could also be argued that M&A might destroy value for the bidder firm: 1. Indeed, a commonly posed motive might be to increase diversification: Diversification can be appealing for managers and workers of the firm that seek to preserve the organization and their reputational capital. However, this is in contrast to the existence of a well-diversified base of shareholders who can diversify across firms in the capital markets. We will see more about the effects of diversification later. 5 2. Also, if we think of the M&A as an action with many competitors or bidders, it is likely that the wining bidder is paying too much (winner’s curse). In this situation, the last bid will be in excess of the present value of the estimated cash flows, otherwise there will be a higher bid. 3. The winner curse could result from hubris (excessive auto-confidence, pride, arrogance) by the managers of the bidding firm. The results from hubris could be a transfer of wealth from bidder to target firms (bidder price will decline and target will increase). 4. Takeovers could be a solution to agency problems in the firm: If incumbent managers do not maximize shareholders’ value, a group of outside managers (other firm) will take over, fire them, and increase the firm’s value. However, M&A can also be a manifestation of agency problems. Managers can be motivated to increase firms’ size. Mangers can receive pecuniary and nonpecuniary rents if they manage a larger firm. Agency problems, hubris and value destroying diversification are more likely if there is abundant free-cash flow in the firm. The question left is: do M&A’s increase or destroy value? If they do, which party, the bidder or the target (or both equally) receives the gains? Think about the different theories that justify M&A and make implications on value creation. 6 Empirical results These results are obtained using event study methodologies. The return is computed as the unexpected change in prices of a large sample of M&A around the announcement date of the event (please see the handout on event studies). 1. Returns in successful M&A A. Returns to targets Around a positive 30% (20%) abnormal return in tender offers (mergers). B. Return to bidder firms: In perfectly competitive capital markets we should observe only zero NPV projects. The results in general suggest that the return to bidders is not statistically significant (we can not reject the null hypothesis that the abnormal return is zero). 2. Unsuccessful takeovers. B. Returns to targets: If the takeover fails in an initial stage, but is taken over in a later stage (in period of 2 months), the returns to targets are even more positive than in successful takeovers. If the firm is not taken over (in a period of five years), the return that was positive around the announcement (like a successful M&A) becomes negative after two years of remaining independent (the takeover was unsuccessful) 7 C. Returns to bidders: In general, the returns to bidders are not different from zero, although there is a range of results depending on the initial response and on whether or not the acquiring firm made a later takeover. 3. Method of payment: A. For target firms there is a positive abnormal return when the bidder uses cash or equity. B. For bidder firms: The return is negative when stock is used as method of payment. The return is insignificant when cash is used. 4. Single versus multiple bids: A. Target firms: The positive return for target firms is more positive when there are multiple bidders. B. The return to bidders is negative. The bidder that comes to rescue a firm from a takeover is normally called “White Knight” and it seems that they pay too much (“winners curse”?) 5. Private vs. Public Targets: Acquirers of private targets experience zero or negative returns but acquirers of private firms gain at the announcement of the acquisition. 6. Large versus small bidders: Large bidders experience losses at the announcement of the acquisition, while small capitalization bidders gains at the announcement. 8 Post Merger Performance The post merger performance is usually adjusted by changes in performance of other firms in the same industry that did not merge. The results are ambiguous, and depend on the sample composition, period of study, and methodology used. In general, it is safe to say that the empirical results so far do not show significant improvements in performance of merging firms. Conclusions on Empirical Evidence In general, there is value created in M&A. Target firms experience large gains and bidder firms show no statistically significant gains or losses. Thus, we observe a combined creation of wealth. The sources of these gains can be synergies (although in general we do not observe improvements in operating performance after the merger), and information released in the acquisition process. 9 Corporate Focus and Internal Capital Markets Advantages of diversification: 1. Diversification leads to economics of scope. 2. Multidivisional firms create a level of management concerned with coordination of specialized divisions, and they are inherently more efficient and thus more profitable than their lines of business would be separately. 3. Firms diversify to overcome imperfections in external capital markets. If the information asymmetry between the firm and potential investors becomes too large, firms may decide to forego positive net present value (NPV) projects. Diversified firms, by creating a larger internal capital market, reduce the underinvestment problem. 4. Another potential benefit of diversification arises from combining businesses with imperfectly correlated earnings streams. This coinsurance effect gives diversified firms greater debt capacity than single-line businesses of similar size. One way in which increased debt capacity creates value is by increasing interest tax shields. Thus, diversified firms are predicted to have higher leverage and lower tax payments than their businesses would show if operated separately. 5. A further tax advantage arises from the tax code’s asymmetric treatment of gains and losses. Note that undiversified firms are at a significant tax disadvantage because tax is paid to the government when income is positive, but the government does not pay the firm when income is negative. This disadvantage is 10 reduced, but not eliminated, by the tax code’s carryback and carryforward provisions. Many authors argue, however, that related diversified firms perform better than conglomerates argues that related diversification affects value more positively than unrelated diversification because skills and resources can be used in related markets. Others discuss the effects of reputation and economies of scope, which arise when the joint cost of producing two or more outputs is less than the sum of the costs of producing each output by itself. Diversification can create several costs: 1. Diversified firms will invest too much in lines of business with poor investment opportunities. This argument can lead to cross-subsidization of failing business segments. A failing business cannot have a value below zero if operated on its own, but can have a negative value if it is part of a conglomerate that provides cross-subsidies. 2. Managers diversify to protect the value of their human capital. 3. Theoretically, if diversification might reduce under-investment problems, it can also lead to over-investment. The cross-subsidization of divisions within a conglomerate gives divisional managers easy access to capital, which may exacerbate the agency costs of free cash flow (Jensen,1986). Proponents of conglomerate diversification implicitly assume that managers of conglomerates are better at monitoring the divisions than the external capital market and that agency costs are not large enough to offset this benefit. 11 Empirical Results on diversification 1. There was a steady trend toward greater focus during the 1980s and 1990s. 2. The trend toward greater focus is associated with greater shareholder wealth. This relation is not trivial in economic magnitude 3. In general, diversification reduces value. The estimated value loss averaged 13% to 15% over the 1986-91 sample period, occurred for firms of all sizes, and was mitigated when the diversification was within related industries. 4. In general, over-investment is associated with lower value for diversified firms, and segments of diversified firms over invest more than single-line businesses do. 1. There is evidence that suggests the subsidization of poorly performing segments contributes to the value loss from diversification. 12