The Empirical Evidence On Post Merger Performance Finance Essay

The Empirical Evidence On Post Merger Performance Finance Essay

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Study of M and A performance has been part of the strategic management, corporate finance, and organizational behavior literature for decades. Researchers have made use of various criteria in their attempt to appraise M&A performance. For instance, Zollo and Singh (2004) found "there exists much heterogeneity both on the definition of the performance of M&As and on its measurement". In a study of 88 empirical conducted between 1970 and 2006, Zollo and Meier (2008) acknowledged 12 different approaches, varying along several scopes, for measuring the impact of M&As. Essentially, there are four commonly used performance evaluation approaches in M&A field which can be classified as quantitative and qualitative methods:

Cording et al. (2010) reported 92 percent of empirical works used event study and accounting-based methods. According to Zollo and Meier (2008), only 28 percent of researches use accounting based measures, while 41 percent of the total reviewed articles use short-term event study.

4.1 Event Studies

Event study has been dominant empirical financial research approach since the 1970s (Martynova and Renneboog, 2008) and is broadly applied in M&A study. Event studies measure the abnormal returns to the shareholders for the period surrounding the announcement of the merger. Abnormal return is fundamentally the difference between the raw returns which is basically the change in the share prices and a benchmark index calculated by for example the Capital Asset Pricing Model (CAPM) or S&P500, among others (Krishanmurti and Vishwanant, 2008). The first event study is said to be done by Fama, Fisher, Jensen & Roll in 1969, who examined the stock splits to public listed companies. Ever since, it has become an influential tool that help companies to investigate effects of an event on stock return (Boehmer et al., 1991; McWilliams & Siegel, 1997; MacKinlay, 1997). Indeed, stock returns reflect immediate, unbiased, rational, and risk-adjusted expectations of firm value in future based on the arrival of new information.

Researchers usually identify a period (event window) over which the impact of the event will be analysed which can be classified into short-term and long-term event study. "The short term approach assumes stock market efficiency that means the stock market reaction to acquisitions when they are announced or completed provides a reliable measure of the expected value of the acquisition. The long term performance assessment assumes the stock market spends time to evaluate the value implications of acquisitions and wait new information about the progress of the merger. Besides, the probability of M & A will be analyzed" (Sudarsanam, 2003, p.71).

Whether value is created or destroyed as a result of a merger can be directly measured by event study since it is a forward looking approach. It also has few backdrops as it is underlined by many assumptions about the stock market and event based study is prone to confounding events, which could skew the returns for particular companies at particular events.(Bruner,2002)

Evidence using Event Studies

Owing to the large number of empirical studies, as well as the variety of samples and sampling techniques used, the main findings have been tabulated. The subsequent discussion therefore focuses on highlighting the main findings and identifying how specific studies have contributed to our understanding of measures of acquirer performance and the factors that influence it. Table 1 contains a summary of studies examining the short-run impact of acquisitions, while Table 2 includes details on long-run studies.

Short-run event studies

The 'short-run' event period over which the performance of bidding companies is measured varies noticeably between researches with some studies analysing performance in so far as four months prior to the bid announcement (Franks and Harris 1989) and up to three months afterwards (Higson and Elliot 1998). Regardless of the event window selected, however, the evidence on the whole suggests little if any positive returns to shareholders in acquiring companies. Of the studies reviewed in Table 1, only the early studies in the US by Asquith et al. (1983) and in the UK by Franks and Harris (1989) observed significant positive returns to acquirers Indeed it is to be noted that both of these studies included takeovers during the period when takeovers appear to have been more beneficial to acquiring firm shareholders (Bradley et al. 1988; Bruner 2002). Franks and Harris conducted their research in 1950s while Asquith et Lal conducted theirs in 1960s.

The remaining studies from both the UK and US come to the conclusion that either no significant difference in the returns of acquirers or significantly negative returns around the bid announcement. In addition, as can been noticed from Table 1, more recent research appears to conclude increasingly negative performance of acquirers, a finding in line with evidence presented by Andrade et al. (2001). Moreover, it must be noted that recent evidence from other countries tends to be more positive compared to findings documented for UK and US. For example, Campa and Hernando (2004) point out insignificant gains from a sample of Continental European takeovers, while Ben-Amar and Andre (2006) report positive announcement returns from a sample of listed Canadian companies.

Sudarsanam and Mahate (2003) report significantly negative abnormal returns of 1.4%, over the −1 to +1 day period, with only a third of acquirers experiencing wealth gains based on their research on a sample of 519 UK acquirers between 1983 and 1995. This evidence is largely consistent with other UK studies by Sudarsanam et al. (1996) and Holl and Kyriazis (1997). For the extended post announcement period of +2 to +40 days, Sudarsanam and Mahate (2003) also proclaim generally negative abnormal returns but do not find the differences to be statistically significant - findings broadly similar to Limmack (1991) and Gregory (1997). However, almost 50% of acquirers are shown to experience wealth losses over the extended event window.

Long-run event studies.

Motivated by early studies suggesting that M&As may have a negative impact on the long-run wealth of shareholders (Asquith 1983; Malatesta 1983), the long-run post M&A performance has also been subject to a great deal of research. As shown in Table 2, recent studies advocate that M&A produce either insignificant or negative abnormal returns in the long run. In the UK, for example, Limmack (1991) reports significantly negative returns for a sample of 448 takeovers between 1977 and 1986. Consistent with his findings is that of Kennedy and Limmack (1996) for their research on takeovers during the 1980s, and Gregory (1997) based on his study of takeovers between 1984 and 1992. Finally, Sudarsanam and Mahate (2003, 2006) also report significant negative returns in the post-bid period. Table 2 also illustrates that recent evidence from US studies is broadly consistent with the UK findings cited above, with Agrawal et al. (1992), Loughran and Vijh (1997) and Rau and Vermaelen (1998) reporting significant negative returns.

A recent research by Alexandridis et al. (2006) uses the three-factor model formulated by Fama and French (1993) and the traditional capital asset pricing model (CAPM) methodology. Both models experienced a negative abnormal return of around −1%. Gregory and McCorriston (2005) find that bidders lose −9.36% and −27% in years +3 and +5 following the announcement while there were no significant returns for years 0 to +2. Hence, the overwhelming consensus is that shareholders in acquiring companies suffer significant wealth losses when long-run returns are considered.

4.2 Accounting Studies

Accounting study is based on the reported financial results of the bidder's pre and post merger to examine changes in financial performance. Changes in net income, profit margin, growth rates, return on equity (ROE), return on asset (ROA) and liquidity of the firm are the focus of accounting studies (Bruner, 2002; Pilloff, 1996). The studies of the operating performance provide a supplementary measure to evaluate the result of the merger. The main outcome these studies give is whether the merger resulted in providing an edge to the acquirers over their competitors. (Bruner, 2002)

Most of the study on merger performance has focused on the use of share price figures due to the susceptibility of accounting data to managerial manipulation through altering accounting policies and earnings management (Stanton 1987). A number of researchers prefer using accounting information to determine the long-run impact of acquisitions on operating performance of firms, arguing that any benefits from M&As will eventually materialize in the firm's accounting records.

Evidence using Accounting Studies

Table 3 presents a review of accounting studies.

Meeks (1977) concludes that profitability increased in the year of the takeover but decreased drastically below the pre merger levels, sometimes to the extent of 50% in each of the five subsequent years.

Dickerson et al. (1997), in their study on a cross section of UK firms, led to the conclusion that that there was no evidence that M & A had positive impacts on the acquiring company's financial performance and led to a permanent detrimental effect on company performance and profitability. This finding was consistent with that of Meeks (1977).

Healy et al. (1992) examined post M & A operating performance of the biggest 50 mergers between 1979 and 1984 and the same industry performance was used as benchmark. The authors indicated that acquirers experienced improvements in asset productivity, resulting in increase in operating cash flows relative to their industry peers. Interestingly, this paper came to the conclusion that the post-acquisition performance of acquirers is reduced after the takeover but is still better than their non-acquired sector peers, suggesting that acquisitions serve to lower the impact of poor performance.

Andrade et al. (2001) studied the post acquisition performance of approximately 2000 US mergers during the period 1973 and 1998. They found that post-merger operating margins (measured as cash flow to sales) relative to the industry improve and are about 3.2% after the acquisition versus 2.9% before. The authors conclude that 'the combined target and acquirer operating performance is strong relative to their industry peers prior to the merger, and improves slightly subsequent to the merger transaction' (p. 116).

Ghosh (2001) attempted to show whether operating performance is actually improved post acquisition and whether the performance of acquirer is associated to the mode of payment employed. He used a sample of all the mergers and acquisition from 1981 to 1995. He compared the pre and post-merger operating cash flow performances relative to the merged firms to examine whether the operating performance had improved post acquisition. And he found no evidence that operating cash flow performance improves subsequent to acquisition against what was concluded by Healy, Palepu & Ruback (1992) that cash flow performance improves post acquisition. He also came to a conclusion in his research that cash as a mode of payment was a better alternative in order to better employ the assets of the combined firm and produce better wealth gains compared to equity as a mode of payment

 

The bottom line of the accounting studies is that there is no strong relation on average between acquisitions and post-acquisition accounting or productivity performance. One probable justification is that the accounting data are too noisy to isolate the effects of the acquisition. This is acceptable given the transformations the accounts of the merging firms go through at the merger (restatements, special amortization and depreciation, merger related costs, etc.).

4.3 Survey of Executives

A survey study is a primary source of information which involves asking the executives of the companies whether the acquisition actually created value. Under, this method, standardized questionnaires are set for managers to assess the impact of a merger on the company. The answers of the executives from the interview are then analyzed to arrive at a conclusion.

According to Bruner (2002), 'survey by practitioners is often casually reported, limiting the ability to replicate the study and understand the methodological strengths and weaknesses. For this reason, scholars tend to give practitioners surveys rather less attention.'

Moreover since the managers may or may not be stockholders and their outlook may not be focused on economic value creation. Also convincing the executives for involvement is a time consuming task and unfortunately, these surveys are known to have a low rate of participation. (Bruner, 2002)

Despite consisting of some backdrops, this approach has its advantages as it gives a perception into value creation that may be unknown in the market and the benefits from the intimate familiarity with the actual success of the acquisition.

Evidence Using Survey of Executives

In a research entailed by Ingham, Kran and Lovestam (1992) who interviewed 146 of UK's top 500 companies between 1984 and 1988 on the basis of a questionnaire, it was held that 77% of the 146 CEOs surveyed are in the opinion that there was a rise in the short term profitability post the merger and 68% believed that the profitability increased in the long run.

In a survey conducted by pooling 50 executives via the internet to evaluate the success to create wealth or otherwise of the merger, on average the respondents said that 37% of the deals created value for the buyers. Also it was found after considering all the respondents that only 21% of the deals achieve the buyer's strategic goals. (Bruner, 2002)

The frame of reference has a key role on the impact on the responses. Executive opinions tend to be more positive on the post-merger value creation in the case where the particular executive is involved. Indeed, the survey of the 50 executives concentrated on executives who were personally involved in a merger deal and were asked to respond to it. The result was different. 58% of the respondents said that there was value creation in their deal. 51% believed that they attained their strategic goal while 31% of the respondents didn't agree with it. The remaining was not aware of the outcome of their deals.

A survey by Business week(1995) for the period 1990-1995 consisting a sample of 248 acquirers purchasing a total of 1,045 targets, compared to 96 non acquiring firms , revealed that 69% of non-acquirers had their returns superior to that of the competitors. (Bruner, 2002)

A survey conducted by KPMG International (1999) based on a sample of 700 of the most expensive merger deals between 1996 and 1998 showed that 17% of the deals amplified shareholder value while 53% reduced it. 30% broke-even. Interviews with 107 executives disclosed that 82% of the respondents said their deals were successful. (Bruner, 2002).

4.4 Clinical Studies

Clinical studies focus on one case or a small sample is studied in great depth and insights, usually through field interviews with executives and knowledgeable observers. This is an inductive research which is good for looking out for new patterns and behaviours with regards to a deal (Bruner, 2004). The aim of clinical studies is to fill in gaps left by event and accounting studies (Jensen, 1986). However, due the small number of observations; researcher cannot do hypothesis testing and reports can be idiosyncratic implying difficulty for the decision makers to make bigger decisions from only one report (Bruner, 2002).

Evidence Using Clinical Studies

Several clinical studies piloted over the years have shown the way to uncovering the truths behind the success or failures of mergers. Lys and Vincent (1995) studied the acquisition of NCR Corporation by AT&T's, which lead to a decrease of the AT&T's shareholders wealth by $3.9billion and $6.5billion. Their research revealed three main reasons for the failure. First, maximizing shareholders wealth was not one of the objectives of the management, managerial overconfidence and thirdly, ignorance of accessible data.

A study to determine whether value is created or destroyed following an acquisition was conducted by Kaplan, Mitchell & Wruck (1997). They analysed the mergers of Cooper industries acquisition of Cameron iron works and that of Premark's acquisition of Florida tile and observed different share market reactions to their announcement. One acquisition increased the share value and the second decreased it. However, based on several field interviews with executives they concluded that both the acquisitions didn't create value due to lack of knowledge regarding target firm and the imposition of inappropriate organizational strategies on the target firm.

Ruback (1982) attempted to find the effect of the takeover of Conoco by Dupont on shareholder value. He discovered that Conoco's shareholders received gains of $3.2billion while the shareholders of Dupont suffered losses of $800 million. He couldn't establish the reason for net gain of $2.4billion from the deal and was unable to find a specific source. This study illustrated the possible problems associated in a clinical study.