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THE ANALYSIS OF COMPANIES' ACCOUNTING PERFORMANCE RATIOS FROM

MERGERS AND ACQUISITION

Conference Paper · June 2012

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 THE BUCHAREST FACULTY OF ACCOUNTING
UNIVERSITY OF ECONOMIC AND MANAGEMENT INFFORMATION
STUDIES SYSTEMS

Proceedings
of the 7th International Conference
ACCOUNTING AND MANAGEMENT
INFORMATION SYSTEMS
AMIS 2012

June 13-14, 2012

Bucharest University of Economic Studies
Piaţa Romana, No. 6, Sector 1
Bucharest, Romania

ISSN 2247-6245
ISSN-L 2247-6245

1
 THE ANALYSIS OF COMPANIES’ ACCOUNTING
PERFORMANCE RATIOS FROM MERGERS AND
ACQUISITION

Florentin CALOIAN, Laura BRAD1, Radu CIOBANU and Anca STAICU

Bucharest University of Economic Studies, Romania

ABSTRACT
This study measures the impact of mergers and acquisitions (M&As) on the performance of
companies in Romania. To achieve this, we analysed the pre-merger and post-merger
financial rates for companies listed on Bucharest Stock Exchange who made at least one
merger or acquisition in the period 2006-2011. A set of three rates (ROA, ROE and ROS) was
analysed in order to measure the economic performance of companies before and after the
M&A announcement was made. Moreover, a logit model was realized where the influence of
ROA, ROE and ROS was observed. In many cases, results showed that the performance of
companies it could be significantly influenced by the M&A announcement. Moreover, a
conclusion about the value of the company can be subtracted by analysing the results obtain
in our logit model.

KEY WORDS: Acquisitions, Mergers, Financial ratios, Economic performance

INTRODUCTION

Acquisitions and mergers are a mechanism by which companies gain access to new
resources, increase their incomes and reduce their costs. The success of M&A
activities can be pointed out through the economic potential which the M&A
transaction develop, resulting in increased financial performance of the company.

The European market is getting through a continuous development over the past
20 years, integrating more and more economies that were mostly characterized
through a centralized socialist economy before 1989. During that period, most
European companies have limited their activity to their national borders compared to
the U.S. that were developed abroad. Due to this reason, the value of M&A activities
realized in Europe was reduces and the capital transfer was limited to state borders.
(Campa and Hernando, 2004). With the liberalization of markets and with the IPO
process of several companies that were controlled by the state, the number of M&A
activities increased and large companies from developed countries were attracted by
the possibility of realizing new investments. Foreign investors were attracted by the
possibilities of development in the countries of Central and Eastern Europe due to low
price of M&A transactions and of labour force that could lead to significant gains
from these activities.

1
Correspondence address: Laura BRAD, Bucharest University of Economic Studies, Piata Romana,
nr. 6, Bucharest, FABBV Department, Room 1104, email: laura_brad2004@yahoo.com

754
The M&A market in Central and Eastern Europe was characterized in the early 1990s
by privatizations. In Romania, the privatization of companies owned by the State
Ownership Fund, which was achieved in the last decade of last century, is mainly
characterized by takeovers of those companies. According to some researches these
transactions haven’t been characterized by positive performance, due mainly to a
capital market not well developed and due to a lack of legal regulations regarding
capital markets and mergers and acquisitions process. (Pop, D 2006).

Using the financial ratios analysis, the study attempt to investigate the performance
changes for companies that are involved in M&A activities in the past 5 years in
Romania. We focus on the empirical evidence of the performance from acquisitions
and takeovers of all the companies listed on the Bucharest Stock Exchange (BSE) as
few studies were realized upon this market. A takeover may be a friendly or a hostile
process, depending on the acquiring firm approach. It may be affected through
agreements between the acquirer and the majority shareholders, through the purchase
of shares from the open market, or by making an offer for acquisition of the acquirer’s
shares to the entire body of shareholders. Acquisitions can take place either by
acquisition of shares of the target company, either by acquisition of assets and
liabilities of the target company.

The paper is structured as follows: the next section gives a brief overview of the
related studies in this field, Section 3 presents the database and the methodology used,
Section 4,outlines the approaches to the measurement and estimation of performance
change and Section 5 is dedicated to discusses and conclusions.

1. LITERATURE REVIEW

The influence of macroeconomic environment upon the performance obtained by

companies cannot be denied as they quickly react to each modification. As a fact,
during a financial crisis, important changes can be observed, especially in the mergers
& acquisitions area. As they highly influence the performance acquired in different
economic branches, the measurement of their performance is definitely important.

Two ways of quantifying the performance obtained in the mergers & acquisition
sector are mainly studied in the present foreign literature: on one side, the market
share price using event studies (Sudarsanam,S. and Mahate, A.A’s (2006)
Moeller,S.B., Schlingemann, F.P.,Stulz,R.M. (2004) and on the other side, the
accounting measures of performance. Several studies focus either on the market
performance, either on the accounting measurements, but most of them use both of
these techniques. From this point of view, Kabir,R, Roosenboom,P.F.J (2003) realized
a connection between the stock market and the operating performance of several
enterprises as the first was able to anticipate the changes in operating performance of
the issuing companies. Moreover, they discovered no connection between stock
market reaction, financial ratios and the favorable macroeconomic conditions. On the
other side, Tuch, C.& O’Sullivan,N. (2007) discovered that there is no evidence of
higher performance in the short term using event studies, but a negative one on the
long term event study, while the accounting measures offers a mixt conclusion.

The problem of performance in mergers and acquisitions is not new; as many

researchers tried to develop different solution on how better performance

755
measurement is provided. They used not only the classical ratios that represents a
company’s performance, but also some calculated indicators generated by
manipulating the financial statements. As a fact, Healy , P. , Palepu, K. G. , Ruback,
R.S. (1990) studied if merged firms had increased their post-merger operation cash
flow relative to the pre-merger values. They use a cash flow indicator upon 50 largest
acquisitions between 1979-1983, which was not affected by goodwill or depreciation
and discovered that there was a high increase in their asset productivity. Opposite
results were subtracted from their study by Sharma,D.S.&Ho,J(2002) who realised
that the post-merger performance measured either by cash flows, either by accounting
ratios like ROA, ROE, EPS and PM got worsen than the performance achieved before
the merger process. Same results were obtained by others researchers like Fowler K,
Schmidt D (1989) who concluded that the acquisition process decreases the
performance of the company if it is measured by return on assets, while Marimuthu,
M. (2008) revealed that there is no significance difference between the low and high
sales growth companies in terms of performance after the acquisition was made, as
sales growth rate is an insignificant performance measure.

On the other hand, mixt results about the performance that the acquirer and the taken
company were found by Selcuk, E. A & Yilmaz, A. A (2011) who analyzed the
impact of M&A on the performance of 62 acquired Turkish companies that were
traded on Istanbul Stock of Exchange. They discovered that while significance
performance could be observed on long terms event studies, ROA and ROS value
from the intercept model were significantly lower than those of pre-acquisition ones.
Similar opinions were formulated by Agorastos, K, Pazarskis, M, Karagiorkos, T
(2011) as they realized a research upon post mergers financial performance using
companies listed on the Athens Stock Exchange between 1998 and 2002. The
performance was quantified using 5 main groups of financial ratios and the results
shows that conglomerate mergers performance are above the bench market when
liquidity ratios and financial structure ratio are concerned.

As performance can be measured using non-financial and non-economic variables, we

consider that Gantumur, T & Stephan, A (2011) is quite important. They proved
insights that M&A determined an important growth in innovation performance in the
telecommunication industry due to post mergers R&D charges and also to weakness
of internal technological capabilities that acquired companies had before merger.

Besides, with a high level of consistency, comparative studies provide a further

consideration on the performance gained in the mergers and acquisitions domain.
Martinova&Renneboog (2006) realized a European study on 28 countries, including
Romania, and discovered that several variables like the takeover kind, the size of the
companies, the financial structures of enterprises affect the performance in the post-
merger period.

In the same direction goes Gruici,B.C., Constantin, L.G., Iamandi. I.E (2010)
comparative study during the recent financial crisis. Their conclusion is that the
Romanian Mergers and acquisition market is quite undeveloped as the failure
characteristic of this process is still present. On the other side, Romanian companies
report better post merger performances during the financial crisis as they consider
merger a proper way to raise capital and why not to create future development
oportunnies.

756
As there are many contradictions on the main literature about mergers and acquisition
performance, and as there are no significant studies in the Romanian literature, we are
interested in quantifying the impact of this process upon financial and accounting
ratios.

2. DATABASE AND METHODOLOGY

2.1. The performance measured by accounting ratios

The purpose of this article is to identify if there have been movements in the
performance obtained by the companies that were supposed to a takeover offer
process in the 5 years period. In order to realize the analysis and to determine the
performance obtain in the acquisition process, we analysed three return ratios like
return on equity, return on assets and return on sales. The idea can be justified by the
fact that first off all classical measurement of the performance should be done, as no
proper conclusion about recent period was undertaken. Moreover, the event study
methodology is actually based on the market reaction at the announcement of the offer
and cumulative abnormal returns are calculated. As this perspective is based more on
the efficiency market hypothesis and not on the financial and accounting expectation,
we consider that return ratios are a better measurement for the performance obtained
by the company. Additionally, we can calculate several other ratios in order to point
out if they have an important influence upon the acquisition process. Our research is
based on a sample formed initially from all the take-over bids activities from 2006 to
2011 that took place on the Bucharest Stock of Exchange (BSE), with a number of 27
companies.

For each company we extracted financial information from their financial statements,
as we wanted to show the performance acquired due to the acquisition process. The
following formulas were used in order to quantify the performance obtained by the
companies:

One explication for formula used for return on equity and return on assets is that we
wanted to illustrate the result obtained due to initial values of material assets and
shareholder’s equity and to evaluate the performance gained with primary resources.
On the other hand, dividing results from the current period to resources from the
previous one generates some ratios that can be compared with the inflation rate or the
interest rate. Regarding the third indicator, it measures the profitability obtained due
to current companies activity, as the profit of the company was generated by the sales
realised between the beginning and the ending of a financial period. The performance
of the companies using the three return ratios was determined before and after the

757
takeover process. Our intention was to compare and analyse the company
performance for two years before and two years after the takeover process in order to
see whether the M&A transaction improves performance or not. Due to some
limitations to financial statement information mainly for the companies that are no
longer listed on the BSE, this purpose could not have been properly fulfilled for all
the firms in the database.

2.2. The logit model

In practice, the classical regression model does not offer proper solution to the
researchers’ requirements, as frequently dependent variables have a binary evolution.
Consequently, other solutions were developed as no relevant results are provided
using the OLS model. Moreover, the estimated values are not permanently range
between 0 and 1 and no proper estimation can be realised. As a fact, binary models
were developed (logit and probit models), in which the negative effect of the classical
model is eliminated, as the variable is generated using the distribution of the residual
term. As many variables do not have a normal distribution, the logit models, based on
the cumulative distribution of errors, offers more consistently and robust results.
Moreover, the logit model is based on maximize the likelihood which is unbiased and
which minimizes the variance of a large number of variables. In practice, the logit
model it is frequently used in the banking sector in order to establish which
companies can obtain financial support from banks.

The model used has is based on the following model:

where y is the dependent variable, ..., are the independent variables, and
is the error term, them in a regression based on the logit model, the probability of
changing the dependent variable is

where p is the probability and it has a value between 0 and 1 (  ),

The importance of the model comes from the fact that the model is constructed on
using the cumulative istribution of the residual form.

Taking this facts into consideration, we realised a logit model for each type of offer.
Basically, we have a selling (S symbol) a buying (B) and a taking over bid
(purchasing offer P) , so the dependent variable the specific kind of offer. Even
though we do not have similar proportion for each value of the dependent variable, as

758
logit model assumption are for obtaining better results, we think that logit models can
offer better results than the OLS estimation.

2.3. The logit model interpretation

Due to its non-linear distribution, the logit model is analysed in a particular manner. If
the coefficients’ sigh and the way of accepting them are similar with those from the
classical regression model, when we talk about economical results they have a totally
different signification. In particularly, the absolute value of the coefficients is entirely
different from that resulted from a linear probability model. Consequently, the logit
coefficients are more dynamically as the changing probability of the estimated value
to be 1, caeteris paribus, will fluctuate as it reaches 1.

In order to mark out the economic impact, an approximation for each coefficient can
be used. Generally, they are multiply by 0.25 or are divided by 4 in order to be similar
with the values from the classical regression method. The problem is that the size of
our sample is quite low, and basically, even an approximation method cannot generate
equivalent coefficients from both regression models.

Regarding the present study, firstly the numbers of selling, buying and taking offers
was quantified as they are going to represent the dummy variables in the model
analysed. After that, different indicators were calculated such as the average before
the date of takeover bid for return on equity, return on sales and return on assets. Not
only the average values were determined, but also the previous value before the data
of anouncement was taken into consideration. Finally, in order to point out the
performance obtained by the companies that were suppose to a takeover offer, several
logit models were realised. The purpose was to determine how the variable included
in the study can influence the type of takeover in Romania.

3. RESULTS

3.1. Results on the accounting performance ratios

As we have mentioned, for each company that was subject of performance analysis,
we calculated three profitability ratios, taking into account their financial statements.
The reaction of the market can be pointed out if the performance of the company is
marked by a severely jump: even an important increase, even a drastically decrease.
This reaction proves that the market reaction can be similar with the semi-strong
efficient market hypothesis.

On the other hand, several companies do not have pre-takeover process and post-
takeover process performance information as this event took place even in 2010, so
financial information were not provided, even in the past where no financial
information was founded. As a consequence, we can only analyse the performance
obtained before or after the takeover offer and anticipate how the market will react or
have reacted to this process.

Firstly, we realised a summary of the performance obtained by the companies.

759
 Table 1. The evolution of companies performance after the takeover process
Year Nr. S B T ROA ROE ROS
2005 1 1 mixt results mixt results mixt results
Jump /
drastically drastically
2006 6 2 4 constant
falls falls
evolution
important constant
2007 5 1 4 mixt results
jumps values
no
2008 2 1 1 important mixt results mixt results
modification
drastically
falls,
2009 5 2 3 mixt results mixt results
constant
values
no no no
2010 5 2 3 information information information
provided provided provided
no no no
2011 2 1 1 information information information
provided provided provided

As it can be seen there are cases when the market reaction is marked by an important
fall or a severely jump, but in general mixed evolution can be identified. At a closer
look, macroeconomics connections can be observed, as important jumps are typically
for the boom period, while drastically falls can be measured in the recession economic
cycle.

At a closer analyse, the mixed results can be spread into severely falls and important
jumps, constant evolution and uncertain decisions. Looking at return on assets, we
identify that ROLAST has the worst performance as its return on assets falls more
than 40%. Same evolution, but with a smaller impact can be observed upon UPS and
Kandia, while positive jumps can be illustrated on ALU and POLICOLOR.

When we talk about the return on equity, same results can be observed as ROLAST is
still on the last position when its performance is measured, while huge expectations
are obtained by SCD. The last ratio, which measures the impact of profitability on
sales, is in the same direction as the others indicators’ evolution was. Actually, the
results can be justified by the fact that same amount is divided by different accounting
elements, so the modification it should be made by those, but generally, there are also
other factors that influence the profitability obtained by the company. Nonetheless, we
cannot omit the evolution of macroeconomic environment as financial crisis affected
the Romanian market and as companies felt the negative effect of the macroeconomic
evolution.

The results are somehow in the manner that we expected them to be, as no constant
evolution is obtained by the company and as they are sensitive to the market reaction.
The impact of takeover process can be consequently analysed in several ways. For
example, important jumps or severely falls can be a way of stakeholders’
understanding the takeover process. As a fact, if better influence and benefits of the
takeover process can be identified, then the market reacts in a positive way and the
profitability ratios set down a positive evolution. On the other way, if takeover is
concerned as a reorganization process, if stakeholders do not anticipate positive
evolution of the company due to the takeover process, then the performance is marked

760
by a drastic fall. Besides that, we have a sample of enterprises that are characterised
by no significant modifications in their financial measurement performance. The
reason of this unobserved modification can be explained by the fact that no benefits or
problems can be identified by the companies, as there is no real reasons to doubt
about the plans that the company realize for next years.

In conclusion, the performance gained by recent takeovers bid offer cannot be

classified in a single evolution, as mixed results were obtained during the Romanian
market. Nonetheless, the severely falls or important jumps obtained in the profitability
of a company should be connected not only with the previous performance, but also
with the macroeconomic environment evolution which can influence the company’s
behaviour on the market.

3.2. The logit results

The logit model form and its particular interpretation is quite important as economic
conclusion about the value of the companies can be formulated.

After establishing the research methodology, several economic models were realised
using the economical program Eviews. As independent variables included in the
analyse are not uncorelated, as they should be, better results were obtained by using
unifactorial logit regression. As a consequnce, the selling offer was influenced
individually by the average of return on equity, the average of return on assets, while
the buying offer was influenced by the return on assets, average of return on equity,
and the previous value of the return on sales before the date of announcement.
Unfortunately, no relevant correlation could have been detected for the taking over
bid, as the significance value of the coefficients was not economically different from
zero. More than 50 simulations were realized in order to find the better correlation
between the independent variables and the binary one. Several results are summarized
in the next table.

Table 2. The decision type of several logit models

binary variable independent variables
S average of ROE, ROS, ROA
S average of ROA
S average of ROE
S last ROE, Last ROS
P average of ROE
P average of ROE, ROS, ROA
P average of ROE, ROS
P last ROE, ROA, ROS
B average of ROA
B average of ROE
B last ROA, last ROS
B last ROA, Last ROE, Last ROS
Results
coefficients are not significantly
different from zero
probability of error 17,81%
the model is correctly defined
the model is correctly defined
coefficients are not significantly
different from zero
coefficients are not significantly
different from zero
probability of error 18,72%
coefficients are not significantly
different from zero
the model is correctly defined
the model is correctly defined
probability of error 16,7%
coefficients are not significantly
different from zero

The previous table encounters only a few simulations that were made. Different
conclusion can be formulated by analyzing it. Firstly, better results are provided when
only an independent variable is included in the study research. Secondly, generally,
761
even though the coefficient of the constant resulted is not significantly different from
zero, the models cannot be rejected as they are properly formulated. Thirdly, multiple
factor influence cannot be observed as the independent variables are connected by the
net profit obtained in the current financial year.

Even though the model provided looks like a linear one, none should analyze it as a
classical regression model. Particular interpretation is conferred to the nonlinear
model, where the value of is not relevant for the entire model validation as the
value of it is divided in a few ratios (McFadden R-squared) Actually, for a better
understanding of the logit model, several steps have to be done.

Firstly, the coefficent sign can be analysed as the interpretation of z-test is similar
with t- test, the one from the classical regression model. In order to accept that
coeficients are significantly different from zero, it is recomanded that the value of z-
test to be under 5%. Due to a small number of variables used, the validation criteria
can be modified by increasing the value accepted for the z-tes up to 10-15%. It is
generally accepted that the higher the z-value is, major errors can be done. On the
other side, the relevance of the model is quantified by the practical and statistical
coefficient signification. The model is approved if the probability of the likelihood
ratio is less than 5%.

In order to point out the importance of coefficient value, several logit models were
realised as it is seen in the next table.

Table 3. The results obtained in the logit model using a single independent variable
Dependent variable Independent variable coefficient's value probability
S average of ROE 7,2664 0,0556
T average of ROE -0,1119 0,965
B average of ROE -8,3782 0,0446
S average of ROA 9,3052 0,1461
T average of ROA 4,5897 0,4116
B average of ROA -26,5948 0,0298
S average of ROS 3,6227 0,4681
T average of ROS 9,4704 0,1022
B average of ROS -24,7924 0,0462
S ROE last value 5,7284 0,0635
T ROE last value -0,4376 0,8459
B ROE last value -5,4801 0,0675
S ROA last value 7,5906 0,1781
T ROA last value 1,4012 0,7744
B ROA last value -10,4304 0,0854
S ROS last value -1,4017 0,6566
T ROS last value 2,7554 0,4105
B ROS last value -1,4669 0,661

In the first example, the raise of the average of return on equity with one per cent
determines a modification of the probability for a selling takeover bid with 7,26%,
while a similar raise decreases the modification probability of a buying offer with
8,37%. As it is shown above, the looking to change probability for a selling takeover
bid is significantly influence by previous return on equity values. When the
modification is due to almost each ratios analysed, without the last year ROS value,
there is a high probability to have a takeover buying offer. In the last case, the
increase with 1% in the average of return on sales influence the looking to change
probability of an take over process with 9.47% if higher risk is assumed, as the
762
probability of making mistakes is greater than 10%. If the classical regression model
would have been realised, than the average of return on equity coefficient would have
been 1.816 when the approximation model is used. Consequently, a 1% increase in
the average of ROE would have generated a 1.8% modification of dependent variable.
The logit model can also provide information about the percentage of takings over
process that were necessary to be realized. In order to this, forecasting values obtain
using 50% information criteria (the possibility of being or not a similar process with
that analysed). The conclusions point out that more than 70% for taking offers, buying
offers and selling offers is justified by the economical background of the company.

Moreover, even though no multiple models were realized, the economic interpretation
has to be provided. Using the logit model, we can formulate an opinion about the
value of the company when the selling, buying or the taking over process is taking
place. As a fact, if the company is having a selling offer that we can say that is
overvalue by the market, while a company that is having a buying offer it could be
undervalue by the market. Nonetheless, a company suppose at a takeover process it is
consider to be properly value by the market itself.

Further research can be made using monthly data as better ways of quantifying the
performance can be obtained. More specifically, not only accounting data it should be
used, but also financial and non-financial data as the performance of the company in a
takeover process can be drastically influence by the macroeconomic environment.

DISCUSSION AND CONCLUSION

This paper aims to identify a correlation between some accounting performance’s

measurements and the takeover bid offer, a buying offer or a selling one on a sample
of 27 enterprises from the Romanian Market between 2006 and 2010. As a fact, the
study was divided into two sections: the first one, measures the performance gained
by the company using three accounting ratios: return on equity, return on sales and
return on assets, while the second one points out the economic importance of mergers
and acquisitions using a logit model.

The results obtained offer mixt interpretation and can be correlated with other M&A’s
studies. On one hand, there are companies who obtain a better performance
(quantified by ROA, ROE like SCD, ALU) after the takeover bid offer was
announced. Similar results were obtained by Verde, S. (2007) regarding the M&A’s in
Europe in the energy industry. On the other hand, there were companies than
decreased value and lost financial performance after the announcement was made. As
a fact, we have severally falls in companies like Rolast. These results can be
connected with Rau, P, R and Vermaelen, T (1998) who concluded that the companies
over extrapolate the bidders past performance.

Regarding the methodology used, problems were encounter as no adequate financial

data were provided for all our companies. Actually, because we used annual data, not
a proper evaluation of the performance obtained by companies could have been
established, especially when the process analysed was at the beginning or at the end of
our study period. Another problem comes from the way we choose to calculate the
accounting ratios. For a further study an average between the beginning and the end

763
value of financial elements can be calculated as the net result can be generated not
only by past performance, but also by present financial turnover.

On the other hand, the second study points the economic background of mergers and
acquisition using a logit model. The results points out that the probability of being
change from 0 to 1 for the takeover buying, selling, and taking process is influence by
our independent variables as follow: return on equity generally influence the selling
offer, the taking process is generated by return on sales, while return on assets, on
sales and on equity affects the likelihood of change in a buying takeover process.
Nevertheless, several problems were identified as the sample was quite small, as our
independent variables were correlated, so no multiple models could have been
realised. For a further research, we recommend more financial indicators to be
calculated as they can provide better information about the mergers and acquisition
process. Consequently, the goodwill gained by the company can be analysed, other
financial element like cash flows or profitability ratios can be calculated in order to
obtain better relevance of the macroeconomic environment influence upon the
performance of companies implied in a M&A process.

In conclusion, we proved that the M&A announcement influence generally positive

the performance obtained on Romania Market.

ACKNOWLEDGEMENT

This work was co-finaced from the European Social Fund through Sectoral
Operational Programme Human Resources Development 2007-2013, project number
POSDRU/107/1.5/S/77213 „Ph.D. for a career in interdisciplinary economic research
at the European standards”.

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 Appendix
The company used in our study

Number Company Type of offer

1 ALU S
2 CBC S
3 COMI T
4 COTR S
6 ELECTROCERAMICA B
7 FAUR T
8 KANDIA DULCE T
9 MPN T
10 POLICOLOR -1 T
11 POLICOLOR -2 B
12 PPL T
13 PTR T
14 ROLAST B
15 RRC T
16 SCD - 1 B
17 SCD - 2 T
18 SILCOTUB B
19 SNO S
20 SNP S
21 SOCP T
22 SRT S
23 STZ B
24 TEL S
25 UPS B
26 VESY - 1 S
27 VESY - 2 S

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