Download C1 Event Studies Assessments Abstract Businesses have today

C1 Event Studies Assessments
Abstract
Businesses have today become very dynamic with new entrants, expansions, takeovers and more.
Since the beginning of 20th century, several waves of corporate mergers and acquisitions have
led to business restructuring in all parts of the world. Mergers and acquisitions are increasingly
becoming a good choice for organizations to grow not only for profits but also for gaining
market dominance and empire building. The basic rationale behind Mergers & Acquisition deals
is “One plus one equals three”. Companies can also create competitive advantage by getting
access to global distribution channels and suppliers, technological advancement and a larger
consumer base. If the deal turns out as expected, it could enrich the value of the business and
increase shareholder value. However, we have also seen cases where such mergers have not
turned out as anticipated.
This research paper aims to investigate into the finer aspects of the reactions to mergers and
acquisition deals and its larger impact on the share price and the reasons for the abnormal
increase or decrease. The aim of this paper is to examine the effect of merger announcement on
both target and acquirer company’s stock prices, a comparison of the price run-up prior to the
announcement followed by a lull period post announcement.
Review of Literature
Study of Mergers & Acquisitions requires analysis from the viewpoint of corporate finance,
strategic management, and organizational behavior. When we hear reports and news about the
success or failure of a merger, the below questions usually prompt us,
“How is the success of a merger measured?”
“Whether using different samples affect the results?”
“What are the approaches used to measure the success of the merger?”
“What are the features of the measures used?”
Analysis of Mergers and Acquisitions can be from various angles like short term objectives and
long term goals, expected returns, level of sharing of public information, returns to the acquiring
firm, changes in the management structure so on and so forth.
The commonly used performance evaluation approaches can also be stock market based, or
accounting (finance) based or expert informants’ assessment based. The steps in the assessment
of a merger start with planning, estimation of cash flows and also determining the economic and
financial dependencies of the same.
Merger Events:
In the chart below we can see the number of Mergers and Acquisition in the US over the last 20
years; it can be noticed that there has been a significant decline in the number of mergers during
the period of crisis of 2008-09 but again showing a recovery from 2009-10 onwards.
Reference: www.imaa-institute.org
The overall economic performance and the financial health of the country as a whole also has an
impact on the number of mergers taking place in any economy.
Empirical Research
For the purpose of this assignment, we have picked up the data of 50 target companies and 50
acquiring companies, and we analyze the stock prices of the same during one year.
An empirical research shows that more acquisitions take place when stock markets are booming
than when they are depressed. (Jovanovic and Rousseau, 2001: Rhodes-Kropf, Robinson &
Viswanathan, 2005).
Bouwman, Fuller & Nain (2009) argue that mergers in the periods of increasing stock markets
(high valuation periods) are fundamentally different from those in the periods of falling stock
markets (low valuation periods).
Market Performance during 2014:
According to "M&A trends report 2014" by Deloitte, over the past 12 months, merger and
acquisition (M&A) activity has seen a good growth in the U.S. This trend is likely to continue, if
not increase significantly.
Of the 2,500 corporate and private equity respondents, 84 percent of corporate executives
anticipate a sustained, if not accelerated, pace of M&A activity in the next 24 months. The vast
majority of private equity executives (89 percent) are expecting average to high deal activity
going forward.
Additional findings in the "M&A trends report 2014"

Twenty-one percent of companies look forward to major transformational deals while
around one in three companies will pursue smaller strategic acquisitions.

Around thirty six percent of the private equity firms are looking forward to Initial Public
Offering (IPO).

More than fifty percent of the corporate houses claim to invest in foreign markets.

Companies are now looking at acquisitions in various sectors which includes technology
sector, healthcare, oil and natural gas and also banking and financial sectors.

Firms now wish to shift their focus to industry specific sectors for a better specialization
of the services offered.
We can thus conclude that mergers are going in a big wave during 2014 and the same pace is
also likely to continue.
Mergers and acquisitions are also impacted by manager’s behaviors and perceptions. So we
move on to the next level of the performance measure.
Measure of Managerial confidence & testable predictions:
Rosen (2006) laid down that managers may be influenced by the bullish behavior of the stock
markets in the same way as stock holders. Hence, managers might overestimate the expected
results from the merger which might have a negative impact on the value of the stock.
In this framework, managers may believe that they have above average abilities or from the
underestimation of the downside of the merger due to the illusion of control over its outcome
(Malmendier and Tate, 2008). The managers of bidding firms that experienced recent success
may believe that they can create value from acquisitions (Billett and Qian, 2008). However,
overconfidence may lead managers to undertake bad acquisitions. Hence, we should expect that
overconfident managers should experience lower returns in their acquisitions.
The market valuation theory posits that, when stocks are overvalued, managers are likely to
engage in acquisitions, especially share deals, by using their overvalued stocks to acquire lessovervalued companies (Shleifer and Vishny, 2003).
Apart from the two measures discussed above, empirical analysis is also done from the view
point of the announcement of the merger information or news in the market.
Stock market-based measures:
The abnormal stock returns (ARs) from event study will be potentially determined by five
factors:
(1) how new the information is revealed to the market;
(2) how much information is disclosed in the observation window and how clear and persuasive
they are;
(3) how long it will take for the investors to get the information;
(4) how correctly investors will interpret these information; and
(5) how can the investors’ reaction to the information of confounding effects be isolated.
The assumptions underlying this methodology are that the stock markets are efficient which
implies that the stock price fully incorporates all the market information that is available to the
market traders. The second assumption would be that the event under study is unanticipated and
there are no confounding effects during the event window.
In reality, as we know that markets are not going to be in an ideal situation always and so the coexistence of these factors might not be really practical.
Accounting based measures:
Accounting-based measures of performance also take a long-term perspective of acquisition
performance like long-term event study but embody ex-post, actual, realized returns. This
usually consists of a comparison of accounting measures prior and subsequent to a takeover. The
rationale behind these studies is that the strategic aim of a business is to earn a satisfactory return
on capital, and any benefit arising from takeovers will finally reflected in the firm’s accounting
statements (Tuch and O’Sullivan, 2007).
Accounting measures have a broad sense, such as profitability, employing earning-based
measures and cash flow performance measures (Healy et al., 1992), productivity (Bertrand and
Zitouna, 2008), innovation indicators (Bertrand, 2009), growth rate of sales, or assets (Gugler et
al., 2003). A wide range of accounting ratios in M&A performance assessment can be found in
Martynova and Renneboog’ (2008) research. Return on assets (ROA) is widely used in the M&A
literature (Bertrand and Betschinger. 2011). Meeks (1981) compared profit/sales ratio, return on
equity (ROE) and ROA and concluded that ROA is the most appropriate ratio for measuring
M&A performance. However, Barber and Lyon (1996) stated operating cash flows is optimal in
measuring the performance of firms after significant events, such as takeovers, as earnings can
be easily manipulated. Studies then vary in term of definitions of operating performance, deflator
choice (e.g., market value of assets or equity, book value of assets or sales), performance
benchmarks, and methodology. And the empirical results are sensitive to these aspects.
Advantages of accounting-based measures can be outlined as:
(1) It captures the realized returns;
(2) Similar to long–term event study, more valuable information can be gained to assess M&A
effect;
(3) It is relatively simpler to be implemented compared to event study;
(4) effects of multiple motives can be covered.
However, these advantages comes at some costs:
(1) Like long-term event study, it also incorporate the impacts of outside factors;
(2) It reflects the past rather than present performance expectation;
(3) Accounting data can be distorted by manipulation;
(4) Different accounting standards across countries and change overtime would make a serious
limitation to the validity of using accounting data (Hult et al., 2008);
(5) Accounting policy choice varies over time and between companies, which make it difficult to
make comparison with their benchmarks;
(6) Accounting data fail to evaluate the success of a specific acquisition as they provide
aggregated data measuring the performance of the whole organization (Bruton et al., 1994);
(7) Valid combined performance after M&A is difficult to get, as the financial reporting regime
is different when the target is dissolved or be an independent subsidiary of the bidder (Powell
and Stark, 2005);
(8) Some financial ratios, like ROA, are affected by the method of accounting for the merger
(purchase vs pooling accounting) and the method of financing the merger (cash, debt or equity).
In general, results of post-merger performance measured by accounting based approaches are
ambiguous. The results depend on a various factors and not just the accounting figures or ratios
alone.
Expert informants’ assessment
The basic approach in expert informants’ assessment is like management assessment, but the
respondents are shifted to expert informants. Some scholars use direct data from security analysts
(Hayward, 2002), or directly via the ratings in financial reports and commentary (Schoenberg,
2006). Some scholars used multiple informants to improve the reliability of their findings. For
example, Cannella & Hambrick (1993) collected both the security analysts’ and the executives’
assessment on the acquired firms’ performance for each acquisition, and each expert provided
their assessments of both pre- and post-acquisition performance.
Apart from owning the similar pros and cons with management assessment, this approach
provides external assessment, which can be applied when both managers’ and objective
performance measures are unavailable (Cannella and Hambrick, 1993) and to offset their flaws.
Besides, like management assessment, it enables us to assess the outcomes of acquisition on the
project level, especially when the firms are multidivisional. However, this method may suffer
from expert informants’ subjective bias and they may have limited information.
Schoenberg (2006)’s study show, based on financial press commentary between two and four
years post-acquisition, 44 percent of the acquisitions are described as poor or very poor.
Divestment measure:
This approach assesses the outcomes of M&A by identifying whether an acquired firm has
subsequently been divested or not. The logic of this measure is that merged companies deem to
diversify if the acquired firm’ performance does not meet their expectations (Ravenscraft and
Scherer, 1987). It is a relatively simple way to gauge success with no requirement of detail
information. However, divestment in some instances signals successful restructure and profitable
sale (Kaplan and Weisbach, 1992) or appropriate resource reconfiguration in response to
environmental change (Capon et al., 2001) and these are confirmed by Schoenberg’s (2006)
study.
Ravenscraft and Scherer (1987) report that 33 percent of acquisitions in the 1960s and 1970s
were later divested, while porter (1987) finds that more than 50 percent of the acquisitions made
by 33 firms in unrelated industries were subsequently divested. Mitchell and Lehn (1990) say
20.2 percent of 401 acquisitions, which took place during 1982-1986, were divested by 1988.
Kaplan and Weisbach (1992) concluded that 44 percent of the target companies acquired
between 1971 and 1982 were divested by the end of 1989. However, only 44 percent of the
acquirers who perform divestiture report a loss on sale.
Long run returns of acquirers
So far we have shown the results around the announcement date where acquisitions conducted by
non-overconfident bidders are value increasing and lead to better performance than those
initiated by overconfident bidders irrespective of the valuation period. In addition, nonoverconfident bidders generate their largest returns in bullish periods. However, initial market
reactions are not always consistent to long-term results. Hence, to address this issue, we examine
post event bidder returns. In contrast with announcement returns, overall, bidders lose on average
−4.23% over the 36-month post-event period, but this result is not statistically significant.
Acquisitions undertaken by overconfident bidders are associated with a statistically significant
−21.75%, consistent with previous literature (Doukas and Petmezas, 2007), while acquisitions by
non-overconfident bidders generate an average BHAR of 2.98%, but statistically insignificant.
We find that the difference is equal with 24.73% and statistically significant at conventional
level. We do not find any evidence of significant abnormal returns when examining the longterm performance of acquiring firms by market valuation periods.
When examining bidder post-event returns for the interrelationship between managerial
overconfidence and market valuation, we find that during neutral periods, acquisitions
undertaken by overconfident bidders destroy shareholders wealth by a significant 36-month
BHAR of -38.23%, while acquisitions undertaken by nonoverconfident bidders are value
increasing over the 3-year post-event period (17.92%). Overall, the results are, in general,
consistent when using the CTAR approach to measure long-term returns.
Relationship among these measures
We have discussed the various empirical measures ranging from market performance,
managerial confidence, stock market data, accounting based measures, expert informants’
measures and divestment measures.
The different measures bring into light the different aspects of complex acquisitions and each
measure has its own flaws.
None of the measures is completely perfect by itself but each can offset the other’s flaws.
Discussions & Implications
All the above empirical discussions are subject to the corporate governance and management
policies. Excessive optimism and managerial overconfidence can lead to harmful consequences
on the shareholder value even if there are contractual agreements which tie managers'
compensation to firm performance, it is still uncertain whether they will cancel their valuedestroying corporate actions, sourced from a behavioral bias. Hence, corporate governance
mechanisms should be implemented to monitor CEOs' decisions. This is due to the fact that
firms cannot rely only on stock options and stock grants to align CEOs and shareholders'
interests, as this does not guarantee that the CEO will take a value-improvement decision if he is
affected by overconfidence. Third, recently the importance of independent directors has been
brought into surface in the US, after 2002, with the Sarbanes–Oxley Act and in the UK, after
1992, with the Cadbury Committee Recommendations. The results of our study suggest that the
presence of more independent directors in firms' Board could prove desirable in order to
effectively monitor CEOs decisions, mitigating potential overconfidence when undertaking
relatively optimistic projects. Fourth, our results imply that firms are better off when selecting
non-overconfident bidders, which indicates that firms should be cautious during the process of
CEOs appointment.
Finally, our results imply that the timing of the acquisition plays a role in explaining bidders'
performance. This is an indication that managers can exploit certain period in improving
shareholders' wealth.
Conclusion
On an overall comparison we can conclude that mergers and acquisitions are driven by various
factors which could also be highly subjective and specific to the nature of the industry and the
core values of the firm. Also the stock prices could be driven by a lot of uncharacterized factors
which includes insider information and impact of overseas markets and economic variables.
References:
E-Leader Berlin 2012
Bouwman C Fuller & Nain (2009) Market Valuation and acquisition quality: Empirical evidence
Review of Financial Studies
Jovanovic B & Rousseau P (2001) Mergers and technological change: 1885-2001 Working
Paper
"M&A trends report 2014" by Delloite
International Review of Financial Analysis 19 (2010) 368–378
Investment Management and Financial Innovations, Volume 5, Issue 1, 2008