Are Cash Acquisitions Associated With Better Postcombination Operating Performance Than Stock Acquisitions - 2001

Journal of Banking & Finance 25 (2001) 1113±1138
www.elsevier.com/locate/econbase
Are cash acquisitions associated with better

postcombination operating performance than
stock acquisitions?
a,* b
Scott C. Linn , Jeannette A. Switzer
a
Division of Finance, 205 A Adams Hall, Michael F. Price College of Business,
University of Oklahoma, Norman, OK 73019, USA
b
Faculty of Management, Dalhousie University, Halifax, Nova Scotia, Canada B3H 3J5
Received 15 September 1997; accepted 30 March 2000
Abstract
This study examines the relation between the change in operating performance of
®rms which merge and whether the acquiring ®rm oered cash or stock as the method-
of-payment. We examine how operating performance changed for a sample of 413
combinations. The results indicate that the change in performance of the merged ®rms is
signi®cantly larger for cases in which the acquiring company oered cash as compared
to stock oers. The results are not sensitive to whether the combination involved a
tender oer or a negotiated merger, to oer size, industry relatedness between the
bidder's and the target's businesses or bidder leverage. Ó 2001 Elsevier Science B.V. All
rights reserved.
JEL classi®cation: G30; G34
Keywords: Mergers; Operating performance
*
Corresponding author. Tel: +1-405-325-3444 ext. 5591; fax: +1-405-325-1957.
E-mail address: slinn@ou.edu (S.C. Linn).
0378-4266/01/$ - see front matter Ó 2001 Elsevier Science B.V. All rights reserved.
PII: S 0 3 7 8 - 4 2 6 6 ( 0 0 ) 0 0 1 0 8 - 4
1114 S.C. Linn, J.A. Switzer / Journal of Banking & Finance 25 (2001) 1113±1138
1. Introduction
A recent study by Loughran and Vijh (1997) presents a comprehensive

analysis of the postmerger stock returns of merged ®rms over the ®ve years
following the eective date of the acquisition. Loughran and Vijh conclude that
combinations resulting from cash oers earn excess returns that are signi®cantly
larger than those associated with stock oers. 1 One reason why cash oers may
be associated with greater postmerger excess returns is that the postcombination
operating results for such oers may exhibit greater improvement than what is
observed for combinations associated with stock oers. This issue has not yet
been directly addressed in the literature for a large sample of corporate combi-
nations. The present study is designed to examine whether improvements in the
postacquistion operating performance for combinations in which cash was of-
fered are signi®cantly dierent from the improvements associated with stock
oers for a large sample of combinations. The study thereby complements the
results that have been presented on the stock return performance of ®rms fol-
lowing corporate combinations, and provides further insight into why post-
combination excess returns dier between cash and stock oers.
Fig. 1 illustrates our primary results. We ®nd that cash oers are associated
with signi®cantly greater increases in industry-adjusted pretax operating per-
formance as compared with combination cash/stock oers that themselves
dominate oers that involve only stock. These results are not sensitive to
factors such as oer size, the relatedness of the bidder's and the target's
businesses, nor bidder leverage. Further, the results are not sensitive to the
inclusion or exclusion of tender oers that led to mergers, in contrast to an
examination of only negotiated mergers.
1
Results on the relation between postacquistion common stock returns and the method of
payment oered have been mixed. Agrawal et al. (1992) and Franks et al. (1988) report that bidders
who oer stock perform worse than cash bidders. In contrast Franks et al. (1991) ®nd no support
for such a ®nding. Agrawal et al. (1992) examine a sample from the period 1955±1987 and ®nd
average (and statistically signi®cant) negative performance of )10% for their full sample over the
®ve-years postmerger period. They also ®nd that the results of zero postmerger performance
reported by Franks et al. (1991) for mergers during 1975±1984 are con®ned to the period Franks,
Harris and Titman examine. Langetieg (1978), using a matched control sample design, ®nds no
signi®cant positive or negative stock return behavior. Magenheim and Mueller (1988) ®nd
underperformance, but when Bradley and Jarrell (1988) examine the same sample using a dierent
methodology they ®nd no underperformance. Loderer and Martin (1992) after accounting for size
and market risk, ®nd no postacquisition underperformance on average. The empirical evidence
consistently indicates that both target and bidder share prices respond more positively to a cash
takeover oer than they do to a stock oer at the time the oer is ®rst announced (for instance
Asquith et al., 1987; Travlos, 1987; Huang and Walkling, 1987; Eckbo et al., 1990; Amihud et al.,
1990; Peterson and Peterson, 1991). Martin (1996) presents tests of the motivation for the choice of
cash versus stock by bidders.
S.C. Linn, J.A. Switzer / Journal of Banking & Finance 25 (2001) 1113±1138 1115
Fig. 1. Median changes in industry-adjusted operating performance returns for a sample of 413
corporate combinations by method-of-payment, where change is de®ned as performance after the
combination minus performance before.
Several studies have examined changes in operating performance accom-

panying mergers, including, Healy et al. (1992), Cornett and Tehranian (1992),
Jarrell (1990), Clark and Ofek (1994), Ravenscraft and Scherer (1988) and
Herman and Lowenstein (1988). Among these studies, Healy et al. (1992) in-
vestigate whether dierences in operating performance are associated with the
acquirer's choice of cash or stock as the method-of-payment. Their sample
includes 13 mergers, out of 50, which involved cash oers. Healy et al. ®nd no
relation between changes in performance and the method-of-payment. It is
possible however, that this result may have been in¯uenced by the small, se-
lective sample examined. Healy et al. do however ®nd that performance in
general improves. Cornett and Tehranian (1992) also report improved oper-
ating performance for a sample of 30 mergers in the banking industry but do
not focus on whether these improvements are related to the method-of-pay-
ment. Clark and Ofek (1994) investigate the relation between postmerger in-
dustry-adjusted performance and whether cash was included in the oer for a
sample of takeovers involving 38 ``distressed'' targets. They ®nd no signi®cant
relation. 2 They do not investigate the relation between cash versus stock oers
2
The dummy variable used by Clark and Ofek (1994) is de®ned so that it equals 1 when an
acquisition is for cash or when it involves a mixed cash plus securities oer.
and the dierence between the pre and postmerger performance of their sample
®rms. They also do not ®nd any general improvement in performance as a
consequence of the mergers studied.
While the focus of the paper is not on a direct test of why cash oers out-
perform stock oers, our results are consistent with the explanations oered by
Fishman (1989) and Berkovitch and Narayanan (1990) for why cash oers are
sometimes selected over stock oers. Fishman (1989) argues that bidders use
cash to deter competing bids when they have favorable private information
indicating a high value for the target, potentially due to synergies. Berkovitch
and Narayanan (1990) argue that a large cash oer increases the likelihood that
the target will accept the initial bid and eliminates any delay during which
other ®rms might oer competing bids. Important to their argument is that the
share of synergistic gains captured by the bidding ®rm increases with the
fraction of the oer represented by cash. Thus bidders with very favorable
private information about future excess operating returns would tend to use
larger amounts of cash in their oers, both to deter competition and to ensure
that they capture a large share of the synergistic gains. 3
The sample examined in this study is described in Section 2. The results of
the empirical analysis are presented in Section 3. Section 4 provides a summary
with conclusions.
2. The sample
The sample of combinations examined in this paper is from the period 1967 to
1987. The sample consists of bidder and target pairs involved in tender oers
that led to mergers or negotiated mergers. Combinations completed prior to
1979 were identi®ed using the Federal Trade Commission's Statistical Report on
Mergers and Acquisitions for July 1981. Target ®rms associated with combina-
tions that occurred after 1979 were identi®ed by examining NYSE/AMEX
delistings indicated on the Center for Research in Security Prices (CRSP) daily
returns ®le. The corresponding acquirers were identi®ed from the reports about
the combinations that appeared in the Wall Street Journal Index and the asso-
ciated WSJ articles. Information obtained from the Wall Street Journal articles
about the oers included the method-of-payment along with other terms of the
transaction, and the completion date. Acquisitions were excluded if the method-
of-payment involved a security other than stock, cash, or a combination of stock
and cash. Acquisitions that involved the use of straight debt, preferred stock or
convertible securities as part of the payment package were excluded.
3
A potential source of expost gains may arise from reorganizing the management team of the
target, which can lead to real gains under some circumstances (see, for instance, Martin and
McConnell, 1991).
We examine the change in operating performance following a combination

for two overlapping samples. The ®rst, and larger of the two samples is com-
posed of those combinations for which the operating performance of the bidder
and target were available on the COMPUSTAT Industrial or Research Tapes
for at least one common year of the ®ve years preceding the merger, and for
which the merged ®rm had operating data available for at least one of the ®ve
years following the merger. This sample allows or the possibility that the bidder
was either liquidated or merged with another company during the postmerger
period with which it is associated. The ®nal sample consists of 413 acquisitions.
The sample includes 211 combinations that involved payment with cash only,
152 that involved payment with stock only, and 50 that involved cash and
stock.
The second sample includes only those cases in which the bidder and target
each had operating data available on the COMPUSTAT Industrial or Re-
search Tapes for each of the ®ve consecutive years prior to the combination,
and for which the merged ®rm had operating data available for each of the ®ve
consecutive years following the combination. This sample includes cases with a
more complete set of operating histories, but this comes at a cost of some
potential selection bias. This smaller sample consists of 324 acquisitions.
Within this sample 156 cases involved cash oers, 120 involved stock oers and
48 involved cash and stock oers.
We ®nd that the results are largely the same for both samples despite the
selection bias present in the second. The tables presented later are therefore
primarily based upon the larger, less constrained, of the two samples. 4
Negotiated mergers and mergers preceded by tender oers are both repre-
sented in the ®nal sample. We report results for the full sample and then
separately for the negotiated mergers. Table 1 provides a breakdown of the
timing of the sample events by year of acquisition and method-of-payment for
the sample of 413 cases described above. The time pattern for the smaller
sample of 324 cases is similar to that reported in Table 1.
3. Empirical results
3.1. Measurement methods
A pretax cash ¯ow return is used as our measure of operating performance.

All data for the computation of cash ¯ow returns are obtained from the
COMPUSTAT data ®les, including the COMPUSTAT Research ®le. Pretax
4
Likewise, the results are not materially in¯uenced by the inclusion of tender oers in the sample
de®nition. We return to this issue later in the paper.
Table 1
Distribution of combinations by year of acquisition and method-of-payment used by the acquirer
Year Payment method Total
Cash Stock Cash/stock
1967 0 1 0 1
1968 0 1 0 1
1969 1 4 0 5
1970 3 16 0 19
1971 2 4 0 6
1972 1 2 0 3
1973 4 14 0 18
1974 4 6 0 10
1975 4 6 0 10
1976 12 9 0 21
1977 10 13 4 27
1978 18 7 4 29
1979 21 10 8 39
1980 15 11 4 30
1981 10 9 6 25
1982 12 7 6 25
1983 8 7 2 17
1984 12 3 4 19
1985 26 7 5 38
1986 28 8 5 41
1987 20 7 2 29
Total 211 152 50 413
cash ¯ow is measured as after tax income before extraordinary items, plus
depreciation and amortization charges, net interest expense (interest expense ±
interest income) and total income taxes. 5 Measures of performance based only
on net income may be aected by both the accounting method (purchase or
pooling) used for the acquisition and by the choice of ®nancing, either of which
may distort the measurement of changes in operating performance. Postac-
quisition net income may also be aected if the bidder issued debt or sold
marketable securities to raise the funds for a cash oer. If the bidder raised
cash through an increase in debt, interest expense will increase; if, however,
cash is raised by selling marketable securities, future interest income will de-
crease. Either situation will reduce reported net income confounding the
identi®cation of any real change in productivity. The de®nition of operating
performance used in this study is unaected by depreciation, goodwill, or the
5
The COMPUSTAT data items involved are: income before extraordinary items (#18) plus
depreciation and amortization (#14) plus interest expense (#15) minus interest income (#62) plus
total income taxes (#16).
type of ®nancing used to fund the acquisition. Changes in the cash ¯ow
measure examined should therefore be an accurate indicator of productivity/
eciency eects that result from a combination. We scale cash ¯ow perfor-
mance to form a return measure by dividing by the pseudo-market value of the
®rmÕs assets. We compute the pseudo-market value of assets by adding the
market value of equity to the book values of preferred stock and long-term and
short-term interest bearing or zero coupon debt. 6 The market value of equity
is computed using the year-end price and shares outstanding from the COM-
PUSTAT ®les. The pseudo-market value of the assets is computed as of the
beginning of the year in which pretax cash ¯ow will be computed.
The preacquisition operating performance for each combination in the
sample is computed as a weighted-average of the performance measures for the
bidder and the target involved, where the weights are based upon the pseudo-
market values of each companyÕs assets. Postacquisition performance is that of
the surviving bidder. Each company is paired with a portfolio of similar
companies that operate in the same industry. The industry membership of each
sample company was identi®ed using its primary 4-digit SIC Code. Care was
taken to con®rm that the comparison companies also had the same primary 4-
digit SIC Codes. This involved independent checking of SIC Codes using the
codes reported in the COMPUSTAT ®les as well as published sources such as
MoodyÕs Manuals. 7 Excess cash ¯ow returns are then measured as the dif-
ference between the performance of either the bidder/target portfolio (preac-
quisition) or the bidder alone (postacquisition) and a weighted-average of the
performance of a portfolio of comparison ®rms. 8 Appendix A outlines the
manner in which the industry benchmark performance measures are con-
structed. We test for robustness of the results by using median values, and
separately using mean values, as a basis for constructing the benchmarks and
the tests involved. 9
6
The COMPUSTAT data items involved are: market value of common stock price per share
at year end times common shares outstanding (#24 ´ #25), preferred stock (#130), long-term debt
(#9), short-term debt (#34).
7
Kahle and Walkling (1996) present evidence indicating that matching based upon COMPU-
STAT reported 4-digit SIC codes provides a better match that matching on CRSP supplied SIC
codes.
8
The sample ®rms and the comparison groups exhibit the following similarities: (a) same
industry groups, (b) similar preacquisition accounting performance. These qualities are, as Barber
and Lyon (1996) suggest, preferred in tests of performance changes such as those conducted herein.
We henceforth, for ease of presentation, refer to excess performance as industry-adjusted
performance.
9
The use of median values in studies of operating performance is now common, and provides a
control for the in¯uence of outliers. Numerous authors report median performance measures in
conjunction with studies of the impact of corporate changes, including Healy and Palepu (1990),
Healy et al. (1992), Mikkelson et al. (1997) and Loughran and Ritter (1997).
3.2. The time record of annual operating performance
Table 2 reports the operating performance results for the combinations in

the full sample both before and after adjusting for industry performance. 10
The median (across combinations) pretax operating cash ¯ow returns are
reported for each of the ®ve years preceding and following the acquisition
(panels A and B). The ®nal row in each panel is the grand median for the
associated ®ve-year period. 11 The maximum number of cases represented in
any year is shown in parentheses under the headings identifying the
method-of-payment. 12 Panel C presents the median change in performance
across combinations. Further elaboration on panel C is useful at this point.
De®ne MIACFpost;i as the median industry-adjusted performance of the
merged ®rm i over the ®ve years following the merger, using years in which
data were available. Likewise, de®ne MIACFpre;i as the median annual in-
dustry-adjusted performance of the corresponding target and bidder port-
folio, over the ®ve years prior to the merger, using years in which data were
available. We de®ne the dierence Di MIACFpost;i MIACFpre;i , where i
denotes the combination and there are N combinations represented. The
values presented in columns (2), (4), (6) and (8) of panel C represent the
medians of the Di for the respective samples indicated in the table. Table 3,
which will be discussed separately, reports analogous results based upon
means.
The results presented in Panel C of Table 2 indicate that there was generally
a positive improvement in the operating performance of the combinations in
the sample before accounting for industry eects. However, after taking into
account industry eects it is clear that the sample of cash oers clearly domi-
nates both the stock oer sample (3.14% versus 0.77%) as well as the cash/stock
oer sample (3.14% versus 2.03%). It is interesting to note that performance
improvement lines up in an intuitive manner as Fig. 1 shows: Cash oers
(3.14%), cash/stock oers (2.03%) and stock oers (0.77%). This is what one
10
Our approach closely parallels the approach in Healy et al. (1992). The year of the merger is
excluded from the analysis because operating results for that year will depend upon whether the
purchase or pooling method is used to account for the combination, and thus may not be directly
comparable to the other years examined. Likewise, any transaction costs associated with the merger
will be re¯ected in the merger year's operating results, making comparability with other years
inappropriate.
11
We report the Median Annual Performance for each ®ve-year period. The performance over
the ®ve-year period is calculated for each combination in the sample for each year. The Median
Annual Performance for the ®ve-year period is the median over all years of the performance
measures of all combinations having performance measures during the ®ve-year period.
12
Our approach closely parallels that of Healy et al. (1992). The year of the merger is excluded
from the analysis because operating results for that year will depend upon the method used to
account for the combination, as well as transaction costs associated with the merger.
S.C. Linn, J.A. Switzer / Journal of Banking & Finance 25 (2001) 1113±1138
Table 2
Firm and industry-adjusted median annual operating cash ¯ows for the combinations in the total samplea
Year relative Cash sample n 211 Stock sample n 152 Cash/stock sample n 50 Total sample n 413
to acquisition Firm Industry- Firm Industry- Firm Industry- Firm Industry-
median adjusted median adjusted median adjusted median adjusted
(%) median (%) (%) median (%) (%) median (%) (%) median (%)
(1) (2) (3) (4) (5) (6) (7) (8)
A. Premerger performance
)5 23.91 0.61 16.47 )0.12 21.23 )0.87 20.78 0.04
)4 22.47 0.79 17.21 0.34 23.74 )0.02 21.99 0.54
)3 21.98 1.89 19.56 0.16 24.01 1.76 22.13 1.47
)2 24.01 3.01 19.87 0.57 23.52 1.93 22.58 2.22
)1 23.56 1.28 18.59 0.17 23.79 3.69 22.11 1.39
Median 23.37 1.96 17.89 )0.04 23.21 1.81 21.92 0.66
annual
performance
B. Postmerger performance
1 30.26 3.76 20.75 0.77 30.11 1.41 25.18 2.59
2 25.71 4.91 20.11 )0.78 25.99 1.98 24.01 0.96
3 24.29 6.62 21.76 0.43 24.96 4.12 23.79 3.97
4 24.43 5.51 23.87 3.49 26.84 2.16 24.88 4.98
5 25.36 4.52 22.45 2.72 18.41 4.15 22.85 3.57
1121
1122
Table 2 (Continued)
Year relative Cash sample n 211 Stock sample n 152 Cash/stock sample n 50 Total sample n 413
to acquisition Firm Industry- Firm Industry- Firm Industry- Firm Industry-
(1) (2) (3) (4) (5) (6) (7) (8)
Median 27.32 4.76 22.62 0.12 25.61 2.54 24.16 2.84
annual
performance
C. Dierence between premerger and postmerger performance
Median 3.21 3.14b 5.72 0.77 4.21 2.03 3.87 1.81b
change in
performance
a
Operating cash ¯ow returns are earnings before depreciation, interest expense, taxes, and income on short-term investments de¯ated by the market
value of assets at the beginning of the year. Industry-adjusted values are computed as the dierence between the ®rm value and the median value for
other ®rms in the industry. In the preacquisition period, performance measures for the combined ®rm are weighted averages of the bidder and target
values, where the weights are the relative asset values of the two ®rms. Performance measures for the merged ®rm's industry are weighted averages of
industry medians for the bidder and target, where the weights are the relative asset values of the two sample ®rms. The dierence between the ®ve-year
median postacquisition performance and ®ve-year median preacquisition performance are found for each combination. The numeric values shown in
Panel C are the medians of these dierences. Combinations included in the sample represented in this table must have had at least one common year of
operating performance data available in the COMPUSTAT ®les for both the target and the acquirer during the ®ve years preceding the combination,
and at least one year of operating performance for the merged ®rm during the ®ve years following the combination.
b
Indicates that the median postacquisition industry-adjusted cash ¯ow return is signi®cantly dierent from the median preacquisition industry-adjusted
cash ¯ow return using the Wilcoxon signed-ranks test at the 0.01 level.
Table 3
Firm and industry-adjusted mean annual operating cash ¯ows for the combinations in the total samplea
Year relative to Cash sample n 211 Stock sample n 152 Cash/stock sample n 50 Total sample n 413
acquisition Firm Industry- Firm Industry- Firm Industry- Firm Industry-
mean adjusted mean adjusted mean adjusted mean adjusted
(%) mean (%) (%) mean (%) (%) mean (%) (%) mean (%)
(1) (2) (3) (4) (5) (6) (7) (8)
)5 23.91 0.61 16.01 )0.24 21.69 )0.39 20.73 0.18
)4 23.32 0.66 17.89 )0.01 22.08 )0.83 21.17 0.23
)3 22.76 2.01 19.56 0.16 22.97 1.08 21.61 1.22
)2 24.01 3.01 20.45 0.75 23.43 1.77 22.63 2.03
)1 22.98 1.07 19.21 0.39 23.79 3.69 21.65 1.14
Mean annual 23.40 1.47 21.42 0.21 22.79 1.06 21.57 0.96
performance
1 31.73 3.49 20.75 0.77 29.17 1.26 27.38 2.22
2 26.89 4.07 19.68 )0.51 25.99 1.98 24.13 2.13
3 24.29 6.01 21.03 0.17 24.17 3.69 23.13 3.65
4 24.67 5.35 23.42 3.11 26.41 1.98 24.48 4.14
5 25.42 4.55 22.22 2.36 18.41 4.15 23.20 3.68
1123
1124
Table 3 (Continued)
(1) (2) (3) (4) (5) (6) (7) (8)
Mean annual 26.60 4.69 21.42 1.18 24.83 2.61 24.46 3.16
performance

Mean change in 3.20 3.22b 2.80 0.97 2.04 1.55 2.89 2.20b
performance
a
value of assets at the beginning of the year. Industry-adjusted values are computed as the dierence between the ®rm value and the mean value for other
®rms in the industry. In the preacquisition period, performance measures for the combined ®rm are weighted averages of the bidder and target values,
where the weights are the relative asset values of the two ®rms. Performance measures for the merged ®rm's industry are weighted averages of industry
means for the bidder and target, where the weights are the relative asset values of the two sample ®rms. The dierence between the ®ve-year mean
postacquisition performance and ®ve-year mean preacquisition performance are found for each combination. The numeric values shown in Panel C are
the means of these dierences. Combinations included in the sample represented in this table must have had at least one common year of operating
performance data available in the COMPUSTAT ®les for both the target and the acquirer during the ®ve years preceding the combination, and at least
one year of operating performance for the merged ®rm during the ®ve years following the combination.
b
Indicates that the mean postacquisition industry-adjusted cash ¯ow return is signi®cantly dierent from the mean preacquisition industry-adjusted
cash ¯ow return using the t-test at the 0.01 level.
would expect if cash oers are associated with greater improvement. Panel C
also indicates the that the Wilcoxon signed-ranks test (DeGroot, 1975, Chapter
9) rejects the null hypothesis that the median dierence in industry-adjusted
performance for the cash oers is equal to zero at the 0.01 level. The null
hypothesis is rejected at the 0.10 level for the cash/stock oer sample, but is not
rejected for the stock oer sample at conventional signi®cance levels. Finally,
as documented by Healy et al. (1992), we ®nd that the median dierence for the
total sample is positive and that the null hypothesis that the median equals zero
is rejected at the 0.01 level (1.81%, p < 0.01).
A check for whether the results are sensitive to the use of median values
involved the use of mean values when constructing the cash ¯ow returns,
benchmarks and tests. Table 3 reports these results. Table 3 shows that the
results reported in Table 2 are indeed robust to the use of means versus me-
dians. As panel C of Table 3 shows, the changes in industry-adjusted perfor-
mance measures are similar in magnitude and statistical signi®cance to those
reported in Table 2 (Cash: 3.22%; Cash/stock: 1.55%, Stock: 0.97%). 13 Sta-
tistical tests for equality of means between the premerger and postmerger pe-
riods are based upon the t-test assuming unequal variances. The mean change
is signi®cant at the 0.01 level for the cash oers, is signi®cant at the 0.10 level
for the cash/stock oers, and is not signi®cantly dierent from zero for the
stock oers.
We checked the robustness of the results presented in Tables 2 and 3 in
several additional ways. The ®rst check was for whether the inclusion of tender
oers (that led to mergers) along with negotiated mergers biased the results in
any way. Table 4 reports the raw and industry-adjusted results (based upon
medians) for only the negotiated mergers in the full sample, and Table 5 re-
ports similar results based upon means. The maximum number of negotiated
mergers represented in any year was 244 and of these 66 involved cash oers,
149 involved stock oers and 29 involved cash/stock oers. The conclusions
reached after inspecting Tables 4 and 5 are the same as those reached for the
total sample. The change in industry adjusted performance for the cash sample
is positive and signi®cant, this is followed by a smaller but yet positive and
signi®cant result for the cash/stock sample, while the results for the stock
sample are smaller and never signi®cantly dierent from zero. The results, as
13
While panel C of Table 2 reports the median of the dierences in median performance across
cases, panel C of Table 3 reports the mean of the dierences in the means. The dierences de®ned
earlier as Di equal the mean postacquisition annual performance for combination i, for years in
which data were available, minus the mean annual preacquisition performance for i, for years in
which data were available.
1126
Table 4
Firm and industry-adjusted median annual operating cash ¯ows for the combinations in the negotiated merger samplea
(1) (2) (3) (4) (5) (6) (7) (8)
)5 21.26 0.47 16.21 0.05 20.07 )1.58 19.61 )0.04
)4 21.79 0.56 17.43 0.17 23.17 )0.66 20.86 0.32
)3 22.67 2.36 19.68 0.24 25.04 2.76 22.33 0.57
)2 24.72 3.15 19.50 0.43 24.76 3.69 21.99 2.39
)1 23.65 2.15 18.32 0.18 24.60 3.93 20.86 1.28
Median annual 23.85 1.88 18.01 0.01 21.80 2.72 20.60 1.43
performance
1 27.13 4.21 20.39 1.01 28.76 2.91 24.66 2.61
2 24.96 5.48 19.70 )0.62 23.40 1.74 23.19 0.42
3 23.89 5.21 21.93 1.49 27.08 3.62 23.36 2.58
4 23.43 4.10 23.79 2.72 29.83 3.18 24.98 4.55
5 23.41 5.86 22.63 2.44 18.36 5.80 22.45 3.75
Median annual 26.17 4.53 22.37 0.98 25.77 4.26 23.87 2.41
performance
Median change 3.87 3.66b 6.01 0.56 4.79 2.45b 3.96 1.90b
in performance
a
value of assets at the beginning of the year. Industry-adjusted values are computed as the dierence between the ®rm value and the median value for
other ®rms in the industry. In the preacquisition period, performance measures for the combined ®rm are weighted averages of the bidder and target
values, where the weights are the relative asset values of the two ®rms. Performance measures for the merged ®rm's industry are weighted averages of
industry medians for the bidder and target, where the weights are the relative asset values of the two sample ®rms. The dierence between the ®ve-year
median postacquisition performance and ®ve-year median preacquisition performance are found for each combination. The numeric values shown in
Panel C are the medians of these dierences. Combinations included in the sample represented in this table must have had at least one common year of
operating performance data available in the COMPUSTAT ®les for both the target and the acquirer during the ®ve years preceding the combination,
and at least one year of operating performance for the merged ®rm during the ®ve years following the combination.
b
Indicates that the median postacquisition industry-adjusted cash ¯ow return is signi®cantly dierent from the median preacquisition industry-adjusted
cash ¯ow return using the Wilcoxon signed-ranks test at the 0.01 level.
1127
1128
Table 5
Firm and industry-adjusted mean annual operating cash ¯ows for the combinations in the negotiated merger samplea
(1) (2) (3) (4) (5) (6) (7) (8)
)5 20.89 0.43 16.01 0.19 18.32 )1.66 17.60 0.04
)4 21.56 0.50 18.01 0.21 22.89 )0.71 19.55 0.18
)3 23.10 2.78 19.26 0.38 25.05 2.76 20.99 1.31
)2 24.01 3.01 19.72 0.75 23.68 3.45 21.35 1.68
)1 23.54 1.57 18.71 0.39 23.11 2.67 20.54 0.98
Mean annual 22.62 1.66 18.34 0.38 22.61 1.30 20.00 0.84
performance
1 28.73 4.36 20.65 0.47 28.31 2.45 23.75 1.76
2 25.03 5.61 20.09 )0.67 24.03 1.69 21.99 1.41
3 23.98 5.23 21.44 1.32 27.67 3.21 22.98 2.68
4 22.03 3.20 24.81 2.69 30.17 3.35 24.74 2.93
5 22.89 5.32 24.31 2.62 17.61 4.95 22.95 3.74
Mean annual 24.53 4.74 22.26 1.29 25.56 3.13 23.28 2.50
performance

Mean change in 1.91 3.08 3.92 0.91 2.95 1.83 3.28 1.66
performance
a
value of assets at the beginning of the year. Industry-adjusted values are computed as the dierence between the ®rm value and the mean value for other
®rms in the industry. In the preacquisition period, performance measures for the combined ®rm are weighted averages of the bidder and target values,
where the weights are the relative asset values of the two ®rms. Performance measures for the merged ®rm's industry are weighted averages of industry
means for the bidder and target, where the weights are the relative asset values of the two sample ®rms. The dierence between the ®ve-year mean
postacquisition performance and ®ve-year mean preacquisition performance are found for each combination. The numeric values shown in Panel C are
the means of these dierences. Combinations included in the sample represented in this table must have had at least one common year of operating
performance data available in the COMPUSTAT ®les for both the target and the acquirer during the ®ve years preceding the combination, and at least
one year of operating performance for the merged ®rm during the ®ve years following the combination.

and indicate that the mean postacquisition industry-adjusted cash ¯ow return is signi®cantly dierent from the mean preacquisition industry-
adjusted cash ¯ow return using the t-test at the 0.05(0.01) level.
1129
Tables 4 and 5 con®rm, are again insensitive to the use of means versus me-
dians. 14 We now turn to an examination of whether the stock versus cash oer
eect is in¯uenced by cross-sectional factors associated with the companies
involved and the deal itself.
3.3. Cross-sectional models of the change in operating performance
Columns 1±2 in Table 6 report results for the total sample estimated under
the assumption that the median industry-adjusted cash ¯ow return of the
bidder/target portfolio for the ®ve-year period preceding a combination serves
as a forecast of how the bidder and target together would have performed had
they not combined. Results based upon means were qualitatively the same and
so are not reported. 15 Columns 3 and 4 of the table report corresponding
results for the sample of negotiated mergers alone. We label the quantity
MIACFpre;i as the forecast, where i represents the combination. The corre-
sponding median for the ®ve years following the combination is labeled MI-
ACFpost;i .
3.4. Dierences in operating performance changes between cash and stock oers
We de®ne a method-of-payment dummy variable STOCK. The latter is

intended to capture any dierential performance changes between cash and
stock oers. The variable STOCK takes the value 1 for stock oers, and the
value 0 otherwise. In addition, to account for any correlation between pre-
combination and postcombination performance, we designate postcombina-
tion industry-adjusted performance as the dependent variable and include
precombination industry-adjusted performance as a regressor. The estimated
model is
MIACFpost;i b0 b1 MIACFpre;i b2 STOCKi ei : 1
14
Finally, as pointed out earlier, all results were recomputed for the subsample in which data for
the ®ve years before the combination and for the ®ve years following were available. The
conclusions drawn from this more restricted sample are qualitatively the same as those drawn
above. These results indicate that the results are not contaminated by such a look-ahead bias. We
subjected this sample to the same tests for robustness as had been done for the larger sample of 413
cases by recomputing the results: (a) utilizing only negotiated mergers, (b) using median values, (c)
using mean values. Again, the results were not qualitatively dierent from those already presented.
These results are available from the authors upon request.
15
The results based upon means are available from the authors upon request.
Table 6
Tests of the sensitivity of the method-of-payment factor in the explanation of the behavior of in-
dustry-adjusted median annual operating cash ¯ows for combinations in the total sample and in the
negotiated merger sample (p-values for two-tailed tests of the null hypotheses that the estimated
coecients equal zero are reported in parentheses)a
Independent Total sample n 413 Negotiated mergers only
variables n 244
(1) (2) (3) (4)
Intercept 0.061 0.191 0.077 0.012
MIACFpre 0.812 (0.033) 0.892 (0.012) 0.671 (0.012) 0.616 (0.038)
STOCK )0.032 (0.009) )0.029 (0.029) )0.041 (0.016) )0.039 (0.057)
TENDER )0.316 (0.308) ) )
LEV 0.051 (0.412) 0.040 (0.299)
RELSIZE 0.012 (0.000) 0.052 (0.000)
FOCUS )0.080 (0.624) 0.043 (0.478)
F)statistic (p-value) 6.95 (0.001) 3.49 (0.002) 4.24 (0.016) 3.98 (0.002)
Adj-R2 0.062 0.109 0.061 0.082
a
Operating cash ¯ow returns are earnings before depreciation, interest expense, taxes, and income
on short-term investments de¯ated by the market value of assets at the beginning of the year.
Industry-adjusted values are computed as the dierence between the ®rm value and the median
value for other ®rms in the industry. In the preacquisition period, performance measures for the
combined ®rm are weighted averages of the bidder and target values, where the weights are the
relative asset values of the two ®rms. Performance measures for the merged ®rm's industry are
weighted averages of industry medians for the bidder and target, where the weights are the relative
asset values of the two sample ®rms. Combinations included in the sample represented in this table
must have had at least one common year of operating performance data available in the COM-
PUSTAT ®les for both the target and the acquirer during the ®ve years preceding the combination,
and at least one year of operating performance for the merged ®rm during the ®ve years following
the combination. MIACF represents the median ®ve-year annual industry-adjusted operating cash
¯ow for the combination (pre: prior to the combination; post: following the combination); STOCK
takes the value 1 when the medium of payment was stock and 0 otherwise; TENDER takes the
value 1 when the combination involved a tender oer and 0 otherwise; LEV takes the value 1 if
the leverage of the bidder was greater than the median leverage for ®rms in the sample (measured at
the ®scal year end prior to the bid), where leverage is measured as the ratio of the companyÕs book
value of short-plus long-term debt to its pseudo-asset value where the latter is measured as the book
value of short-plus long-term debt, plus the book value of preferred stock, plus the market value of
equity; RELSIZE equals the total dollar value oered for the targetÕs shares divided by the total
dollar value of the bidderÕs shares; FOCUS takes the value 1 if the 4-digit main SIC codes of the
bidder and target match.
Complete Model : MIACFpost;j b0 b1 MIACFpre;j b2 STOCKj b3 TENDERj
b4 LEVj b5 RELSIZEj b6 FOCUSj ej :
The results of estimating this model are reported in columns 1 and 3 of Table 6.
The coecient estimate for the variable STOCK is negative and signi®cant
irrespective of the sample examined (column 1, row 3: )0.032, t )2.61,
p-value 0.009; column 3 row 3: )0.041, t )2.41, p-value 0.016). This
result indicates that stock oers are associated with signi®cantly lower indus-
try-adjusted operating performance than are cash oers, con®rming our earlier
conclusions. We conclude from these results that the change in performance for
stock oers is signi®cantly less than for cash oers. 16
3.5. Sensitivity of the cash versus stock oer results to additional controls
The relation between the use of cash versus stock as the method-of-pay-
ment and changes in industry-adjusted operating performance documented in
the prior section could be in¯uenced by company and oer speci®c charac-
teristics. We examine the robustness of the prior result by repeating the re-
gression including several control variables in addition to the dummy variable
STOCK. The additional control variables are: (a) the dummy variable
TENDER which takes the value 1 if the combination involved a tender oer
and 0 if it resulted from a negotiated merger, (b) the dummy variable LEV
which takes the value 1 if the leverage of the bidder was greater than the
median leverage for ®rms in the sample (measured at the ®scal year end prior
to the bid), (c) the continuous variable RELSIZE which equals the total
dollar value oered for the targetÕs shares divided by the total (prean-
nouncement) dollar value of the bidderÕs shares, and (d) the dummy variable
FOCUS which takes the value 1 if the 4-digit main SIC codes of the bidder
and target match. The SIC codes for the ®rms represented in the sample
were, as previously stated, obtained from the COMPUSTAT ®les with in-
dependent checks in MoodyÕs Manuals.
A bidder's leverage is measured as the ratio of the companyÕs book value of
short- plus long-term debt to its pseudo-asset value. The latter is measured as
the book value of short- plus long-term debt, plus the book value of preferred
stock, plus the market value of equity. The data used to compute bidder le-
verage are taken from the COMPUSTAT ®les and are measured at the ®scal
year-end prior to the announcement of a tender oer or the earliest of any news
reports about merger negotiations between the parties. The motivation for
introducing bidder leverage comes from the results reported in Maloney et al.
(1993) and others, who have shown that bidder abnormal returns are positively
related to preannouncement bidder leverage. In contrast, however, Loughran
and Vijh (1997) ®nd no relation between acquirer leverage and postacquisition
excess stock returns.
The ability to detect performance changes may be related to the size of the
target relative to the size of the bidder. A natural conjecture is that a small
target might be expected to contribute only a small amount to the overall
performance of the combined entity and hence any overall performance
change might be related to the size of the target as compared with the size of
16
Tests for homoskedasticity due to White (1980) were conducted for each regression. The null
of homoskedasticity could not be rejected at the 0.05 level for either of the regressions.
the bidder. Asquith et al. (1983), Travlos (1987), Jarrell and Poulsen (1989),
Eckbo et al. (1990) and Peterson and Peterson (1991), amongst others, have
shown that a positive relation exists between announcement period bidder
returns and a measure of the relative size of the target to the size of the
bidder. The size of the oer may also be an indicator of economies of scale.
The variable RELSIZE is equal to the total dollar value oered for the
targetÕs shares divided by the total dollar value of the bidderÕs shares 60 days
prior to the ®rst news of a tender oer or of merger negotiations between the
parties. The mean and standard deviation of RELSIZE equal 0.34 and 0.639,
respectively.
Industry relatedness has frequently been oered as a partial explanation
for the abnormal gains in mergers (Healy et al., 1992). The rationale is that
industry relatedness may capture the extent to which economies of pro-
duction are possible, or that market power is enhanced. Recent evidence on
the bene®ts of refocusing (Comment and Jarrell, 1995) and the value re-
ducing eects of combining unrelated lines of business (Berger and Ofek,
1995) lend further motivation to the necessity of controlling for industry
relatedness.
The regression results for the models that include the additional control
variables are reported in columns 2 and 4 of Table 6. The estimated coecient
on the dummy variable STOCK is always negative. 17 Further, the magnitudes
of the coecient estimates for STOCK are relatively stable across all of the
regressions and exhibit small p-values for tests of the hypothesis that the co-
ecient equals zero, suggesting that neither multicollinearity nor equation
misspeci®cation are confounding problems. The coecient of the control
variable RELSIZE is also statistically signi®cant in both of the regressions, but
its inclusion does not materially in¯uence the result for the method-of-payment
variable STOCK. None of the remaining control variables have statistically
signi®cant coecients in any regression.
Overall, the results presented in Table 6 indicate that the conclusions drawn
in the prior section are not sensitive to controls for other potentially in¯uential
factors or to any correlation between precombination and postcombination
performance. That is, the change in excess operating performance is signi®-
cantly smaller for stock oers than it is for cash oers. 18
17
Again, tests for homoskedasticity due to White (1980) were conducted for each regression. The
null of homoskedasticity could not be rejected at the 0.05 level for any of the regressions.
18
We also analyzed regression models for the smaller sample of combinations identi®ed as ®rms
having ®ve years of continuous data on either side of the combination's completion date, as well as
the subset of this more restricted sample composed of only negotiated mergers. The results are
qualitatively the same as those already presented.
4. Conclusions
This study examines the relation between the change in operating per-
formance of ®rms that merge and whether the acquiring ®rm oered cash or
stock as the method-of-payment. The results for a sample of 413 combina-
tions indicate that the change in performance of the merged ®rms is signi®-
cantly smaller for cases in which the acquiring company oered stock as
compared to cash oers. The results are not sensitive to whether the com-
bination involved a tender oer or a negotiated merger, nor to oer size,
industry relatedness between the bidder's and the target's businesses or bidder
leverage. We examine two overlapping samples. The ®rst sample is de®ned by
a weak restriction on the number of years of operating data available for the
®rms involved before and after the combination. The second sample is re-
stricted to only those cases in which ®ve years of operating data before the
merger and ®ve years of data following the merger are available. We ®nd that
the results are essentially the same for both samples. In summary, the results
presented in this study are consistent with and provide a partial explanation
for recent evidence indicating that the postacquisition stock return perfor-
mance of merged ®rms is signi®cantly larger for cash oers as compared to
stock oers.
While the focus of the paper is not on a direct test of why cash oers out-
perform stock oers, our results are consistent with the explanations oered by
Fishman (1989) and Berkovitch and Narayanan (1990) for why cash oers are
sometimes selected over stock oers. Essentially, if bidders use cash to deter
competing bids when they have favorable private information about potential
synergies, the larger are those synergies, the greater is the likelihood that a cash
oer will be used. The positive improvements in industry-adjusted operating
performance associated with cash oers, while observing no improvements for
stock oers, is consistent with this view.
Acknowledgements
We are grateful to two anonymous reviewers and to our colleagues at the

University of Oklahoma, Concordia University, and Dalhousie University, and
especially to G. Emery and N. Nayar for their comments on earlier versions of
this work. This work is an extension of SwitzerÕs dissertation at the University
of Oklahoma, which G. Emery chaired. Linn gratefully acknowledges support
from the Harold S. Cooksey Estate, and Switzer from the Richard D. Irwin
Foundation's Doctoral Dissertation Fellowship program. Support from the
Center for Financial Studies at the University of Oklahoma is also gratefully
acknowledged.
Appendix A. Operating performance measurement
Changes in operating performance resulting from an acquisition are evalu-

ated by comparing the preacquisition industry-adjusted performance of a
portfolio, consisting of the bidding and target ®rms, to the actual postacqui-
sition industry-adjusted performance of the combined entity. The preacquisi-
tion performance of the portfolio is conceptually an indicator of how the two
separate ®rms would have performed if they had remained independent.
The preacquisition cash ¯ow return for year t is the sum of the cash ¯ows of
the bidder and target ®rms for combination i de¯ated by the sum of their asset
values:
CFB;i CFT;i
CFi ; A:1
ASSETB;i ASSETT;i
where cash ¯ows for the individual ®rms (CFB;i and CFT;i ) are measured as
pretax earnings before extraordinary items, depreciation, goodwill, interest
expense, and interest income, and B and T denote `bidder' and `target', re-
spectively. 19 These data are obtained from the Annual Industrial COMPU-
STAT and Research Tapes. The variable ASSET is computed as of the
beginning of each sample year, during the preacquisition period, and is equal to
the market value of equity calculated using data from the CRSP Master File,
plus the book values of interest bearing or zero coupon debt and preferred
stock which are obtained from COMPUSTAT.
A separate industry portfolio is constructed for each bidder and each target.
For instance, an industry portfolio for a particular bidder consists of those
®rms from the COMPUSTAT database with the same 4-digit SIC code as the
bidder. The industry portfolios are denoted with the subscripts B±I and T±I for
the bidder and target industries, respectively. The bidder and the target are
excluded from these industry portfolios. The cash ¯ow performance of these
portfolios is used to control for industry-speci®c eects. Because the number of
comparable ®rms for an industry varies across the sample cases, and to avoid
the in¯uence of outliers, median values are used initially, but we also computed
the results using means and found no qualitative dierence.
The industry cash ¯ow return for combination i in year t is computed as a
weighted-average of the cash ¯ow returns for the bidder and target industry
portfolios, where the weights are the relative asset sizes of the bidder (AS-
SETB;i ) and the target (ASSETT;i ):
19
In order to keep the notation manageable we suppress the time subscript here and in
subsequent expressions.

ASSETB;i CFB±I;i
CFI;i
ASSETB;i ASSETT;i ASSETB±I;i

ASSETT;i CFT±I;i
: A:2
ASSETB;i ASSETT;i ASSETT±I;i
The cash ¯ow return for the bidder's (or target's) industry is the median op-
erating cash ¯ow for the respective portfolio de¯ated by the median asset value.
The ASSET weights adjust for the relative contributions (in terms of size) of
the bidder and target ®rms to the combined entity. We recomputed the results
using the median of the ratio of CF/ASSET in place of the median value of CF
divided by the median value of ASSET and found that the new results were
qualitatively the same as those presented in the tables included herein.
The preacquisition performance in any year t is the industry-adjusted per-
formance of the bidder±target portfolio for combination i and is the dierence
between CFi (Eq. (A.1)) and CFI;i (Eq. (A.2)):
IACFpre;i CFi CFI;i : A:3
The variable IACFpre;i is computed for each sample year prior to the combi-
nation.
Postacquisition performance in a given year is measured as the actual cash
¯ow return for the combined ®rm in that year, adjusted for industry perfor-
mance during the same period. Industry performance is computed as in
Eq. (A.2) using data from the postcombination period except that the ASSET
weights are the relative asset sizes of the bidder and target ®rms one year prior
to the acquisition. Postacquisition industry-adjusted cash ¯ow performance is
labeled IACFpost;i , again suppressing the time subscript.
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Journal of Banking & Finance 25 (2001) 1113±1138