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Thesis Chapter 2
Thesis Chapter 2
Thesis Chapter 2
the last five decades, and several theories have been proposed and tested for
companies. Several measures have been postulated for analysing the success
USA and Europe, and some in Asia. These studies have focused on different
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(a) The rationale of Mergers and Acquisitions [1, 2],
12] and
The research that has been so far done globally on M&As, can be categorised
into two broad areas: (i) Wealth effects of mergers and (ii) Impact of mergers
Valuation theories state that a firm’s value is the sum total of the discounted
value of firm’ s cash flows generated by the assets already in place plus the
discounted value of the expected future cash flows to be generated from the
potential investment projects. Stock prices of today not only reflect the firm’ s
The efficient market hypothesis states that asset prices in financial markets
of the firms involved, will therefore get reflected in the market’s repricing of the
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underlying securities (equity shares) of the firms; the stock market is “efficient”
in the sense that stock prices adjust very rapidly to new information. These
Past event studies have focused on the impact of merger announcements and
subsequent events, on the stock prices of both firms involved. The market
periods ranging from 3 months to 5 years, before and after the announcement
date of the merger/ acquisition. In these studies, which use the residual
usually tested for statistical significance. Such studies have analysed abnormal
stock returns earned by shareholders of acquired and acquiring firms, after the
Abnormal stock returns generally reflect the value that a transaction potentially
techniques used in event studies 2 have been reviewed by Halpern and Weston
1
The expected returns on equity shares is calculated in accordance with the Capital Asset
Pricing Model (CAPM), and the actual returns are calculated from the stock prices, and the
difference between these two returns is termed as the abnormal returns. When such returns
are cumulated over a period of time and averaged , they are termed as Cumulative Average
Abnormal Returns (CAAR)
2
Event studies examine the effects of the merger / acquisition announcement on the stock
market valuations of target / bidder firms around the time the deal / agreement is announced. A
common method is to calculate cumulative abnormal returns, i.e., the increase in stock price
over that which the capital asset pricing model, would predict excluding the merger / acquisition
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[13, 14]. Other event studies have looked at returns to shareholders in terms
acquisition period
Event studies globally have generally found that target firm share prices have
prices stayed about the same or declined. Generally, target firm share prices
the acquirer. Bidder firms’ share prices are generally expected to stay flat on
average or decline, because the market is assumed to judge the future gains
investors. However, some event studies have also noted that where
beyond the price paid for acquisition, the share prices of acquiring firms have
Joseph P.H. Fan and Vidhan K. Goyal, [15] used industry commodity flows
NYSE, Amex and NASDAQ from 1962 to 1996 in the USA. The study
different types:
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How do the wealth effects of vertical mergers compare with those of
Are the wealth effects in cross-industry, but vertically related firms different
mixed vertical-horizontal, and pure horizontal mergers. The study examined the
there was a time-series relation between vertical merger activity and wealth
returns over a 255-day estimation period that ended 46 days before the initial
merger announcement.
The study found that vertical mergers generated positive wealth effects that
were significantly larger compared with those for diversifying mergers; and that
targets in different industries, the study found that vertically related mergers
unrelated mergers.
that from the time of the announcement to the time of delisting (or 126 days
later, whichever came first), Cumulative Abnormal Return on target stock rose
by 10.1%. The rise was called as a "mark-up." The study reported an average
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rise of 133% in the target firm's stock price that occurred due to
preannouncement rumours, and the change was called a "run-up." The study
also found that mark-ups and run-ups were not correlated, and concluded that
run-ups tended to inflate the premium paid by bidder firms. (For pre-rumour
Michael Bradley, Anand Desai and Han Kim [17] found that stock market
bidding and target firms. The study analysed 236 tender offers that were
successfully completed between 1963 and 1984 in the US and estimated the
examined the factors that determine the division of those gains between the
stockholders of the two firms and documented how the division and the total
gains created have changed with the changing environment of the tender offer
process.
The study also found that target stockholders have captured the lion’s share of
the gains from tender offers, and their share of the gains has increased
firms, on the other hand, had realized a significant positive gain only during the
unregulated period 1963-1968 and in fact, suffered a significant loss during the
sub-period, 1981-1984. The study also found that the total percentage
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synergistic gains from tender offers have remained remarkably constant over
time.
and price related (resulting in collusive synergy). The sample comprised of 157
merger cases that occurred during the period 1969 – 72 in the USA. Using an
event study spanning a window of 200 days prior to the announcement date of
the proposed merger to 50 days after the announcement, the study analysed
the wealth gain/loss to the rivals of the target firms, and compared them with
The study adopted the following methodology, for selecting a suitable sample of
merging firms:
the target firm is big enough to absorb the capital infusion by acquiring firm.
Hence relatively large acquiring firms compared to the targets were chosen
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in the unrelated sample, assuming that the potential financial synergy
(d) Standardization of gains: To standardize the wealth gain to the same asset
base for each of the samples, if the absolute size of any one target varied
significantly from the rest of the sample, such case was eliminated from the
size.
financial synergy and if financial synergy can be fully exploited (large relative
than those that depended primarily on operational synergies. Further, the study
Tim Loughran and Anand Vijh [5] studied the long-term effects of 947
between the post-acquisition returns and the mode of acquisition and form of
payment. The study found that during a five-year period following the
stock mergers) did not earn significantly positive excess returns. The study
suggested that firms that pay in stock tend to have overvalued shares, whereas
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firms that pay in cash tend to have undervalued shares; and that during the
after takeover were likely due to benchmark errors rather than mis-pricing at
Agrawal, Anup and Jaffe, Jeffrey [20] reviewed the literature on long-run stock
perhaps even positive) following tender offers. However, the study felt that
effects of both methodology and chance might modify such conclusion. The
study did not find evidence to support the conjecture that under-performance
Mercer Management Consulting and Business Week [21] did a joint study of
price returns for 150 deals of the size $500 million-plus from 1990 to 1995.
Using a large sample and comparing total return three months before the
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merger announcements with returns up to 36 months afterward, the analysis
used the S&P industry indexes to filter out, as much as possible, other external
events affecting acquirers' returns. Stock returns were compared for 248
acquiring companies (that had acquired 1045 companies from January 1990
through July 1995) with those of 96 non-acquirers (companies that made zero
The study found that acquiring firms in the 1990’s (where most of the deals
were done ostensibly for business reasons) had performed better, than they did
after 1980’s transactions, a high proportion of which were financially driven. But
most of the '90s deals still had not worked - about half of the 150 deals were
only marginally to shareholder wealth. Only 17% of the total deals had created
substantial returns for the acquiring companies; 33% created only marginal
returns, 20% eroded some returns, and 30% substantially eroded shareholder
The study also found that the non-acquirer firms had done better than the
acquiring firms. While 69% of the companies that made no acquisitions larger
indices, only 58% of the acquiring firms had produced superior returns. Further,
the more experienced the acquiring firm was, the better were the returns: 72%
of companies that completed six or more deals valued over $5 million each
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yielded returns above the industry average, compared with 54% of companies
merger period was again tested using a sample of 937 mergers and 227 tender
offers between 1955 and 1987, between NYSE acquirers and NYSE / AMEX
target firms. The study hypothesised that the long-run performance of the
acquiring firm would reflect that part of the net present value of the merger that
was not captured by the announcement period return. The study used two
alternate methodologies and control groups, to adjust for beta risk and market
The results of the study indicated that the stocks of acquiring firms performed
statistically significant loss of about 10% over the 5-year post-merger period,
which was validated by various specifications. Also, neither the firm size effect
returns. The study also did not find any conclusive evidence that the negative
returns were caused by a slow adjustment of the market to the merger event.
However, the study observed that effects of both methodology and chance may
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modify the conclusion. Two explanations of under-performance (speed of price-
adjustment and EPS myopia) were seen as not supported by the data, while
underperformance (if any) in the long run after the acquisition, as found by
included bidding firms in mergers and tender offers announced and completed
between January 1980 and December 1991 (3169 mergers and 348 tender
offers). The study found that after adjusting for both firm size and book-to-
completion date. On the other hand, acquirers in tender offers were found to
average.
based benchmark. The study used a methodology that was said to be robust
size deciles of every month based on market capitalization of NYSE and AMEX
firms. The deciles were further segregated into quintiles using book-to-market
ratios. Portfolio returns were calculated for every month by averaging the
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monthly returns for these 50 portfolios. The returns were then used as
benchmarks to calculate abnormal performance for each firm relative to its size
and book-to-market benchmark (as the difference between its monthly return
and that of its control portfolio) every month for 36 months after the merger
completion date. CAARs were calculated by averaging across all acquirer firms
The study showed that bidders in mergers under performed, while bidders in
tender offers over performed in the three years after the acquisition. However,
performed much worse than other stocks, and earned significant negative bias-
The fact that glamour bidders in tender offers performed significantly worse
than value bidders, suggested that companies with low book-to-market ratios
interpreted this finding as evidence that both the market and the management
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Lubatkin [11] reviewed the findings of previous studies that had investigated
either directly or indirectly the question, “Do mergers provide real benefits to
the acquiring firm?”. The review suggested that acquiring firms might benefit
The review also pointed out that in general, only mergers completed by
merger studies, in order to protect against any bias associated with the
was suggested that the clean data screening procedure used to protect against
performance and experience, then this sampling bias might explain the low
return observed for acquiring firms in prior merger studies. Lubatkin therefore
suggested using a large sample size for such studies, to test explicitly the
relaxing the clean data screen and forming groups of mergers relatively
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Efficiency Theory: Operating synergies, financial synergies and
management synergies.
Alexandra Reed and Fred Weston [2] reviewed short-term impact studies and
merger performance. The review suggested that the overall impact of mergers
on short-term share value was positive, but the result seemed skewed toward
those who are "leaving" the deal – i.e., target shareholders who sell to the
bidder - and away from those who are "staying" in the deal – i.e., the
shareholders of the company that will remain after the merger. The research
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2.1.1.2 Studies in Europe
Mara Faccio, John J. McConnell and David Stolin [23] documented an average
announcement period return of +1.05% for the stocks of the acquiring firms, in
The study concluded that returns are not significantly lower for companies that
wealth for the controlling shareholder to the change in wealth implied by the
bidder’s stock price reaction, it was found that the wealth of the controlling
families did not increase more than what was implied by their investment in the
bidder.
have a stock market where a firm's stock price does not react to firm-specific
First, the stock market may be informationally inefficient, which implies that
stock prices are not linked to firm values. In such a stock market, stock
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prices will not change when new information about firm value is released
Third, though a stock market may be efficient, and the news may be value-
Fourth, insider trading prohibitions may not exist in a stock market or, if they
exist, are not enforced. In such stock market, the superior information of
insiders may have been incorporated in stock prices through their trades
great deal of information is incorporated into stock prices, then any of the
above four reasons could explain why a corporate news announcement may
not really be an event. This calls into question whether event studies represent
the best way to capture impact of mergers and acquisitions on acquiring firms’
The evidence suggested however, that it cannot explain some important and
worrying features of asset market behaviour [25, 26]. Most importantly for the
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times to be subject to substantial misalignments, which can persist for
and Ruback [27] observed that: “research studies have reached the point of
diminishing returns from efforts that focused solely on effects of stock prices
relationship between these other factors and stock prices would continue to be
Empirical evidence in the form of event studies on US companies [17, 18 & 20]
pointed out that the target firms’ valuations increased substantially in takeovers,
brought positive stock returns to shareholders of both the bidding and target
firms (combined). The studies also found that target stockholders have
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In summary, research based on event studies on the effect of mergers, had
showed impairment of value (measured by share price and other indicators) for
these traps performed better than their peer firms - both acquiring and non-
firm shareholders had loss of market value post the acquisitions, as indicated
mergers. This approach implicitly assumed that markets are efficient, since
Concluding that mergers have caused poor returns, based on stock market
value in excess of the sum of the market values of the bidding and target
firms. But the abnormal returns estimated in event studies do not identify
which components of the present value of net cash flows have changed.
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Some event studies which have demonstrated abnormal returns through
these alternative sources of gains, and thus could not reach definitive
acquiring firms
When abnormal returns are computed using market model, there could
asset pricing model (CAPM), and this assumes stationarity of the risk-free
and systematic risk of acquiring firms could be higher / lower before the
For many years, the traditional wisdom was that the announcement-period
stock price reaction fully captures the information effects of mergers. However,
several long-term event studies measuring negative abnormal returns over the
three to five years following merger completion cast doubt on the interpretation
period event windows are flawed, particularly those attempting to document the
wealth effect of the event. In fact, some authors found that the long-term
negative drift in acquiring firm stock prices overwhelmed the positive combined
stock price reaction at announcement, making the net wealth effect negative
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2.1.2.2 Limitations of long-term event studies
There are also some methodological concerns with long-term event studies,
particularly the calculation of the point estimates and the assumptions required
to assess statistical significance. The basic concern stems from all tests of
The most dramatic long-term abnormal performance comes from certain sub-
samples of acquiring firms. For example, Loughran and Vijh [5] calculated long-
term abnormal returns for acquiring firms using stock financing and for those
paying with cash over the period 1970-1989. They found that acquiring firms
using stock financing had abnormal returns of 224.2 percent over the five-year
period after the merger, whereas the abnormal return was 18.5 percent for cash
mergers.
An additional statistical concern with many long-term event studies is that the
test statistics assume that abnormal returns are independent across firms.
However, major corporate actions like mergers are not random events, and
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Mergers could also cluster through time by industry. This clustering leads to
growth and profitability ratios, returns ratios, cash flows, and market share
Meeks and Meeks [30] studied the use of profitability measures as indicators of
Post-Merger Efficiency. They concluded that the ratios, profit to sales (NPM),
share holders’ return on equity capital (ROE), and return on Total Net Assets
can cause a bias in the results of such studies, due to differences in accounting
practices
Healy, Palepu and Ruback, [7] examined post-acquisition performance for the
50 largest U.S. mergers between 1979 and 1984, by analysing the post-merger
cash flow performance of acquiring and target firms. The study used post-
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performance that result from mergers, to control for the impact of the financing
of the acquisition and the method of accounting for the transaction. Abnormal
the relation between the cash flow measures of post-merger performance and
operating cash flow returns in comparison with their industries, in the five years
post-merger cash flows was achieved at the expense of the merging firms’
long-term viability, since the sample firms maintained their capital expenditure
and R&D rates in relation to their industries. The results indicated that the cash
flow improvements did not come from policies that could impede the long-
The study also found no evidence that transaction characteristics such as (a)
the method of financing, (b) whether the merger is hostile or friendly, or (c) the
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firms’ equity at the merger announcement. The abnormal announcement
returns suggested that the stock price gains at the merger announcement
acquiring firms. The study also found that strategic takeovers generated
substantial gains for acquirers, while takeovers for financial reasons barely
broke even.
used by Healy and the team, or a simple comparison of post- and pre-
acquisition industry-adjusted cash flows are likely to be biased. The bias was
errors, (b) whether merging firms outperformed industry-median firms, and (c) whether
sample of large acquisitions between 1981 and 1995, the study compared the
post- and pre-acquisition performance (over three years each) of merging firms
years.
The study found that merging firms’ post-acquisition operating cash flow
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which suggested that estimates of improvements in cash flow from a regression
was accounted for, the study did not find evidence of improvements in the
merging firms’ post-acquisition operating cash flow did not increase relative to
Malcolm Salter and Wolf Weinhold [3] studied a sample of 36 companies and
compared their operating returns with those of other stocks listed on the New
York Stock Exchange (NYSE). The study found that the average return on
equity (ROE) for the sample of merging firms was 44% lower than average
NYSE-listed firm levels, and their average return on assets (ROA) was 75%
lower than average NYSE-listed firm levels. The results suggested that
Weston and Mansinghka [12] analysed the effects of the conglomerate merger
and a combined industrial and non-industrial sample. The ratios used for the
study were Operating Profit Margin3 (EBIAT / Total Assets), Gross Profit Margin
(EBIT / Total Assets), Net Income / Net worth 4, and Debt / Net worth. The ratios
3
EBIAT = Earnings Before Interest, Amortization and Taxes and EBIT = Earnings Before
Interest and Taxes
4
Net worth was calculated by two methods, first including and then excluding preferred stock
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of the same sample and control firms for the years 1958 and 1968 were
The study found that for the year 1958, the earnings rates of the companies in
than the earnings rates of the conglomerate firms. By 1968, there were no
thus suggested that the conglomerate firms in the 1950s were diversifying
defensively to avoid (1) sales and profit instability, (2) adverse growth
Heron and Lie [31] investigated the relation between method of payment in
of 859 acquisitions between 1985 and 1997 in the USA. The study investigated
(a) Whether managers of bidding firms managed their earnings prior to the
(b) Whether industry and economic-wide conditions played a role in the change
of operating performance
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(c) Whether performance was comparable to firms in a similar industry with
After adjusting for the above factors, the study found that even though
performance.
From the results obtained, the study opined that a potential explanation for the
stock price reactions to quarterly earnings announcements over the three years
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The study also suggested that investors could also be overly optimistic about
Consequently, the study concluded that method of payment does not appear to
acquired firms with low market-to-book value ratios, and when the acquirer and
target belonged to the same industry. The study found little evidence to support
for the notion that firms that conduct stock acquisitions disappoint their
Another finding of the study was a more dramatic increase in debt ratios around
cash acquisitions than around stock acquisitions, which, in turn, may contribute
suggesting that the trends in stock returns were due to differential changes in
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2.1.3.2 Studies in Europe
Geoffrey Meeks [32] explored the gains from mergers, for a sample of 233
transactions in the United Kingdom between 1964 and 1971. The study tested
return on assets (ROA)5 with the change in ROA for the industry. The analysis
performance dropping to further lower levels, five years after the merger. For
industry. The study concluded that the mergers in the sample suffered a “mild
decline in profitability”.
Marina Martynova, Sjoerd Oosting and Luc Renneboog investigated the long-
term profitability of corporate takeovers [33], of which both the acquiring and
target companies were from Continental Europe or the UK, and in which at
least one of the participants was a publicly traded company. The study
EBITDA minus changes in working capital, (3) EBITDA / book value of assets
The study found that both acquiring and target companies significantly
outperformed the median peers in their industry prior to the takeovers, but the
5
Meeks defines return on assets as pre-tax profits (after depreciation, but before tax) divided
by the average of beginning and ending assets for the year. The key metric was R change = RAfter -
RBefore where RAfter and RBefore were measures of performance relative to the weighted average of
returns of the buyer’s and target’s industries.
6
• EBITDA = Earnings Before Interest, Taxes, Depreciation and Amortization
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takeover. However, the decrease became insignificant after controlling for the
bids and tender offers. The acquirer’s leverage prior takeover seems to have
suggested that companies with excessive cash holdings suffer from free cash
flow problems and are more likely to make poor acquisitions. Acquisitions of
Magnus Bild, Paul Guest, Andy Cosh and Mikael Runsten [34] studied value
comparing the present value of the acquirer’s future earnings before the
acquisition, with those that actually result following takeover. The study also
accounted for the cost of the acquisition, the acquirer’s cost of capital, and the
earnings which are created beyond the sample period. The study found that by
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that on average, acquisitions destroyed roughly 30 percent of the acquirer’s
pre-acquisition value.
companies listed at the Athens Stock Exchange (ASE), that executed at least
one merger or acquisition in the period from 1998 to 2002. Selected accounting
performance and compare pre- and post-merger firm performance for three
years before and after merger, while the year of merger event was omitted from
The analysis showed that for the firms in the sample, post-merger gross profit
margin decreased slightly, while the Liquidity ratios - quick ratio and current
ratio did not show a decrease in their values. Solvency ratios - net worth/total
assets, and total debt/net worth also decreased slightly in values. The study
also found that earnings before taxes/net worth, and returns on assets
nations (Belgium, German, France, Netherlands, Sweden, U.K., and U.S.) All
7
Financial variables included Profitability (Earnings before taxes/Net worth), Returns on assets,
Gross profit margin, Liquidity (Quick ratio), Current ratio, Solvency (Net worth/Total assets and
Total Debt/ Net worth)
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the studies had applied standard tests and data criteria and therefore afforded
a cross-border comparison of results across parts of Europe and the U.S. The
research tested theories about mergers and consequent changes in size, risk,
ways: (a) profit divided by equity; (b) profit divided by assets, and (c) profit
profitability for five years before the transaction) were compared to similar
measures for two benchmark groups: (i) firms matched on the basis of size and
industry and who had made no acquisitions, and (ii) a general sample of firms
that neither made acquisitions nor were acquired during the observation period.
significantly larger than targets, that acquirers had been growing faster than
their peers and their target firms, and that they were more highly leveraged
than target firms and peer firms. In profitability, the acquirers had showed no
significant differences—the specific data for the U.S. were generally found to
from the findings was that acquirers reported worse returns in the years after
be claimed across the seven countries. Mergers appeared to have but modest
effects, up or down, on the profitability of the merging firms in the three to five
years following merger. Any economic efficiency gains from the mergers
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Richard Schoenberg investigated [37] the comparability of four common
(i) 21-day cumulative abnormal returns (using 3 month beta prior to the merger
(iii) Divestment data (whether acquired firm was divested either 6, 9 or 13 years
reports)
The observations reflected the information asymmetry that can exist between
aspects. Based on this, the study recommended that future acquisition studies
61
should consider employing multiple performance measures in order to gain a
holistic view of the outcome, and that there was still scope to identify, refine and
Keith, Hastenburg and Joran Ven [38] reviewed research literature on mergers,
to examine the dilemma: if most mergers are considered failure for the
motives, (ii) they use “key success factors”, and (iii) they evaluate mergers
motives in the merger deals done by their firms. The survey showed that the
economic motives tend to be the driving force behind most mergers. However,
the study found that both strategic and personal motives were important,
suggesting that multiple motives exist for mergers, and that some of them are
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achievement or non-achievement of the original objectives of the merger. The
were extremely successful, and that firms were able to achieve (i) an increase
showed that for 12 out of the 17 motives, managers indicated a high degree of
profitability or ROI) was used, mergers would be termed as failure, while using
achieving the set objectives. The study therefore strongly recommended the
observed during 1948 - 1977. The results of the study indicated that in both the
short-run and the long-run, acquisitions had a negative net impact on company
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investment. The results were consistent with other studies based on the
American experience, which suggested that takeovers did not lead to enhanced
acquiring Australian firms during the period 1986 to 1991, by comparing post-
acquisition control-adjusted performance (for 3 years after merger) with the pre-
earnings and cash flow information. The study also tested whether there were
The study found that, based on analysis of four accrual and four cash flow
acquisition and the payment of a premium (goodwill) also did not seem to
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Timothy A. Kruse, Hun Y. Park, Kwangwoo Park, and Kazunori Suzuki
Exchange, in the period 1969 to 1997. The study focused on the effect of
The study analysed the cash-flow performance in the five-year period following
merger aggregate of the acquiring and target firms. A sample of control firms
operating cash flow divided by market value of assets (operating return), and
entire sample, and also that the pre- and post-merger performance was highly
correlated. The study concluded that control firm adjusted long-term operating
insignificant, and there was a high correlation between pre- and post-merger
diversifying mergers, and was especially marked among diversifying firms that
acquired their sales or trading company affiliates. The results were consistent
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Increases in employment surrounding the mergers were positively related to
mergers that were completed before the end of the equity bubble in 1989. In
performance among mergers that occurred in the 1990s. The results of the
addition, the study also inferred that rescue mergers involving distressed
targets had not lead to inferior long-term performance of the acquiring firms.
operating cash flow returns8 and found that financial performance improved
period suggested that companies had not sacrificed long-term investments for
crucial. The tendency for merger activity to cluster through time by industry, as
8
Measure used was the ratio of operating cash flow to book values of operating assets of the
companies
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seen from past studies, means that a short sample period will contain
these samples. Also, if there is a common shock that induces merger activity at
spanning a longer time period allows for statistical techniques that are better
The sample comprised of 138 active acquiring firms that made 3500
acquisitions during 1967-1976 period. The study tested whether there are
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which are fundamental considerations in the successful implementation of a
The study found that all factors considered, except price paid were significantly
related to the performance, and that they together accounted for most of the
The six key acquisition variables, on the average largely determined the
study also suggested that both excessively small and excessively large
Kitching (44) analysed results of corporate mergers in USA, two to seven years
after the event, to find what distinguished successful cases from failures. The
(ii) Financial results actually obtained versus forecasts made before the
merger (where they existed), and on the ease and dollar payoff of the
synergy achieved
(i) Nearly half of the mergers were of conglomerate type, and they also
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Table 6
Vol.45, pp 84-101
(ii) Size mismatch (acquired companies sales were less than 2% of acquiring
considered failures
(iii) In terms of dollar payoff from synergy, production & technology were at the
up better; and finance had the biggest payoff (see table 7 below)
Table 7
Which functions produce the biggest payoff from synergy after acquisitions?
69
Type of merger Finance Marketing Technology Production
(including R&D)
Conglomerate 100 58 20 32
Concentric technology 100 72 72 27
Concentric marketing 100 100 57 72
Horizontal 96 100 41 29
All categories 100 74 33 36
Source: John Kitching, Why do Mergers Miscarry, Harvard Business Review, Nov- Dec 1967,
Vol.45, pp 84-101
Note: Executives scored dollar payoff of synergy as high / medium / low / none for each
acquisition case. Table shows relative payoff values for each function, with 100 representing the
The findings suggested that size differences between the bidder and target
of related acquisitions. When the acquiring firm is substantially larger than the
target firm was relatively small, the human integration needs of the target firm
synergies.
Paul Healy, Krishna Palepu and Richard Ruback [5] examined cash flow return
involved in 50 acquisitions during 1979-1984, and found that acquirers did not
generate any additional cash flows beyond those required to recover the
9
Operating cash flows were defined as sales minus cost of goods sold, administrative &
selling expenses, plus depreciation and good will expenses. Assets were measured by market
value of equity plus book value of debt.
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premium paid. However, while the takeovers were break-even investments on
The sample firms were categorised into two types: (i) friendly transactions that
“strategic” takeovers, and (ii) hostile transactions that generally involved cash
acquirers: financial transactions broke even, at best. Results also showed that
the premiums in strategic takeovers were lower than in financial deals, and that
the synergies were higher, indicating that strategic acquirers were able to pay
Mergers have been one of the most researched areas in finance, yet some
basic issues still remain unresolved. While most empirical research on mergers
shareholder value (measured by share price and other indicators) for a variety
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overvalued stock as a payment mode, and poor post-merger integration.
Similar studies in other countries in Europe and Asia are however, inconclusive.
Extensive work has however been not done in terms of evaluation of post-
firms thus far in developed countries have concluded that the acquiring firms
Asia, and a few studies in USA too, have shown contrary results.
the stocks of both firms involved in 14 large takeover related open offers during
1997 to March 2001 in India, using even study methodology, and found
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Excess Returns) associated with the tender offers. The estimation period used
for the event study was –51 days to –150 days (0 being the open offer
announcement day).
The study observed that the post-announcement stock returns for target firms
undergoing change of control in India were very different from the empirical
evidence in the context of developed countries. The study found that the target
firm valuations had increased in the run-up to the open offer announcement.
the gains were seen to have been wiped out subsequently - indicating that
valuation gains associated with takeovers in large part reflected private value of
control, expected to be high in Indian context. The fact that only one large open
value of control may be the driver in the market for corporate control.
acquisitions in India, after the Takeover Code came into effect in 1997. The
which open offers were made during 1997- 98 to 2000-01 to gain management
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The model was able to discriminate the target firms correctly to the tune of 62
per cent, and reasons for the low discriminating power of the model were
reasons. The study suggested that the model might be used for screening
that this could help in reducing the number of companies considered for
The study also compared the pre and post-takeover performance for a sample
of 20 companies, using the same set of eight financial ratios, for a period of
three years each immediately preceding and succeeding the takeover attempt,
and tested for statistical significance using t-test. The study found that two
profitability ratios used viz. EBIT/Sales and ROCE declined significantly in the
post-takeover period. Since the assets turnover ratio also showed a decline,
the study concluded that both profitability and efficiency of the companies
declined in post-takeover period. However, a ‘t’ test applied to each of the eight
not significant. The study concluded that the financial performance of the target
Beena [48] analysed the role of mergers in the private corporate manufacturing
growth of assets of acquiring firms, and the sources of financing for their
growth. The study suggested that acceleration of the merger movement in the
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early 1990s in India was accompanied by the dominance of mergers between
firms belonging to same business group or business house with similar product
in only one fifth of the sample firms. The firms in the sample had also mobilised
The study noted signs that mergers between unrelated firms, as also the
since 1992-93. The study concluded that the merger wave in the early 1990s
firms into two categories - Indian owned and foreign owned. The sample
consisted of 115 cases of mergers and acquisitions (84 Indian owned and 31
foreign-owned acquiring firms), which was said to have accounted for about 22
per cent of the total number of mergers and acquisitions that occurred in the
Table 8
Trends of M&As during 1990 to 2000
Year Non-Mfg Mfg Total
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Source: P. L. Beena, Towards understanding the merger wave in the Indian corporate sector – a
comparative perspective, working paper, February 2004. Figures in brackets represent the number of
MNE related deals
The study used some select financial ratios 11 to test whether there was any
phases was tested by using t-statistics. The study did not find any evidence of
improvement in the chosen financial ratios of the acquiring firms in the sample
Nagesh Kumar [50] studied the M&A activity in the Indian corporate sector
affiliates, for the period 1993 to 2000. The study examined the industrial
composition of the deals as well as their motives, and the patterns of foreign
direct investment (FDI) into India, through cross-border M & As. The study
observed that in contrast to nearly all of FDI inflows to India that was in the
inflows since 1996 in India had occurred in the form of acquisition of existing
11
The financial ratios used were Price - Cost Margin (Profit After Tax / Net Sales), Rate of
return (Profit Before Tax /Total Capital Employed), Shareholders’ Profit (Profit After Tax /Net
Worth), Dividend per equity (Dividend Per Share / Earnings Per Share), Debt-equity ratio,
Export intensity (Export/Gross sales), R&D intensity (R&D expenditure/Gross sales) and
Capacity utilization (Net Sales/Total Assets).
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enterprises in the country. In addition, the deals relating to MNEs were
the deals involved buying out the local partners in joint ventures, or raising the
equity stake.
motive in about a fifth of the cases, while ten per cent of the
has suffered. Quality up-gradation was seen as a priority for firms, but product
distribution, and export orientation was seen to be limited for firms in the
sample.
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The study observed that the number of mergers and acquisitions between
Indian firms had increased substantially post the initiation of economic reforms.
The study also found that 50 percent of all mergers during 1990-97 were
horizontal in nature, 16 percent were vertical in nature, and the remaining were
Table 9
97
Source: Basant Rakesh, Corporate Response to Economic Reforms, Economic and Political Weekly,
March 2000, pp 813-822
The study also found that of those mergers, 60 percent were by private Indian
Table 10
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Source: Basant Rakesh, Corporate Response to Economic Reforms, Economic and Political Weekly,
March 2000, pp 813-822
(small and large) that took place during 1995-96, that four out of the five
(measured through certain Financial Ratios12 for three years after the merger).
Of all the contributing factors, the net profit margin seemed to have significantly
improved post-merger, since the asset turnover did not change significantly
post the merger. The study inferred that shareholder value improved for the
large companies that seemed to have joined hands to create bigger entities
mergers [53] by EVA analysis, only two of the five mergers were found to have
profitability, growth, leverage, liquidity and tax provisions 13, the study found that
the acquiring firms performed better than industry in terms of profitability. The
study found that the mergers led to financial synergies and a one-time growth
of 43% in asset base for the acquiring firms, in the merger year. The growth in
sales and operating income for the acquiring firms in the merger year was
12
Ratios used were Net Profit Margin (PAT/Sales), Operating Profit Margin, Return on Capital
Employed, Cost of Production / Sales, Debt-equity Ratio and Operating Cash Flow.
13
Ratios used were: Operating Return on Assets (PBIDT/ Net Assets), Growth Rate (average
growth rate in total assets), Leverage (Total Debt /(Total Debt + Equity Capital)), Tax Provision (
Tax / Operating Profit) and Liquidity ((Current Assets – Inventory) / Current Liabilities)
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However, the average annual growth rate of assets over the three years prior to
merger and the three post-merger years was found to be same, at around 16%,
implying that mergers did not contribute to the acquiring firm’s growth rate in
competing firm that was not involved in merger showed that if no merger had
taken place the post-merger period profitability would have improved further.
The study concluded that the firm performance had not improved due to
mergers for the sample firms, and that mergers had created significant
advantages only in terms of the debt position of the acquirer. The study also
inferred that the type of merger - horizontal or BIFR- revival or those between
group companies & subsidiaries - did not significantly affect the post-merger
performance.
The study also observed that both the merging firms (acquirer and acquired)
were at the lower end in terms of size, growth, tax and liquidity of their industry.
The firms however performed better than their industry in terms of profitability.
Most of the mergers were also between group companies or subsidiary firms,
response to changes in industrial policy, but the restructuring had not improved
the profitability of firms in the post-merger period. Several of the acquired firms
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in the sample were also much smaller in size of operations, relative to the
acquiring firm.
Justin Paul [55] analysed the merger between Bank of Madura and ICICI Bank,
for indications of synergy in the Indian banking industry and the strategic
examined various issues relevant to the merger, like reasons for the merger,
both the banks, and the share price trends before and after the merger related
developments. The study also assessed the suitability of the merger between
the 57 year old Bank of Madura that had a traditional focus on mass banking
strategies based on social objectives, and ICICI Bank, a six year old ‘new age’
organisation, which had been emphasising parameters like profitability and the
interests of shareholders.
The study found that the final swap ratio was 1:2 in favour of Bank of Madura,
but if the valuation had been done on basis of the market price of the shares,
the balance sheets and the NPAs of both the banks, the swap ratio could have
ICICI’s desire to acquire a good bank from South India where they did not have
expected from the merger were increased financial capability, branch network,
customer base, rural reach and better technology. Also, while ICICI bank
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shares had declined in price at the time of and after the merger
potential challenge given the differing work cultures in the two organizations.
Mishra and Rashmi Goel [56] analysed the merger of Reliance Industries
Limited (RIL) with its group company, Reliance Petroleum Limited (RPL). Since
expected cost advantages and growth prospects, the study was undertaken to
Using the share price movements around the announcement date of the
merger, the study examined whether shareholders of the two firms had gained
or lost due to the merger. Cumulative excess returns (CER) were computed for
the period of -20 days to +20 days, i.e. from 20 days before the merger to 20
days after the merger announcement date, separately for RIL and RPL. CER
was also estimated for the two firms (combined), using both market value and
The study showed that positive excess returns had accrued to shareholders of
shareholders of RIL, they had lost in value, and the shareholders of RPL had
gained from the deal. For the combined firm, average cumulative loss of returns
was observed, as measured by both market value and book value of capital.
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The study concluded that the RIL-RPL merger was apparently not driven by
seemed to indicate that the deal was undertaken by the managers of RIL to
Harbir Singh and Prashant Kale [57] studied the returns to acquiring firm
The study observed that during 1992-97, shareholders of acquiring firms had
related and unrelated acquisitions. The study also found that during 1998-2002,
positive but much lower abnormal returns: the abnormal returns were more
From the findings the researchers inferred that in the period of 1992-97, the
Indian M&A market was not well developed and hence target firms were
after 1998 were more expensive, and so more efforts had to be put in by the
examining the daily stock price movements and volume traded of 42 target
companies during the period of 1996-1999. The study examined the pattern of
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stock prices and trading volume of the sample companies, and estimated
average residuals (AR) and Cumulative Average Residuals (CAR), for 150 & 10
Based on the analysis the study concluded that in case of companies belonging
to the same business group, there existed evidence for the presence of insider
announcement. The results also suggested that non-group companies did not
information, which however did not seem to exist for non-group merger
companies.
Rajesh Kumar and Prabina Rajib [59] analysed the financial characteristics of
53 firms involved in multiple (more than three) mergers between 1993 and
2002, using control groups based on industry sector and sales in the earliest
year of initiation of merger activity. The study found that the average sales,
profits and cash flow for a period of ten years were higher for the merging firms
financial leverage and unused debt capacity appeared to be motives for firms to
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be an especially important variable in the decision of firms to become a multiple
acquirer, as also maximizing the size and increasing the efficiency in producing
sales per value of assets. The study also concluded that firms whose main
shareholder power was not strong were more likely to be involved in multiple
mergers.
Pitabas Mohanty [60] observed that firms that have gone for related mergers
(or acquisitions) have performed better than companies that have gone for
more attention of researchers during the last decade. Review of the existing
sector in India, over a limited period of time. Research done so far had covered
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(a) Rationale for mergers and acquisitions, distribution of acquisitions by
(f) Investigation into likely presence of insider trading prior to the merger
announcements
mergers
acquiring firms, and research in that area has been sporadic, and limited to
analysis of individual cases, for limited periods of time and for small samples of
86
mergers of Indian companies has been quite limited so far; and therefore
provides scope for additional research in the area. Scope for additional
types of mergers, for longer time periods, for different industries, for different
sizes of merging and merged firms, and for variations over different time-
periods in history, etc. There has also been no prior research on stock price
returns in the long run following mergers / acquisitions, for merging firms in
India
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