NEW EVIDENCE & PERSPECTIVES ON

MERGERS

PROJECT BY

ABHISHEK SAHU

CHITRAK KUMAR

ISHAN GARG

HIMANSHU GUPTA
 INTRODUCTION

• BASIC FEATURES OF MERGERS DURING 1990S WERE

A) MERGERS OCCURRED IN WAVES
B) WITHIN A WAVE, MERGERS STRONGLY CLUSTER BY INDUSTRY.
• THESE FEATURES TELLS US THAT MERGERS MIGHT OCCUR AS A REACTION OF
UNEXPECTED SHOCK TO INDUSTRY STRUCTURE.
• MAJOR OBJECTIVE IS TO DISCUSS ABOUT THESE SHOCKS AND THEIR RESULTANT
MERGERS THAT TOOK PLACE DURING 1990S.
• WE ALSO CAME TO KNOW THAT INDUSTRY SHOCK & DEREGULATION BECAME A
DOMINANT FACTOR IN MERGERS & ACQUISITION ACTIVITY WHICH ACCOUNTED
FOR NEARLY HALF OF MERGERS ACTIVITY AFTER LATE 1980S.
 REASONS FOR MERGERS

• EFFICIENCY RELATED REASONS THAT INVOLVES ECONOMICS OF SCALE.

• ATTEMPTS TO CREATE MARKET POWER BY FORMING MONOPOLIES OR
OLIGOPOLY.
• FOR MARKET DISCIPLINE, SUCH AS REMOVAL OF INCOMPETENT TARGET
MANAGEMENT.
• SELF SERVING ATTEMPTS BY ACQUIRER MANAGEMENT TO “OVER-EXPAND” &
OTHER AGENCY COST.
• TO TAKE ADVANTAGE OF OPPORTUNITIES FOR DIVERSIFICATION BY EXPLOITING
INTERNAL CAPITAL MARKETS AND MANAGING RISK FOR UNDIVERSIFIED
MANAGERS.
 WHAT’S NEW IN 1990S MERGERS
• THERE WAS MAJORLY 3 WAVES OF TAKEOVERS SINCE EARLY 1960S, BUT THESE WERE SMALL IN
VALUE AS COMPARED TO 1980S AND 1990S MERGERS.
• MERGERS IN 1990S USED OVERWHELMING USE OF STOCKS AS A METHOD OF PAYMENT DURING THE
LATTER DECADE.
• AROUND 70% MERGERS INVOLVED STOCK COMPARISON WHICH WAS 50% MORE COMPARED TO
1980S.
• BID HOSTILITY ALSO DISAPPEARED IN 1990S MERGERS AND REDUCED TO 4% AS COMPARED TO 14%
IN 1980S & HOSTILE BIDDERS ACQUIRED LESS THAN 3% OF TARGETS.
• ALSO, IF AN INDUSTRY SHOWED HIGH AMOUNT OF WAVES OF MERGERS IN THE PREVIOUS DECADE
THEN IT IS MORE LIKELY TO SHOW LESS MERGERS IN UPCOMING DECADES.
 WHAT’S NEW IN 1990S MERGERS
• IN 1990S MERGERS RESEARCHERS FOUND THAT A SIGNIFICANT PORTION OF
MERGER ACTIVITY MIGHT BE DUE TO INDUSTRY LEVEL SHOCKS. EG.
TECHNOLOGICAL INNOVATION, SUPPLY SHOCKS SUCH AS OIL PRICES &
DEREGULATION.
• MAJOR INDUSTRIES THAT WENT FOR MERGERS DUING 1970S TO 1990S WERE:
AIRLINES (1978), BROADCASTING ( 1984), BANKS (1994), NATURAL GAS
(1974), TRUCKING (1980), TELECOM (1996).
• SO, OF ALL THESE INDUSTRIES NEARLY 50% WERE DEREGULATED AND HENCE WE
CAN SAY THAT KEY DRIVER FOR MERGERS IN 1980S ERA WAS DEREGULATION.
WINNERS AND LOSERS IN MERGER GAME
INTRODUCTION

• MERGER REPRESENT MASSIVE REALLOCATIONS OF RESOURCES WITHIN THE

ECONOMY, BOTH WITHIN AND ACROSS INDUSTRIES.

• IN 1995, THE VALUE OF THE M&A EQUALLED 5% OF GDP AND WAS

EQUIVALENT TO 48% OF NON-RESIDENTIAL GROSS INVESTMENT.

• MERGER OFTEN ENABLES FIRM TO DOUBLE ITS SIZE IN A MATTER OF MONTHS.

STOCK MARKET REACTION TO MERGER ANNOUNCEMENTS

• STOCK PRICES ADJUST QUICKLY FOLLOWING A MERGER ANNOUNCEMENT, INCORPORATING ANY EXPECTED
VALUE CHANGES IN AN EFFICIENT CAPITAL MARKET.
• WE CAN MEASURE, WHETHER MERGERS CREATE OR DESTRUCT VALUE BY TRADITIONAL EVENT STUDY
APPROACH FOR A SHORTER WINDOW.
• THE COMBINED AVERAGE ABNORMAL RETURN IS RELIABLY POSITIVE, SUGGESTING THAT MERGER DO CREATE
VALUE, BUT THE STATISTICAL PRECISION IS CONSIDERABLY REDUCED AS WE LENGTHENED THE EVENT WINDOW
• MERGERS CAN BE FINANCED BY EITHER DEBT OR EQUITY, IN BOTH THE CASES I.E., TARGET OR ACQUIRER FIRM’S
SHAREHOLDER THE MERGER FINANCED BY DEBT CREATES MORE VALUE THEN EQUITY, MANAGERS GO FOR
EQUITY FINANCED ONLY WHEN STOCK MARKET PERCEIVED THAT THE FIRM IS OVERVALUED.
• TARGET FIRM SHAREHOLDER ARE CLEARLY WINNERS IN MERGER TRANSACTION AS THEIR STOCK PRICES
INCREASES, ON THE CONTRARY THE ACQUIRER FIRM SHAREHOLDER ARE LOSERS
• BASED ON THE ANNOUNCEMENT PERIOD STOCK MARKET RESPONSE, WE CONCLUDE THAT MERGER CREATE
VALUE ON BEHALF OF THE SHAREHOLDERS OF THE COMBINED FIRMS.
 LONG-TERM ABNORMAL RETURNS

• TRADITIONAL WISDOM – ANNOUNCEMENT PERIOD STOCK PRICE REACTION IMPOUNDS THE

INFORMATION EFFECTS OF MERGERS
• RECENT STUDIES – INVESTORS FAIL TO ACCESS THE FULL IMPACT OF CORPORATE ANNOUNCEMENTS
AND INFERENCES BASED ON ANNOUNCEMENT PERIOD EVENT WINDOWS ARE FLAWED
• LOUGHRAN AND VIJH – ACQUIRING FIRMS USING STOCK FINANCING HAVE ABNORMAL RETURNS
OF -24.2% WHEREAS IT IS 18.5% FOR CASH MERGERS OVER THE 5 YEAR PERIOD AFTER THE
MERGER
• VALUE FIRMS – HIGH BOOK-TO-MARKET RATIO AND HAVE HIGHER RETURNS
• GROWTH FIRMS – LOW BOOK-TO-MARKET RATIO AND HAVE RELATIVELY LOW RETURNS
• FAMA AND FRENCH – HIGH RETURNS OF VALUE FIRMS IS DUE TO INCREASED RISK
• SHLEIFER AND VISHNY – INVESTORS MISTAKENLY ESTIMATE FUTURE PERFORMANCE BY
EXTRAPOLATING FROM PAST PERFORMANCE
 LONG TERM ABNORMAL RETURNS
(CONT.)
• RECENT STUDIES – EXPECTED RETURNS FOR SHORT TERM EVENT ARE VIRTUALLY ZERO
WHEREAS IN LONG-TERM EVENT THE MODEL USED TO CALCULATE EXPECTED RETURNS
BECOMES INCREASINGLY IMPORTANT

• AS THE LONG TERM EXPECTED RETURNS CAN ONLY BE ROUGHLY ESTIMATED, THE ESTIMATES
OF LONG TERM ABNORMAL RETURNS ARE NECESSARILY IMPRECISE

• STATISTICAL CONCERN – ABNORMAL RETURNS ARE INDEPENDENT ACROSS FIRMS. HOWEVER,

MERGERS ARE NOT RANDOM EVENTS AND THUS EVENT SAMPLES ARE UNLIKELY TO CONSIST
OF INDEPENDENT OBSERVATIONS
• Abnormal returns are closer to zero than that who use samples covering
shorter time periods
• Significant abnormal returns are only found for the equal-weighted
portfolio
• Long-run abnormal performance results do not change the priors that
mergers create value for the stockholders of the combined firms
 PRE AND POST MERGER PROFITABILITY

• OPERATING PERFORMANCES ANALYSIS ARE DONE TO CHECK

WHETHER THE EXPECTED GAIN FROM THE MERGER IS AS EXPECTED AS
WAS SHOWN AT THE TIME OF ANNOUNCEMENT.

• THERE WERE TWO MAJOR STUDIES WHICH HAVE BEEN DONE FOR THE
SAME
• RAVENSCRAFT AND SCHERER (1989)
• HEALY, PALEPU AND RUBACK (1992)
 Ravenscraft and Scherer (1989)
• THE FIRST REPORT EXAMINE TARGET FIRM PROFITABILITY OVER
THE PERIOD 1975 TO 1977 USING THE LINE OF BUSINESS DATA
COLLECTED FROM FEDERAL TRADE COMMISSION.
• WHERE THEY COLLECTED DATA FROM 471 FIRMS FROM 1950 TO
1976 BY THE BUSINESS SEGMENT WHERE THEY OPERATE.
• THEY FOUND OUT THAT THE FIRM SUFFERED A LOSS IN
PROFITABILITY AFTER THE MERGER.
• THEY CONCLUDED THAT MERGER ACTUALLY DESTROYS THE
VALUE WHICH CONTRADICTS THE CONCLUSION FROM STOCK
MARKET ANNOUNCEMENTS.
 Healy, Palepu and Ruback (1992)

• THEY TOOK THE DATA FROM 50 TOP MERGERS BETWEEN 1979

AND 1984 AND ANALYZED THE OPERATING PROFIT.
• THEY ANALYZED THE OPERATING PERFORMANCE FOR THE
COMBINED FIRM FROM THE INDUSTRY MEDIAN .
• THUS THEY FOUND THAT THE MERGED FIRM EXPERIENCED
GROWTH IN ASSET PRODUCTIVITY LEADING THE HIGHER
OPERATING CASH FLOW WHEN COMPARED TO PEERS.
• THUS, THE POST MERGER OPERATING PERFORMANCE
IMPROVED AS COMPARED TO THE PEERS.
• TO INTERPRET OUR FINDING FIRST THE DATA NEEDS TO BE
COMPARED WITH CORRECT STANDARDS:
• AN ACCURATE PERFORMANCE BENCHMARK IS CRUCIAL.
• THE TENDENCY FOR MERGER TO CLUSTER THROUGH TIME
IN INDUSTRY.
• CROSS SECTIONAL CORRELATION MUST BE INCLUDED.
 Pre and Post merger Abnormal Operating
Profit
T-1 T+1 T+2
2.92% 3.27% 3.15%
2012 2101 1796
A B r2
1.07% .804 .551
 WHERE WE STAND?

• EARLIER REVIEW PAPERS ON EVIDENCE OF MERGERS BY JENSEN AND

RUBACK (1983) AND JARREL, BRICKLEY AND NETTER (1988)
• BOTH THESE STUDIES CONCLUDED THAT MERGER CREATE VALUE FOR THE
STOCKHOLDERS OF THE COMBINED FIRMS, WITH MAJORITY OF GAINS
ACCRUING TO SHAREHOLDER OF TARGET COMPANY.
• THE STUDY IN THIS REPORT ALSO FOUND THE SAME WHEN THEY
ANALYZED FIRM MORE THAN 4000 FIRMS DURING 1973-1998.
• THUS WE CAN SAY THAT MERGER ACTUALLY HELPS IN CREATING MORE
VALUE FOR SHAREHOLDERS.
 FOR PRODUCTION MERGER:

• IT WAS SEEN THROUGH RESEARCH FINDING OF MC GUCKIN AND

NGUYEN THAT THE ACQUIRING PLANT SUFFERS PRODUCTIVITY
LOSSES WHILE THE ACQUIRED PLANT EXPERIENCE PRODUCTIVITY
IMPROVEMENT. THUS NET RESULT IS ZERO.
 CHALLENGES:

• NEGATIVE DRIFT OF ACQUIRING FIRM

• UNDERLYING SOURCE OF GAIN FROM THE ACQUIRING
FIRM HAS NOT BEEN IDENTIFIED.
• ALL THE PROFIT SEEMS TO GO TO THE TARGET FIRM
SHAREHOLDERS
• WHAT IS ABNORMAL RETURN FOR THE ACQUIRING FIRM.