The pace of mergers and acquisitions (M&As) has been increasingly investigated in the literature in the last two decades in response to the rise in M&A activities as well as the increasing complexity of such transactions themselves (Gaughan, 2007). With the purpose of setting an M&A context for the dissertation topic, we will explore M&A activities in terms of its definition, types, motives and process. We will also discuss role of M&A activities in shareholder's value creation process.
A) Definition of Merger and Acquisition:-
In the broad sense, mergers and acquisitions may look like a number of different transactions ranging from the purchase and sales of undertaking, concentration between undertakings, alliances, cooperation and joint ventures to the formation of companies, corporate succession/ ensuring the independence of businesses, management buy-out and buy-in, change of legal form, initial public offering and even restructuring (Picot, 2002, p.15). However, Nakamura (2005) as cited in Hoang and Lapumnuaypon (2007), explains that using a large definition of M&A could create complexity and misunderstanding as it imply everything from pure mergers to strategic alliance. Therefore, this dissertation adopts the definition of M&A in a narrower sense as clarified below.
ï‚·ï€ ï€ ï€ ï€ "A merger is a combination of two corporations in which only
one corporation survives and the merged company goes out of existence." p.12 In a merger, the acquiring company takes the assets and liabilities of the merged company (Gaughan, 2007).
ï‚· "A merger is pooling of the interests of two companies into a new enterprise, requiring the agreement of both sets of shareholders." p.552 For example, in the case of Daimler-Benz and Chrysler in 1998, stock of both the companies' were surrendered and the stock of new company called DaimlerChrysler was issued. (Pike and Neale, 2009)
ï‚· According to European Central Bank (2000) and Chunlai Chen and Findlay (2003) "acquisition is the purchase of shares or assets on another company to achieve a managerial influence", not necessarily by mutual agreement, according to Jagersma (2005). [cited in Hoang and Lapumnuaypon (2007)]
ï€ ï€ ï€ ï€ ï€ ï€ ï‚· An acquisition is slightly different thing than merger, it occurs when one company takes over another and clearly established itself as the new owner. For example, News Corp.'s bid to acquire Dow Jones was equal to a 65% premium over the stock's market price. (www.scribd.com) accessed on 26th November, 2009.
Acquiring company:-
This refers to the acquiring firm in a tender offer. That is the firm which initiates the merger.
Target company:-
This refers to the victim of an acquisition, or the company being acquired by another company.
Types of Mergers and Acquisition:-
1) Horizontal mergers :- This occurs when two merging companies producing similar product and services in the same industry. In other words When two competitor companies combine together its called a horizontal merger. This generally happens when companies trying to achieve economics of scale and monopoly. For example, in 1998, two petroleum companies, Exxon and Mobil, combined in a $78.9 billion merger (Gaughan, 2005). According to Gaughan (2007), there are some government restriction as this kind of merger can create strong market monopoly.
Record shows that out of total global mergers and acquisitions horizontal mergers and acquisitions accounts for about 42%. However, the share of horizontal M&As in CBA (cross-border acquisitions) is substantially smaller (at 32%) than that of horizontal mergers in domestic M&A (45%). (Hijzen et al. 2006)
2) Vertical mergers:- When two companies producing different goods or services for one specific finished product, get merged is called vertical merger. This type of merger eliminates competition between the two firms. (Silam and Gupta, 2009).
A vertical merger occurs when two companies combine who have a buyer-seller relationship. For example, in 1993, Merck, the world's largest drug company, acquired Medco containment services. (Gaughan, 2007).
3) Congomerate mergers:- When companies are not in competition of each other and also not having a buyer-seller relation ship than that kind of merger is called conglomerate merger. It generally happens between two companies operating in different industries. For example, in 1985, General food got merged with Philip Morris, a tobacco company for $5.6 billion. Another good example of a conglomerate is General Electric which have manage a diverse portfolio of companies in a way that creates shareholders wealth. (Gaughan, 2007).
4) Cross border acquisition:- According to lexicon.ft.com, an acquisition in which the target and acquiring companies are located in different geographical locations. One of such example is an acquisition of Mannesmann AG, a German company by Vodafone Air touch Plc, a British company.
Acquisitions can be categorised into two, i.e. friendly or hostile. Friendly acquisitions occur when the target firm expresses its agreement to be acquired, whereas hostile acquisitions don't have the same agreement from the target firm and the acquiring firm needs to actively purchase large stakes of the target company in order to have a majority stake. (Gaughan, 2007).
There are some issues with cross border acquisition for example finding the right target companies with high value creation abilities and scope to expand in different environment. Secondly many cross border acquisition fails to generate their full potential because preparation, planning and implementation processes fails to explain clearly what success means. (Jagersma, 2005)
5) Leveraged Buyouts (LBO):- In this kind of acquisition acquiring company finances the deal using borrowed money (Gaughan, 2005). One problem with LBOs is that buyer takes on substantial debt (Gaughan, 2005)
6) Management Buyouts:- one version of an LBO is a management Buyout. In the case of management buyout, the buyer of a company, or a division of a company, is the manager of entity (Gaughan, 2005).
The Five-stage (5-S) Model :-
According to Sudarsanam (2003), there are five different stage in which we can divide the M&A process.
Corporate strategy development;
Organizing for acquisitions;
Deal structuring and negotiation;
Post-acquisition integration; and
Post-acquisition audit and organizational learning.
So here the author regards M & A as a process, rather than as a transaction, which requires insights from a number of disciplines to understand.
Motives behind mergers and acquisition:-
According to Gaughan (2007), there are many possible motives or reasons that can force the firm to engage in merger and acquisition process. One of the most common reasons is expansion. Acquiring a company in a line of business or geographic area into which the company may want to expand can be a faster way of expansion rather than internal expansion alone. There could be some financial motives behind the M & A process as well.
According to Joel Sinkin, president of Accounting Transition Advisors in New York, as cited by Gold (2009), many mergers over the past few years occurred because enterprises were looking for new talent and lucrative client niches. However with the recent economic downturn, M&As are emerging for additional motives as well.
According to Jay Nisberg as cited in Gold (2009), primarily top-line growth and quality human capital is the motivation behind M&A. Furthermore he also expects increase in number of M&A activities for 2010 with the cautioned that firms of all sizes will be much more selective in choosing their merger partner.
These motives, with their respective shareholder wealth effect, are analyzed as under.
1) Growth - you merge in order to grow - focus on added value.
According to Gaughan (2007), Growth is the most fundamental motives behind merger and acquisition. Habeck et al. (2000) states, growth means unlocking the "merger added value" by taking the benefit of the positive combinations offered by the company's combined resources. According to Alex Mandl as cited in Carry (2000), "In the last three years, growth through acquisition has been a critical part of the success of many companies operating in the new economy. In fact, I would say that M&A has been the single most important factor in building up their market capitalization." p. 146
Companies looking for expansion are often faced with two alternatives either internal expansion or expansion through merger and acquisition. According to Gaughan (2007), internal growth is much slower and uncertain process while M&A is much faster and cheaper in comparison to internal expansion, although it brings with it own uncertainties. If the company seeks to expand within its own industry than they may conclude that internal growth is not an acceptable alternative because competitors may respond quickly and take market share. Habeck et al (2000) states, "Growth by acquisition can be just as effective as in-house-driven effort to grow your company." p.54
Secondly using merger and acquisition as a growth tool is also more suitable when a company wants to expand to another geographical region. It could be that company's market is limited to the particular part of country or region and it wants to expand internationally. For example US firm wants to expand in UK market. In many instance it is quicker and less risky to grow geographically through M&A. (Gaughan, 2007)
Here the managers need to be assuring that, M&A will generate expected return for the shareholders. It seen that management often successful in generating high return through massive growth however, board need to critically examine the expected profitability of the revenue derived from the growth and determine if the growth is worth the cost. (Gaughan, 2007)
2) Synergy :-
According to Gaughan (2007) "The term synergy is often associated with the physical sciences rather than with economics or finance. It refers to the type of reactions that occur when two substances or factors combine to produce a greater effect together than that which the sum of two operating independently could account for." p124. According to Mishra and Goel (2005), "synergy is realised when the value of the combined firm is greater than the sum of the value of the individual firms."
According to Seth (1990), the word synergy and value creation is thesaurus to each other. Synergy can be a misleading word which some might consider as a synonyms for reducing cost but it also include positive aspect of merger such as knowledge sharing and growth aspects (Habeck et al. 2000).As per the survey carried out by Bhide (1993), to examine the motives behind 77 acquisitions in 1985 and 1986, reveals that operating synergy was the most important motive in 1/3 of those acquisitions. (cited in pages.stern.nyu.edu) accessed on 22nd December, 2010
To explain that in simple word, synergy refers to the phenomenon of 2+2=5. "In mergers this translates into the ability of a corporate combination to be more profitable than the individual part of the firms that were combined." (Gaughan, 2007) p124.
According to Gaughan (2007), the anticipated existence of synergistic advantages allows company to incur the expenses of the acquisition process and still be able to afford to give target shareholder a premium for their shares. Synergy may allow the combined firm to appear to have a positive net acquisition value (NAV).
NAV = VAB - [ VA + VB ] - P - E
Where:-
VAB = the combine value of the two firms
VB = the value of B
VA = the value of A
P = premium paid for B
E = expenses for the acquisition process
So Reorganisation equation would be;
NAV = [ VAB - ( VA + VB )] - (P + E )
To explain the above equation, the term in the brackets shows the synergistic effects which should be higher than the sum of P + E to justify going forward with the merger otherwise it would be considered that the bidding company have over paid the target.
There are two main foams of synergy that is operating synergy and financial synergy. Operating synergy focus on revenue enhancement and cost reduction which is generally derived in horizontal or vertical mergers. The financial synergy refers to the possibility that the cost of capital may be reduced by combining two companies. (Gaughan, 2007)
3) Diversification :-
The word diversification suggest growing outside the company's current industry category. A wish for diversification could lead the firm into the mergers and acquisition process. When there is a downturn in the returns from a particular industry, firms operating in that industry may decide to acquire or merger with the firms operating in different industries that are more profitable in order to cover their losses. Secondly when the acquirer's industry is mature and facing high level of competition, diversification can force the firm to engage in M&As process. consequently innovation may not be able to bring about higher returns, the bidding company may opt for diversification through M&A (Gaughan, 2007). Furthermore, to achieve a high market share in any market, diversification through mergers and acquisition is a quick way to get entry without adding any extra capacity to a market that already have excess capacity (Hopkins et al, 1999). According to Sudarsanam (1995), diversification through merger allows the acquirer to diversify risk, which can be achieved if the cash flow of the acquiring firm and target firm are not highly positively correlated.
4) Tax motives:-
Whether the tax motives should considered an important determinant of M&A or not, has been a debated topic. Certain studies have concluded that mergers and acquisitions may be an effective means to secure tax benefits. Gilson, Scholes, and Wolfson assert that for a certain small fraction of mergers, tax motives is an important determinant. However Hayn argues that " potential tax benefits stemming from net operating loss carry forwards and unused tax credits positively affects announcement-period returns of firms involving tax-free acquisitions, and capital gains and the step up in the acquired assets' basic affects returns of firms involved in taxable acquisitions." (Gaughan, 2007) p165.
5) Managerial motive :-
Merger and acquisition literature confirms that managerial motives for mergers are considered as crucial determinants of the incidence, rationale, type, deal structure and outcome of mergers. This motives can be from purely financial to personal. According to Levy and Sarnat (1994), Managers wish to increase the size of the firm can be an important motive behind M&A as they believe bigger the size of the firm, higher will be the compensation for them. Furthermore Gaughan (2005) believes that managers may act to diversify their own employment risk from M&A activities, as it is believed that mergers and acquisition diversify the firms activities which results in stabilised cash flow and reduced bankruptcy risk.
According to Grundy and Slack (2005), managers may act to maximise their own interests rather than those of shareholders. They might settle for a low premium offer from a bidder in exchange for a share in management control of the merged entity or a more exalted managerial position. Furthermore Grundy and Slack (2005) reports that bidding company's managers overestimates their capacity to create value out of M&A and often overpay for them.
6) Efficiency:-
Efficiency is also important motive that drives companies into M&A process. Efficiency can be gained in the form of managerial, operational or financial form. According to Levy and Sarnat (1994), a company may acquire or merge with another company in order to achieve efficiency in any of these area. Acquiring or merging with a firm that has an efficient management offers higher managerial efficiency while increase in debt capacity or reduction in debt cost because of merger offers financial efficiency. (Hackett 1996)
Drivers of M&A in Pharmaceutical sector:-
In a whole pharmaceutical sector where the world's largest player, Pfizer Inc. enjoy only an 11% of global market share, there is still plenty of space for mergers and acquisition. In spite of the fact that growth by acquisition is considered as high-risky business transaction, in the current economic situation, most drug companies are following a low-risk business strategy. According to the experts drivers for the pharmaceutical industry M&A are compelling.
According to John Maddox, a managing director of Infusion Pharma Consulting LLC, N. J. based strategy consultancy, "Constantly expiring drug patents and the need for a broader pipeline of strategic-scale products continue to pressure pharmaceutical firms to do deals." (cited by Harrison, 2003)
Increasing cost for developing new drugs for the market also create need for M&A in pharmaceutical and health care sector. According to Steve Elek, who runs the health care M&A practice at PricewaterhouseCoopers, "It is much cheaper for someone to be on a prescription program over the course of a year than to spend a week or two in a hospital. I think that will continue to be a driver of activity in this sector" (cited by Harrison, 2003)
The Economic Perspective On Merger:-
The logic for mergers under the economic perspective mainly depends on their impact on the various costs faced by the firm and the market power enjoyed by the firm. Thus in the following analysis we will examine how firms merger allows the firm to gain competitive advantage over their competitors through cost reduction or increase in market power.
As per the value theory, firm is considered as an economic unit whose final goal is the maximisation of profit or more precisely the net present value of the firm. Similarly the traditional theory of the firm conclude that only those corporation will survive who will able to maximise their corporate performance and those that are not able to maximise their corporate performance will either be taken over or eliminated. ( Mishra and Goel, 2005)
 Economy of scale :-
According to Sudarsanam (2003), the term economy of scale refers to the reduction in the cost per unit because of increase in total production in a given period. In other words, fixed cost for e.g. rents, salary etc. are invariant to the volume of production so cost of production decrease because of increase in total production.
Thus in a merger, total production increase and cost per unit decreases as the merging firms produce and sell a larger volume of their product than each on its own. Thus merger and acquisition provide with an opportunity for economy of scale. Sudarsanam (2003),
According to caslon.com.au, M&As allow the firm to build a stronger and bigger business with the opportunities of economies of scale, some of which are mentioned below. (accessed on 26th January, 2010)
A firm's cash flow would increase.
Talented executives can be attracted.
Interest of wider range of investor can be served.
It also increase the financial capacity of the firm.
 Economy of scope :-
According to Sudarsanam (2003), the term economy of scope refers to the increase in volume and sales and hence revenue and profit rather than decrease in cost of production. Thus increase in sales and profit through scope economies is often a strategic rationale for mergers of firms selling related products and services.
According to caslon.com.au, benefits of economies of scope can be achieved with the combination of two firm, some of which are listed below. (Accessed on 26th January, 2010)
It increases the share capital and other technical resources
It allows exchange of managers which creates opportunities for each other
 Economy of learning :-
Sudarsanam (2003) conclude, merger may allows the firm to achieve economy of learning through sharing of accumulated knowledge and the experience of the workforces of the merging firms however according to Sudarsanam (2003), economy of learning is not as strong rationale as economy of scope and economy of scale.
Finance theory perspective on mergers:-
According to Sudarsanam (2003), finance theory perspective concentrate mainly on firms' internal system, decision processes and decision makers' motivation and their behaviour. Finance theory perspective considered the merger decision in the common interests of their financial claim holders. It considers the following elements: [Sudarsanam (2003), p52]
 shareholder wealth maximization as the significant goal of corporate investment and financing decisions;
 "the agency model of the firm as a nexus of contracts and characterization of managers as agents, agency costs and conflicts of interest between principals and agents;"
 deviation from paramount goal of shareholder wealth maximisation is due to the agency problems;
 managers are monitored and controlled by the corporate governance.
 failure of internal governance of firms may activate an external control devise that means there is external constraints imposed by the market for corporate control.
 hostile takeovers control managers.
 real option provide a outline for analyzing certain types of acquisitions and means of evaluating targets.
Summary of the multiple perspectives on mergers:-
The table below provides a summary of different prospective on mergers.
Perspective
Focus
Major Elements
Economic
External to firm, on competitors
Various market structures e.g. monopoly and how firms compete in each
Vertical integration
Competition based on cost and perceived benefits
Scale and scope economies
Relative transaction cost as determinant of market versus hierarchies
Merger driven by above
Strategy
External
How to achieve sustainable competitive advantage
Firm's resources and capabilities (R&C)
How firms develop these
Competitive advantage result of Superior R&C
Sustainable advantage rests on R&C resistant to imitation and replication
R & C path dependent on and part of firms evaluation
Mergers a means to acquiring R&C
Finance theory
Internal to firm
Shareholders, creditors and managers in a nexus of contracts
Diffusion of firm ownership
Agency conflicts and costs
Corporate governance
Market for corporate control
Real options
Managers agents of equity and debt holders
Managers' interests diverge from principals' interests
Mergers motivated by managerial interests
Managers monitored and controlled by corporate governance
Hostile takeovers control managers
Real option framework for exploratory acquisitions
Managerial
Internal to firm
Managerial utility
Control loss due to mergers
Hostile takeovers
Incentive to align managerial and shareholder interests
Takeover defences
Managerial incentives in takeover context
Organizational
Internal to merging firms
Political processes, cultures
Conflicts among groups
M & A as change process
Acquisition decisions not always rational
Dilution of acquisition quality
Post-merger integration problems
Source: Sudarsanam (2003), p.58
Review of stock market assessment of acquisition:-
Effect of post-merger and acquisition in terms of stock market return have been empirically assessed in many countries. According to Mishra and Goel (2005), there are few popular ways to measures the performances value created by acquisition. However, short run stock performance of acquiring company, target company and the combined company is most commonly used and reliable method because in an efficient capital market stock prices quickly adjust to the new information and integrate any new changes in value occurred because of merger and acquisition activities. To evaluate the post acquisition performance in stock market, CAPM was tested by the number of researchers, including William Sharpe, John Lintner and Jack Treynor which was refined by others such as Fisher Black. (Sudarsanam,2003)
Assuming that capital market are efficient and competitive in incorporating any new information and changes, the CAPM set out the relation between risk and expected returns on company's stock:
1) Capital asset pricing model :
E(Rit) = Rft + ï¢I[E(Rmt) - Rft]
Where, E(Rit) = expected return in period t on stock i
Rit = actual return in period t on stock i
Rft = risk free return in period t
ï¢I = beta of stock i
E(Rmt) = expected return on the market in period t
[Sudarsanam (2003) p.68]
Beta refer to systematic risk and not to the specific risk because we can remove that by holding diversified portfolio. Hence investor expect risk premium for holding risky portfolio. [Sudarsanam (2003) p.69]
Risk premium on i = ï¢I[E(Rmt) - Rft]
Beta estimate is generally based on the historical relationship between individual stock's returns and the market returns and made using sophisticated econometric methods i.e. time series regression;
Rit = ï¡i + ï¢i Rmt
Where ï¡i , ï¢i are estimated parameters of the regression and above equation is known as the market model. [Sudarsanam (2003) p.69]
2) Mean-adjusted model: The expected return on security is constant across the time but can differ across securities therefore the expected return on security i in period t is given by
E(Rit) = Ki
The above model is consistent with Capital asset pricing model under assumptions of constant systematic risk and stationary optimal investment opportunity set for investors. (Grundy and Slack, 2005) p.239
3) Market-adjusted model: The expected return on security is constant across securities and can be different across time therefore the expected return on security i in period t is given by
E(Rit) = E(Rmt)
The above model is consistent with Capital asset pricing model under the assumption of ï¢=1 for all securities. (Grundy and Slack, 2005) p.239
Number of empirical tests are made to evaluate whether the CAPM value shows the desired result in evaluating stock market performance however it found not to be so exclusive and so Fama and French came up with the new model of assets returns which include 3 factors that is
Beta;
Size;
Book to market value of equity
4) Fama and French three factor model: The expected return in period t on stock i is given by:
Rit - Rft = ï¡i + ï¢i (Rmt - Rft) + hi HMLt + si SMBt
Where,
Rft = risk free return in period t
Rmt = value weighted return on the market index in time t
HML = return on mimicking portfolio for the book to market factor
SMB = return on mimicking portfolio for the size factor.
Source: Grundy and Slack, (2005) p.239
Calculating abnormal returns:
The above all equations shows the normal return in the absence of any event such as mergers and acquisition. So the actual return at the time of merger exceed the normal return, that abnormal return ARit in time t for the stock of merging company i is a measure of the merger impact on the value of the merger impact on the value of the stock to investors. [Sudarsanam (2003) p.69]
ARit = Rit - E(Rit)
There are two methods for computing abnormal returns:
1) Cumulative Abnormal Returns (CAR): it shows the sum of daily abnormal returns generated over the period. CAR for security i during period T is given by:
T
CARiT = ï“ ARit
t=1
(Grundy and Slack, 2005) p 240
2) Buy-and-Hold Abnormal Returns (BHAR): it is calculated as the return on buy-and-hold investment in sample firm less the expected return on buy-and-hold investment in a controlled firm. BHAR for security i during time T is given by:
T T
BHARiT = ï (1+ Rit) - ï [1 + E(Rit)]
t=1 t=1
(Grundy and Slack, 2005) p. 240
Merger momentum:-
According to Rosen (2003), the term "Merger momentum" shows a correlation between the market reaction to a merger announcement and recent market conditions. Therefore hot merger market is when the market reaction to the merger announcement is positive or favourable.
We focuses on three different theories which are each consistent with merger momentum but have different projecting about long term return.
According to Rosen (2003), the neoclassical theory of mergers assumes that managers act to maximise shareholders value. As per this theory, merger momentum may result from shocks that increase synergies for a group of M&As so M&A announced following these shocks should be better than on average than other mergers, leading to correlated announcement returns.
According to Gorton et. al. (2002), a second theory of merger is that when there are managerial motivations behind mergers. If managerial objectives lead to M&A decisions, then mergers during waves may be worse than other mergers. A worse acquisition decision taken by managers in hot market, either to pursue private benefits or by overvaluing target firms, might result in negative return to bidders in the long run even with a positive announcement return included.
According to Rosen (2003), the third theory focuses on momentum result from overly optimistic belief on the part from investors and managers both.
Following evidence are marked by Rosen (2003) on merger momentum.
 Evidence shows that mergers occur when the overall stock market is hot.
 Studies have noted that mergers announced in hot merger markets lead to long-run falls in the acquirer's stock price
 Researches shows that mergers announced in hot stock markets are associated with long-run returns that are no higher, and possibly worse, than those announced in cold stock markets.
 Finally there is also few evidence that keeping other things constant, the short-run reaction to an announcement is reversed in the long run.
Empirical Findings:-
The significant surveys by Jensen and Ruback (1983); Department of Trade and Industry (1988); and Mathur (1989) as cited in Pike and Neale (2009), conclude that on an average mergers and acquisitions are not wealth creating exercise but it transfer the wealth from the shareholders of acquirers to the shareholders of acquired. Similarly a very meaningful study made by Franks and Harris (1989) as cited in Pike and Neale (2009), focusing on huge UK and Us data covering 1900 of UK and 1555 of US based acquisitions shows the following result; p. 584
Table: The gains from mergers
UK (months) US (months)
0
-4 to +1
0
-4 to -1
Targets
+24%
+31%
+16%
+24%
Bidders
+1%
+8%
+1%
+4%
Source: By Franks and Harris (1989), cited in Pike and Neale (2009)
In the above table, both UK and US data shows that there is a substantial increase in the wealth for the shareholders of target companies, however there is relatively smaller but statistically significant increase in wealth for the shareholders of the acquiring company even before and after the bid.
A followed study based on UK data by Limmack (1991) as cited in Pike and Neale (2009), suggest that " the gains made by the target company shareholders are at the expense of shareholders of bidder companies". p. 584
In 2000, the accounting firm KPMG examined 700 of the worlds' largest cross-border takeovers took place between 1996 and 1998 to assess the value created by the M&A. KPMG measured the companies' stock prices before and after the deal and conclude that only 17% of the acquisitions were succeed to add value to the combined company while rest of the 83% were fail to generate net benefits for shareholders. The reason for the failure puts the light on the fact that many firms focused heavily on business and financial mechanics and ignored the personnel related issued. (cited in Pike and Neale, 2009). In addition, the revised KPMG survey as cited in Pike and Neale (2009), made by using telephonic interview have covered a sample of global companies whose deal are exceeding US$ 100 million between 2002 and 2003, shows that over two-thirds of the deals failed to add shareholders' value.
According to Mishra and Goel (2005), "Many studies conclude that the target company's stock price on an average tends to go up from 10 days before the announcement to 10 days after. The bidding firm will experience no excess stock returns."
In the finance.darela.com, Srdjan Popovic state that there are some misconception about the share prices movements in the situation when one company merge with another. According to him, "following the announcement of acquisition usually the shares of the acquiring company tend to fall and the shares of the target company rise." (accessed on 26th November, 2009)
In the recent case as released on share.com, share prices of Cadbury rose almost 40% after it rejected a hostile £10.2bn bid from Kraft Foods. (accessed on 26th November, 2009)
Kanter (2009) review the article " Mergers That Stick" in Best practice which discuss that, M&A activities has been severely depressed in year 2008 which fell considerably in early 2009. According to the global study carried out by Towers Perrin and Cass Business School as cited in Kanter (2009), examining 204 deals, each worth more than $100 million shows that , "acquiring companies during that period tended to outperform their industry peers in market valuation". however beating rivals during the worst days of economic crisis simply means that acquirers' stock prices fell by a lower percentage than their peers but it has not created new value.
Effect of mergers and acquisition on shareholder's value:-
This section look at findings on the effect of M&A on shareholder's value by previous researchers. While most of the studies conclude that there is wealth creation accrued to shareholders of the target company as a result of merger and acquisition, however there are diverse opinion to wealth effect of M&A for the shareholders of acquiring company.
Kennedy and Limmack (1996) observes that there are excess returns for the shareholders of target company, however there are no significant excess returns either positive or negative to the acquiring company's shareholders. Similarly report by Kirchhoff et al. (2006), shows that there are significant positive returns earn by the shareholders of acquired companies, while shareholders of bidding company fails to earn abnormal return generated from the merger and acquisition activities. However the report ends up with the conclusion that there is no clear evidence found to prove that merger and acquisition destroy value for the shareholders of acquiring company.
A careful study of the combined returns in a sample of 3688 mergers from the period 1973 to 1988 by Andrade et al. (2001) shows the combined return to acquired and acquirer is roughly 2%. In addition Andrade et al., (2001) conclude that, "merger create value on behalf of the shareholders of combined firms" p. 112
According to Mishra and Goel (2005), "mergers and acquisitions (M&A) are among the most efficient strategies for companies to grow and for driving shareholder value." However Hoehn and Hope (2006) in the Pricewaterhousecoopers UK Economic Outlook state that, mergers and acquisitions are considered as highly risky corporate transaction. Many studies over the many years have shown that the majority of M&A deals mostly fails whether it judge for enhancing business operations or for creating value for their acquiring shareholders.
A visiting professor at New York University, Mark Sirower claims as cited in Pike and Neale (2009), "65 per cent of mergers fail to benefit acquiring companies, whose shares subsequently underperform their sector." p.589 Similarly a study by Mishra and Goel (2005) conclude, "on an average, a merger is not a wealth creating exercise but transfers wealth from bidders to target shareholders."
Event study carried out by Swaminathan et al. (2008), to examine the separate returns to acquirer and target firms conclude that target companies returns are consistently greater than zero, while acquiring companies returns are not significant.
(Source: Swaminathan et al. 2008) p.41
There are numerous studies made on examine long run effects on shareholder value. As per the study made by Loughran and Vijh in (1997) as cited in Stalstedt and Eriksson (2006), to examine long run effect on 1000 mergers between 1970 and 1989, shareholders of acquiring company earns negative average abnormal returns with an average return of -6.5% while acquiring firm earned abnormal return of 43%. According to Sudarsanam (2003), types of payment also affects abnormal returns in the long run. Tests shows that cash payment has earned an average abnormal return of 18.5% while stock payment has earned an average abnormal return of -24.5%.
An article named 'Wall Street's Biggest Con Is M&A 'Advice'' posted in the Wall Street Journal (Europe edition) by David Weidner on 21st September 2009 put some light on M&A game: "M&A is a mostly empty exercise built on promises of profits and efficiencies that rarely come to fruition." Companies almost always pay premium to the acquiring firms, hurting their shareholders and enriching few except the CEOs who do deals and the investment bankers who goad them into the next must-have merger." (online.wsj.com) accessed on 28th November, 2009.
Numerous academic research on M&A have shown no evidence that shareholders of acquiring companies perform better in compare to the shareholders of acquired companies. Some companies are able to wring costs from M&A, however they fails. (blog.robertsalomon.com) accessed on 28th November, 2009.
According to blog.robertsalomon.com, "Investment banks love the M&A business. Except for underwriting initial public offerings, advising on mergers is the most profitable business on Wall Street" (accessed on 28th November, 2009.) It also focuses on the winner and loser in the game of M&A. which is as follows;
If most acquisitions fail, the question then becomes: Who wins and who loses?
Winners:
1. Top-level executives on both the acquirer-side (who can justify higher salaries as a result of presiding over larger empires) and acquired-side (who take out a one-time windfall in options and golden parachutes)
2. Interested parties (e.g., bankers and lawyers) whose collect fees associated with deal consummation
3. Acquired firm shareholders
4. Merger arbitrage funds
Losers:
1. Shareholders of the acquiring firm whose wealth gets transferred to the various winners mentioned above
(blog.robertsalomon.com) (accessed on 28th November, 2009.)
Why mergers and acquisitions fail to benefit shareholders of acquiring company:-
According to Habeck et al. (2000), many mergers and acquisitions has instead of created value ended up destroying shareholder value. So in order to gain perfect understanding about factors which lead to the success of an M&A projects, it is required to have deep understanding about causes to M&A failure and critical factors responsible for M&A success. According to Galpin and Herndon (2000) and Nicholas (2004) as cited in Hoang and Lapumnuaypon (2007), " it is essential to understand and try to avoid pitfalls or avoid triggering failure causes to increase the chance to succeed. However, this action itself does not guarantee project success." Furthermore, understanding and closely adhering to critical success factors is also required.
Gadiesh et al. (2001) reveals the fact that from observed studies that "50-70% of the acquisitions actually destroy shareholder value instead of achieving cost and/or revenue benefits". In addition, a lots of mergers fall apart, i.e., firms undertaking M&A fail to integrate. p.188
According to Nahavandi, A., Malekzadeh, A. R., (1993) as cited in Got and Sanz (2002), It is really hard to define what success means in terms of M&A. However some estimate that around 80 percent of M&A do not achieve their pre-merger financial goals and almost 50 percent of them fails. The most common measure used to measure M&A effects is stock market reactions from one day too few days or months after the merger which is undoubtedly inadequate as it simply ignore human and cultural cost of mergers. So it is impractical to anticipate that financial markets, having only partial information, are able to make right predictions about the results of merger.
Why do mergers and acquisitions have such a low rate of success?
Accoding to Haransky (1999), there are five realities which lead to M&A failure. Which are
(1) insufficient assessment of target,
(2) too much focus on the financial aspect of the deal,
(3) paid premiums too high to justify and pressures to make something happen,
(4) M&A as part of an outdated strategic plan
(5) no experience in integration of the entities. (Pp13-14)
Similarly the M&A consultants Gadiesh et al. (2001) identify five factors leading to failure, which are
(1) poor understanding of the strategic levers,
(2) overpayment for the acquisition,
(3) inadequate integration planning and execution,
(4) void in executive leadership and strategic communication,
(5) a severe cultural mismatch (p.188).
According to Zweig (1995) as cited in DiGeorgio (2002), there are some major reasons behind M&A failure.
(1) inadequate due diligence,
(2) lack of compelling strategic rationale,
(3) overpayment for the acquired firm,
(4) conflict between corporate cultures,
(5) failure to quickly meld the two companies.
According to Colin Price as cited in Skapinker (2000) and by Pike and Neale (2009), "the majority of failed mergers suffer from poor implementation. And in about half of those, senior management failed to take account of the different cultures of the companies involved." p589. In addition, melding corporate culture takes time to take advantage of the opportunities, which senior management don't have after the merger occurred. According to Skapinker (2000) as cited in Pike and Neale (2009), "Most mergers are based on the idea of "let's increase revenues", but you have to have a functioning team to manage that process." p589.
Mr Sirower as cited in Pike and Neale (2009), refuse the opinion that the major problem is post-merger implementation. Mr Sirower says , "Many large acquisition are dead on arrival, no matter how well they are managed after the deal is done." p.589 Mr Sirower asks, "why managers should pay a premium to make an acquisition when their shareholders could invest in the target company themselves. How sure are managers that they can extract cost savings or revenue improvements from their acquisition that match the size of the takeover premium?" p589.
As per the study 'Post Merger Share Price Performance of Acquiring Firms' carried out by Frank et al (1991), there was no evidence of positive abnormal post acquisition performance for the acquiring companies. The results shows that underperformance is not due to wealth deterioration from merger, but from the methodology employed to find whether abnormal returns exist.
In addition, the study on the effect of the firm size on abnormal returns from acquisitions by Moeller et al. (2004), covering sample of acquisitions from 1980 to 2001 in the USA, shows that acquisitions by smaller firms leads to statistically significant higher abnormal returns than acquisitions by larger firms. It assumed that the bigger firms often offer premium prices to target firms and end up having net wealth deterioration from merger.
As per the study of mergers covering from the period of 1995 to 2000 by Macdonald (2004), most merger were failed from the shareholders point of view when it measured against the stock price. Analysis shows that acquirer typically over paid for their investment in target companies and when comparing the stock prices of a company that gone through a merger its peers who did not, the stock performed 25% below those peers.
Bidder Returns And Methods Of Payment:-
This section look at findings on the effect of methods of payment on returns to bidder firms.
Effect of method of payment on returns to bidder
Research paper
Time period
No. of observations
Event Window
Cash (%)
Mixed (%)
Stock (%)
Travlos (1987)
1972-1981
167
(-10, +10)
-0.13
NA
-1.60
Asquith (1990)
1973-1983
186
(-1, 0)
0.20
-1.47
-2.40
Servaes (1991)
1972-1987
380
(-1, resolve)
3.44
-3.74
-5.86
Andrade, Mitchell, and Stafford (2001)
1973-1998
3688
(-1,+1)
0.4
NA
-1.5
(-20, close)
-0.2
NA
-6.3
Source: cited in Grundy and Slack (2005) p 203
The above table shows the effects of methods of payment on acquirers return.
A numerous study on M&A finds that acquirer have more negative returns in stock transactions compared with the cash deals. Research made by Travlos (1987), covering 167 M&A transactions from period 1972 to 1981, have found that the average acquirer return in stock transactions was -1.60% while on cash transaction was -0.13%. The research by Asquith, Bruner, and Mullins (1990) and Servaes (1991) also shows that acquiring firm's shareholders earn lower, and indeed negative, return in stock transactions as compared with cash deals. Similarly Andrade, Mitchell, and Stafford (2001), found that 100% cash transactions generates better returns for the bidders than transactions with stock. ( cited in Grundy and Slack, 2005)
Bidder Returns: Single Versus Multiple Bidders
Another vital factor affecting bidder returns is the number of bidder publicly bidding for the target.
Effect of method of payment on returns to bidder
Research paper
Time period
No. of observations
Event Window
Single (%)
Multiple(%)
First bid Acquirer (%)
Late bid Acquirer (%)
Bradley et al. (1988)
1963-1984
236
(-20, +1)
2.75
-0.41
2.0
-2.5
Bradley et al. (1988)
1963-1984
(-20, +40)
2.97
-0.21
Servaes (1991)
1972-1987
384
(-1, resolve)
-0.35
-2.97
Schwert (1996)
1975-1991
1523
(-42,+1)
1.90
0.2
Schwert (1996)
1975-1991
(0, +126)
-0.4
-3.5
Source: cited in Grundy and Slack (2005) p 203
A numerous study on M&A finds that acquirer have lower return when there are multiple bidders and higher returns when there are only single bidder for the target.
Bradley, Desai, and Kim (1988) found, "the announcement return to first bidder acquirers was 2%, roughly the same as the return when there is only a single bidder. By contrast, for successful acquirers who were not the first bidder, the announcement return was -2.5%." They also noted, " when competing bids are actually made…there is … a dissipation of the initial gains to the stockholder of bidding firms" (cited in Grundy and Slack, 2005) p 203
According to Servaes (1991), there are more negative returns to bidder when the contest includes multiple bidders. Schwert (1996) reported that the return in (-42, -1) period was positive for both bidders i.e. single bidder and multiple bidder. While bidder return were worse more noticeably in the multiple bidder contests. [cited by Grundy and Slack (2005)]
