This study investigates the effect of merger bids on stock returns

1. Intro

Previous studies examined the period before the merger date but their methodology uses the merger
date as the event date and doesn’t show the stock market’s response before the merger bid begins.
There was no clarity that stock prices have a negative reaction in the period after the merger bid or not.
Also, the question of whether the acquiring firm’s stockholders gain on average from a merger bid is
unresolved. TO investigate these issues, this paper examines the entire merger process from 480 trading
days before a merger bid until 240 trading days after a merger bid. Two merger events are used, the
announcement date and the outcome date. Also, both unsuccessful and successful merger bids are
studied. In addition, the database contains some firms whose trading was halted by the NYSE when it
was announced they were being acquired.

2. Data

The data is a sample of successful and unsuccessful merger bids where the target firms are listed on the
New York Stock Exchange.

Two event dates are collected for this sample; the ‘press date’ and the ‘outcome date’. The press date is
the date when the financial press first reports a merger bid, and it estimates a date on which
information about the merger bid becomes public. The outcome date is the date the financial press
reports the conclusion of a merger bid. For successful merger attempts, the outcome date is the day the
firms actually merged. For unsuccessful merger attempts, the outcome date is the day the merger bid is
reported abandoned.

Many bidding firms may compete for the same target firm, The withdrawal of one bidding firm does not
necessarily mark the end of the bidding process. There may be another firm simultaneously bidding for
the same target firm or about to enter the bidding process.

the sample of successful mergers in this study consists of 211 target firms and 196 bidding firms. The

sample of unsuccessful merger bids contains 91 target firms and 89 bidding firms. The difference
between the target firm and the bidding firm totals is due to some NYSE firms being acquired by non-
NYSE firms.

3. Methodology

Daily excess returns are calculated using a technique developed by Myron Scholes.

The daily excess return for an asset is calculated as subtracting the expected return for an asset from the
realized return of an asset on a given day t.

Average excess returns for each relative day t are calculated by

where N is the number of securities with excess returns during day t.

Daily average cumulative excess returns, CER’s, are sums of the average excess

returns over event time,

where the CER is for the period from t = K until t = L.

4. Results

4.1. Overview

To evaluate the stock market’s total response to a merger bid, excess returns during several event time
periods are investigated: (1) the period before knowledge of the merger bid, (2) at the announcement of
the merger bid, (3) during the merger bid (after the announcement but before the outcome), (4) at the
outcome of the merger bid, and (5) during the post outcome period.

4.2. Pre-press date period

This section covers the pre-press date period, defined as the period from t = -480 days until t = -20 days
before the press date. Table shows that the target firm’s returns decline on average prior to the merger
bid while the bidding firm’s returns increase on average. This is true for both successful and unsuccessful
merger bids.

4.2.1. Target firms

Although all target firms realize negative average excess returns in the period prior to the press date,
the CER’s for successful target firms are more negative than the CER’s for unsuccessful target firms.

4.2.2. Bidding firms

The average daily cumulative excess returns displayed in table are positive throughout the pre-press
period for all bidding firms. However, the returns for successful bidding firms is larger than that for
unsuccessful bidding firms.

4.3. Press date

The press date is the day that information about a merger bid first appears in the financial press. Table
gives the average daily excess returns for target and bidding firms during the thirty days surrounding the
press date.
4.3.1. Target firms

The excess returns for the target firms are large and impressive. The announcement of a merger bid
generates large positive excess returns for the target firms which are both widespread and statistically
significant. Finally, there is no evidence that the market distinguishes between a merger bid’s potential
success or failure at the press date since all target firms display large excess returns which are of similar
size and significance.

4.3.2. Bidding firms

The market shows little or no reaction on the press day to a merger bid for both successful and
unsuccessful bidding firms.

4.4. Period between the press date and the outcome date

Stock price changes in the period between the press date and the outcome date demonstrate how the
stock market responds to a merger bid in progress. If the outcome of a merger bid is known at the time
of announcement, then in an efficient capital market stock prices gets affected due to this information.
If, the outcome is uncertain, the stock price is not affected much.

4.4.1. Target firms

For target firms in successful mergers, the average CER during the period from the press date to
outcome date is positive and significant. Target firms in unsuccessful merger bids display opposite
results.

4.4.2. Bidding firms

For successful acquiring firms, the lack of abnormal returns continues after the merger bid. The average
CER for the interim period is -0.46 percent. The market’s response to new information for unsuccessful
acquiring firms is surprising. The average CER is strongly negative.

4.5. Outcome date

The outcome date marks the end of a merger bid. For successful mergers, this is the merger
consummation date. For unsuccessful mergers, the outcome date is defined as the day when the
termination of the last merger bid is announced. There are no other ongoing merger bids on the
outcome day and no further merger bids for one year after the outcome day.

4.5.1. Target firms

For target firms in successful mergers, the average two-day excess return on the merger date were
significantly high. These’ positive excess returns at the outcome date signify that there is new
information. For target firms in unsuccessful mergers, the abnormal price change is dramatic. The two-
day excess return at the outcome day are negative
4.5.2. Bidding firms

There is virtually no stock price change for successful and unsuccessful bidding firms on the merger date.
There is little market re-evaluation at the outcome date.

4.6. Post-outcome period

This section examines the post-outcome period, defined as the period from the day following the
outcome date until 240 days after it. The target firms in successful mergers no longer exist and the
successful bidding firms are now transformed into merged firms

4.6.1. Merged firms

After the merger the merged firm has negative excess returns, which is delayed by sixty days or more.
One potential explanation for this pattern of results is that the merging of two independent firms with
different betas may cause a problem with the calculation of excess returns.

4.6.2. Unsuccessful target firms

The CER’s for unsuccessful target firms display a pattern which looks remarkably similar to the CER’s for
merged firms in the post-outcome period. The decline is small and statistically insignificant for the first
80 days following the outcome date but then decreases swiftly over the next 160 days. This may be due
to reduced probability of merger.

4.6.3. Unsuccessful bidding firms

The ‘CER’s for unsuccessful bidding firms are consistently negative for the whole period from the
outcome day until t = +240 days. These negative excess returns for unsuccessful bidding firms may
represent a continuation of the negative stock price reaction first seen during the interim period.

4.7. Firms for which trading was halted

The NYSE occasionally halts trading in the stocks of individual firms. This occurs if there is evidence of
fraud in the trading of a firm’s securities, or if his buy and sell orders are widely out of his capacity to
handle them. Halting trading is an unusual occurrence by the Exchange and usually lasts for only a few
hours

5. Implications and conclusions

The sample of firms is divided into four subsets by determining whether the bid is successful or not and
whether the firm is a target or a bidding firm. Abnormal returns for two events, the merger proposal and
the merger outcome, are estimated. The periods before, between and after the two events are also
examined. In addition, excess returns are calculated for the two events and the entire bid period. Finally,
stocks whose trading was halted on the press date are examined and found to exhibit much larger
excess returns than other successful target firms.

5.1. Market efficiency and uncertainty

Excess returns occur throughout the period from the press date to the outcome date as new
information is released. Furthermore, in unsuccessful merger bids, the market reverses the initial
positive excess returns for both target and bidding firms.
In an efficient capital market, increases in the probability of merger cause prices of target firms to
increase and decreases in the probability of merger cause prices of target firms to decrease.

For successful target firms, there are significantly positive excess returns, and for unsuccessful target
firms, there are significantly negative excess returns.