A study into the abnormal returns of US acquiring firms after the announcement of a merger or acquisition between 2007 and 2009

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A study into the abnormal returns of US

acquiring firms after the announcement of

a merger or acquisition between 2007 and

2009

Bachelor Thesis Economics and Finance Author: Rainier Smeink

Student number: 10624546 Supervisor: I. Naaborg Date: 31 January, 2018

Abstract

The aim of this paper is to get an insight into the performance of a merger and acquisition deal announcement on the shareholders bidding firm’s return. This research is done with an event study methodology based on the paper of MacKinlay (1997). The event study conducts a data sample of 288 M&A deals undertaken by US acquiring firms during the financial crisis

(01/01/2007-01/01/2010). The results are formulated on the outcome of the abnormal returns, calculated by the actual returns minus the expected normal return. This paper finds a significant negative cumulative abnormal return for both the full sample of US acquiring firms as well as the sub sample of only domestic M&A deals. For the cross border M&A deals there is insignificant evidence for a positive wealth effect for shareholders of the bidding firm during the financial crisis. In conclusion this means that acquisitions undertaken during 2007-2009 were value destroying for shareholders of the bidding firm. This can be concluded for both the full sample as well as the domestic acquisitions.

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Statement of Originality

This document is written by Rainier Smeink who declares to take full responsibility for the contents of this document.

I declare that the text and the work presented in this document are original and that no sources other than those mentioned in the text and its references have been used in creating it.

The Faculty of Economics and Business is responsible solely for the supervision of completion of the work, not for the contents.

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1. Introduction

The last 30 years mergers and acquisitions have been a big part of the financial sector. From 1990 on the market for mergers and acquisitions grew massively and in 2007 the total value of transactions is the United States was over 1.3 trillion US dollar (Statista, 2018). After the collapse of the housing bubble in the United States, M&A deals also decreased. Total value of M&A deals in 2008 was ‘only’ 757.4 million US dollar. Although the collapse of the housing bubble caused an huge drop in total value of M&A deals in the US, there was still movement on the market of merger and acquisition. According to Berger and Bouwman (2013) the financial crisis was an ideal investment opportunity for large firms with high liquidity to take over other firms.

With the rising number of M&A deals over the past 30 years, the quantity of studies on this subject has also grown. Goergn and Renneboog (2004) did an event study on the stock return of the bidding firm and find a positive abnormal return on the stock prices of the bidding firm. Also the research of Bradley et al. (1988), who used a sample of 236 acquirers that are listed on the New York Stock Exchange (NYSE) or the American Stock Exchange (AMEX) and Beitel, Schierick and Wahrenburg (2004), who used a dataset containing 98 European M&A deals, give a positive combined return for shareholders of the acquiring firm after the announcement of a M&A deal. On the other hand studies such as the study done by Walker (2000) or the paper written by Moeller and Schlingermann (2004) find a negative cumulative abnormal return on the stock prices of the acquiring firm after the

announcement of a merger or acquisition.

It seems that there isn’t yet a conclusive answer on the question if M&A is value destroying or value creating on the short term for the shareholders of an acquiring firm. The paradox between a rising total value of M&A deals and most papers that report a negative or zero abnormal return makes it interesting to examine this topic. The drop in M&A deals during the beginning of the financial crisis indicates that firms were more cautious and less

investment-orientated. Still there is movement in the market for mergers and acquisitions. Are mergers and acquisition made during a period of economic distress better thought out by managers? Are managers indeed more cautious? In this thesis I will investigate if it is

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valuable for US-listed firms to invest in a M&A deal during a financial crisis. This is stated in the following research question:

‘’What is the wealth effect for shareholders of US listed acquiring firms on the short term

after the announcement of a merger or acquisition during the financial crisis?’’

This paper will be answering the research question as follows. Chapter 2 provides

background information on the financial crisis, furthermore it explains the main motives of M&A transactions and will discuss the existing literature on the abnormal returns around the announcement date. In chapter 3 the methodology will be discussed as well as the hypothesis and the criteria of dataset are explained. Chapter 4 presents the results. Finally in chapter 5 there will be a conclusion and discussion

2.Literature Review

This chapter begins with an explanation for the cause of the financial crisis, furthermore the motives behind merger and acquisition will be explained in 2.2. In 2.3 the existing

researches on abnormal returns around the announcement date are discussed.

2.1 The financial crisis

The sub-prime crisis in 2007 is seen as the beginning of the global financial crisis. Financial institutions had aggressively invested in debt-supported securities and the rules on

mortgages weren’t as strict as they are nowadays. When the housing bubble collapsed and people weren’t able to pay back there debts, financial institutions were fully exposed to the risks, which made them struggling for liquidity. In 2008 the financial crisis became fully visible when some financial institutions in the United States, which ought to be ‘too big to fail’, were brought down. Organizations were struggling to survive financially and

investment opportunities began to rise for capital strong companies.

2.2 Motives for M&A

The primary motive for companies to get involved in a M&A deal is the creation of a

synergy. This synergy is mostly obtained through cost and product efficiency. Synergies are mainly based on the assumption that 1+1>2, meaning that the bidding and target firm

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combined are of greater value than both firms separately. The synergy can be explained through internal economies of scale. The simplest way of internal economies of scale is that the increase in total sales can provide a lower cost price per unit (Haleblian et al., 2009).

The second motive for firms, with strong and healthy liquidity, is the investment opportunity to increase their market share during a crisis. The possibility of acquiring a distressed firm for a discount is then higher (Berger and Bouwman, 2013). Also the number of possible target firms increase during a financial crisis, whereas the number of acquiring firm decrease because of the decreasing investment possibilities during a financial crisis (Archarya, 2011). The increasing demand from target firms and the decreasing quantity of firms, which are able to take over other firms, could cause distressed target firms to lower their firms total price. If they need financial help in order to survive, they are more likely to cooperate with the acquiring firm.

Furthermore there are also motives that are specifically related to cross border M&A deals. Through a cross border M&A deal the acquirer can obtain advantages likes lowering transportation costs or they could benefit of the cultural knowledge of the foreign target firm(Gilroy and Lukas, 2006). These investments are known as brownfield investments. Another motivation for a cross border transaction can be the tax benefits in the target’s country, like the Netherlands or United Kingdom.

The arguments above should all be value improving, generating a positive return after merging. But there are also value-decreasing motives that occur with M&A and thus negative stock returns (Malatesta, 1983). The main argument for a value decreasing M&A deal is the arising of the agency problem. According to Morck et al. (1990) agency problems arise when managers are handling in their own interest rather than trading in the interests of the shareholders. When the acquisition serves the objectives for the manager, the willingness to pay more for the target firm is then higher for managers than it is to the shareholders of the bidding firm.

Managers are infected by hubris, this leads to more risky investments. Roll (1986) explains that the overestimation of a manager’s ability to run the target firm leads to overpayment of the target firm. The overpayment of a target firm immediately causes a negative

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2.3 Previous research

Extensive research has been done on the effect of an M&A announcement on stock returns. This paragraph summarizes some of that research.

On the one hand there are numerous papers which find a significant positive return on stock prices. The survey of Beitel et al. (2004) finds a significant positive abnormal return for the target firm. For shareholders of the acquiring firm there was no significant change in return, but when they combined both firms it resulted in a significant net gain for the bidding firm. The study contains a dataset of 98 European M&A deals from 1985 to 2000. Beitel et al. use the event study methodology, which includes the stock returns of 20 days prior to the announcement date and 20 days after the announcement date.

Kohers and Kohers (2000) did a research on acquisitions of high tech targets and their strong potential for value creation. They did an event study using a sample of 1634 deals that were completed between 1987 till 1996. Their results show that regardless of the way of

payment, the bidding firm gains positive from the acquiring of a high-tech target. The cumulative abnormal return is significantly positive (+1.26%).

Eckbo and Thorburn (2000) present a paper on the acquisition of Canadian target firms, their bidding firms are located in Canada and the US. They included a total of 1846 M&A deals in the period 1964-1983 in their data sample, among which 1452 were domestic and 394 cross border. The findings of the event study are as follows. The domestic deals within Canada perform a significant positive CAR. The cross border deals, with US firms being the acquiring firm turn out to be not different from zero.

Finally the paper of Goergn and Renneboog (2004) did an event study on 288 European merger and acquisitions for the period of 1993-2000. They find a significant positive cumulative abnormal return for shareholders of the acquiring firms of 0.7%.

A study done by Campa and Hernando (2004) examined the 262 merger and acquisition transactions over the period 1998-2000 in the EU. Their results from the event study are a positive cumulative average abnormal return of 9% for the targets firms. For the bidding firm the results were on average not different than zero.

Loderer and Martin (1992) find a positive long term benefit for stockholders of the bidding firm. Their event study, which included 5172 acquisitions during 1964-1998, resulted in a

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positive wealth effect if the acquisition was a tender offer. They examined a 5 year post-acquisition performance of the tender offers.

On the other hand there are papers that conclude an insignificant negative abnormal return. Walker (2000) analyses 278 US mergers and acquisitions during 1980-1996. He finds, using the event study methodology, a -0.84% negative return for acquiring firms at a significance level of 10%.

Moeller and Schlingemann (2004) provide a research on the difference between domestic and cross border deals. They find, for a sample of 4430 acquisitions made by US bidding firms in the period 1985-1995, a slightly significant negative abnormal return, where cross border M&A was to be found 1% lower than the domestic M&A.

Another paper written by Delong (2001) did a research on mergers and acquisitions where at least one of the target or bidding firms was a bank. His sample size was 280 merger deals. He used the event study methodology described by Brown and Warner (1985) with a time frame of (10; 1). The results of the event study present a significant negative CAAR of -1.68%.

Lastly, Datta and Puia did a study on 112 large cross border acquisitions which were undertaken by US bidding firms in the period from 1978 till 1990. Prior to their research they suggested positive wealth effects for shareholders of the acquiring firm. Contrary to their suggestions, the results were statistically significant negative. The timeframes they use [(-1, 0), (-5, +5), (-15, +15), (-20, +20) and (-30, +30)] results that the acquisitions were, on average, negative for the bidding firm.

Nevertheless there are also researches that were insignificant and couldn’t conclude a positive or negative wealth effect. Conn and Connell (1990) did a research on cross border acquisitions for US and British firms. The data set contains 73 M&A deals during 1971-1980. Their research finds a return not significant different than zero. This implements that there is not enough evidence found for neither a positive nor a negative effect on the return of bidding firm’s stock.

Mulherin and Boone (2000) did a study on the wealth effects of a M&A announcement for bidding firms. In their event study they use a sample of 1307 acquisitions during the 1990-1999 period. The event window they use is a 3-day time window, 1 day prior to the

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announcement and 1 day after the announcement. They find an insignificant negative AAR for the bidding firm of -0.37%.

In conclusion there has been a lot of research done on the abnormal returns after the M&A announcement, nevertheless the number of articles which are specific focused on the financial crisis are scarce. There is no clear answer on the question if a M&A deal pays on the short term. As described above the results are dissimilar.

3 .Methodology

In this chapter, the hypothesis is stated. In 3.2 and 3.3 the methodology examining the abnormal returns after announcing an acquisition is explained and in 3.4 the criteria for the sample selection is made clear.

3.1 Hypothesis

As described in chapter 1 this thesis will mainly focus on the short term abnormal return of a M&A deal which took place during the financial crisis. In this paragraph the hypothesis are formulated. As the research question suggested we are mainly focused on the abnormal returns of the acquiring firms. This is why the main hypothesis is:

H0: There is no abnormal return from a M&A deal for shareholders of the acquiring firm during the financial crisis (H0; CAAR all US deals = 0)

H1: There is abnormal return from a M&A deal for shareholders of the acquiring firm during the financial crises. (H1; CAAR all us deals ≠ 0)

But it is also interesting to perform a sub event study on the geographical location of the target firm. That is why I will also perform sub event studies on the location. First the domestic deals are examined and secondly the cross border deals.

Hypothesis 2:

H2: There is abnormal return from a domestic M&A deal for shareholders of the acquiring firm during the financial crises. (H1; CAAR domestic ≠ 0)

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Hypothesis 3:

H3: There is abnormal return from a cross border M&A deal for shareholders of the acquiring firm during the financial crises. (H1; CAAR cross border ≠ 0)

3.2 Methodology

The Efficient Market Hypothesis is one of the main supporting theories for the event study methodology. The EMH states that when a market is fully efficient all known information is accessible for all market participants and thus fully reflects in the market price. There are different degrees of information strength in EMH, the weakest form will only cover the information based on historical information and the strongest form covers all kind of information (even the privileged information is included).

The event study used in this thesis will be based on the paper of MacKinlay. In order to correctly perform the event study a few steps has to be taken.

At first we need to look at the normal returns and the expected returns. The normal returns will be calculated using the market model. As you can see in equation 1 the normal return of stock i is a constant 𝛼 plus the market return * the market risk. The bench market used in this paper is the S&P 500.

𝑅_𝑖𝑡 = 𝛼_𝑖 + 𝛽_𝑖 ∗ (𝑅_𝑚𝑘𝑡) + 𝜀_𝑖 (1)

For firm i the expected return is the average return of a 160 trading day period ending 11 days prior to the announcement date. After calculating the expected return, we calculate the abnormal return. The abnormal return is the actual ex post return of the firm minus the expected return (MacKinlay, 1997). The key issue in this event study is to try and catch the portion of movement in the return caused by the announcement of the M&A deal.

𝐴𝑅𝑖 = 𝑅𝑖𝑡 − 𝐸(𝑅𝑖𝑡) (2)

Furthermore the Cumulative Abnormal Return will be calculated, this is the sum of all the ARi over a certain time window.

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To test if the abnormal returns are statistical significance we need to calculate the cross average of each measure. For cumulative abnormal returns the cross sectional average is:

𝐶𝐴𝐴𝑅_𝑇1,𝑇2 = 1

𝑁∑𝑖=1𝑁 𝐶𝐴𝑅𝑖 (𝑇1,𝑇2) (4)

After we have calculated the CAAR, we will use a cross sectional t-test for cumulative abnormal returns (Brown and Warner, 1985). This equation will test the significance of the CAAR results.

𝑡_{𝐶𝐴𝐴𝑅} = 𝐶𝐴𝐴𝑅 √𝑇1 − 𝑇2 ∗ 𝑠𝐴𝐴𝑅

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A two-sided t-test has to be done for testing the significance of the returns. The critical values for this t-test with degrees of freedom (df=n-1) are displayed in the following table (note: only the values useful for this paper are shown). ( dfUS all =288-1≈∞, dfdomestic

=251-1≈∞, df cross border =37-1≈40) Table 1: Statistics table

Degrees of freedom Significance level

10% 5% 1%

40 1.684 2.021 2.704

∞ 1.645 1.96 2.576

3.3 Event study

In order to perform an event study, we need to specify the period of interest. The period of interest in this paper is the public announcement of an acquisition or merger. The event date is formulated as t=0. The event window is the period surrounding the announcement date, the event window is formulated [t1, t2]. The event window is at least the

announcement date and the day after the announcement in order to capture the price effects on the announcement. It is also interesting to look at the days prior of the

announcement because there could be leaked information which has influence on the price changes. The event windows used in this thesis will be from [-10; 10] till [-1; 1]. The ‘longer’ event windows of 11 [-5; 5] and 21 [-10; 10] are used to capture and examine if any

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The estimation period is the period prior to the event window, this period is mostly used for calculating the normal expected return. The estimation window is shown as [T1-T2]. Based on the researches of Brown and Warner, who used an estimation period of 240 days, and the event study paper of MacKinlay, who said that on average the estimation period should be between 120 and 210 days, I will use in this paper an estimation period of 160 days .The estimation period starts at T1= -170 days before the event date and ends at T2=-11,

estimation period= [-170,-11].

Figure 1: Time line of the event window

3.4 The Data

The data of all merger and acquisitions was obtained from Zephyr database. In order to get the right data for this paper the following criteria is specified:

 The acquiring firm as well as the target firm is listed in the period 01/01/2006 till 01/01/2010

 The deal type is an acquisition or merger

 The percentage of total stake owned after acquisition is 100%

 The announcement date is completed and confirmed in the time period between 01/01/2007 and 01/01/2010

 The acquiring firm is located in the United States of America

A total of 455 deals were provided through the Zephyr database. In order to calculate the CARi and CAARi an event study tool will be used. To perform an event study with the event

study tool WRDS (Wharton Research Data Services) I had to obtain the security TICKER identifier and the announcement date. By filtering and eliminating all firms without a legit

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the firms with more than one merger or acquisition in the period 01/01/2006 - 31/12/2009 had to be observed. Every second M&A deal of the observed firm is eliminated from the sample. The returns of the second merger or acquisition could be highly correlated with the returns of the first deal. After eliminating for both extra criteria a sample of 288 firms were listed.

To answer hypothesis 2 and 3 the criteria is further specified. For hypothesis 2 both the acquiring firm as well as the target firm should be located in the United States of America. This is required in order to test for Domestic deals. For Hypothesis 3 the extra criterion is that the target firm is NOT located in the US, in that way we can calculate the cross border deals. A total of 288 remain listed.

Table 2: Descriptive Statistics

Time period Total number of M&A deals

Number of domestic M&A deals

Number of cross border M&A deals

2007 185 161 24

2008 69 62 7

2009 34 28 6

Total 288 251 37

Source: Zephyr database

4. Results

This chapter presents the obtained results from the event study. The results will be analyzed and provided with an economical meaning. Also we can give a significant answer to the hypothesis, which were provided in 3.1.

4.1 Value creation of US acquirers on all M&A deals

In table 3 you find the results of the event study on the full sample (288 M&A deals). The results show that the average return on a merger and acquisition deal is negative. All the cumulative average abnormal returns are at a significance level of 10% statically negative, which means that investments made during the financial crises are on average negative. At the two days around the announcement date, one day prior and one day post, the average

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return of a M&A deal is -0.69%. This is in line with the paper of Datta and Puia (1995), who also found a significant negative wealth effect in multiple timeframes. Also the results correspond to the research of Moeller and Schlingemann (2004), their findings were

significantly negative for US bidding firms as well. Although they use a different time period (1985-1995) the results seem to be the same. Comparing these results to the study of Kohers and Kohers (2000) we find a difference in outcome, where I find a significant negative CAAR for US firms, they find a positive effect. These difference in outcome can be explained by the difference in target firms. They use the data set of high potential high tech target firms where as I use a much broader data set of all the target firms.

As you can see in table 3 the CAAR is significantly negative for most of the timeframes. Therefore we can reject hypothesis 1, and say that CAAR is different from zero, in this case negatively different. For shareholders of the acquiring firm it is thus more profitable on the short term if the firm does not undertake a merger or acquisition. However the results of the event study on the full sample are clear and significant, the study could be biased because of the relatively large number of domestic deals and relatively low number of cross border deals.

Table 3: CAAR statistics of the full sample

Timeframe (t1;t2) CAAR Cross sectional t-test Significant at

%-level (-10;10) -0.011011 -1.64519 Significant at 10% (-5;5) -.009145203 -1.86512 Significant at 10% (-2;2) -.008543875 -2.21002 Significant at 5% (-1;1) -.006886335 -2.01575 Significant at 5% (-5; 0) -.007613615 -2.13664 Significant at 5% (0; 5) -.009408168 -2.05164 Significant at 5%

4.2 Value creation of US acquirers only domestic deals

In this paragraph we are looking at the results of the event study of only the domestic deals. The sample of 251 M&A deals that found place within the United States were also tested at different time frames in order to accurately analyze the results. As you can see the CAAR at every time frame (t1,t2) is significant at a level of 5%.With these results we can provide a

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domestic M&A deals is different than zero, in this case negative. This means that there is on average a negative abnormal return on a domestic merger or acquisition for shareholders of the acquiring firm. The possible explanations for the negative CAAR could be because of overpaying or because both firms are suffering from the financial crisis. Also the agency problem as explained in 2.2 could be a cause of the negative CAAR. This is in contradiction with the paper of Eckbo and Thorburn (2000). They examined the domestic Canadian M&A deals and found a result with positive significant CAR. The possible explanation for this could be the difference in time period.

Table 4: CAAR statistics of only the domestic deals

Timeframe (t1;t2) CAAR Cross sectional t-test Significant at

%-level (-10;10) -0.016034 -2.22110 Significant at 5% (-5;5) -0.011234 -2.05738 Significant at 5% (-2;2) -0.010279 -2.46377 Significant at 5% (-1;1) -.007793893 -2.05822 Significant at 5% (-5; 0) -.008368735 -2.16611 Significant at 5% (0; 5) -0.011956 -2.35798 Significant at 5%

4.3 Value creation of US acquirers only cross border

The results on the sample of all cross border firm (total of 37) are shown in table 5,

noticeable is the positive returns in all the time frames except for (-1;1) and (-5;0). Although the results are mostly positive nothing much can be said about this because of the

insignificance. Also because of this small sample size the power and reliability of a small sample is low, thus nothing much can be concluded on these results. Comparing these results to previous research the same results are found in the research done by Conn and Connell (1990) who did their research on cross border deals where the acquiring firm is located in the United States and the target firm is located in Canada. In conclusion their findings for the cross border deals were also at a significance level of 5% no different than zero.

Provided the results in table 5 we can’t reject hypothesis 3, this means that there isn’t, at a significance level of 10% or lower, an abnormal return different than zero for cross border M&A announcements during the financial crisis.

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Table 5: CAAR statistics of only cross border deals

Timeframe (t1;t2) CAAR Cross sectional

t-test Significant at %-level (-10;10) 0.025154 1.50409 Not significant at >10% (-5;5) .005892302 0.72492 Not significant at >10% (-2;2) .003947686 0.39374 Not significant at >10% (-1;1) -.000351921 -0.054684 Not significant at >10% (-5; 0) -.002176753 -0.24119 Not significant at >10% (0; 5) .009499236 1.06442 Not significant at >10%

5.Conclusion and discussion

The purpose of this thesis was mainly focused on the abnormal return after a M&A announcement during the financial crisis. First, I collected the data of 288 M&A deals undertaken by US located acquiring firms during the financial crisis (01/01/2007-

01/01/2010). Second, I did an event study based on the paper written by MacKinlay, using different time frames (-10;10), (-5;5), (-2;2), (-1;1), (-5; 0), (0; 5) in order to successfully analyze the effect on the returns. For both the full sample as well as the sample of only the domestic deals, the results of the CAAR were significant negative, which means that on average the announcement of a M&A performs on the short term negative wealth effects. However the event study on the sample of only the cross border deals gives an insignificant positive wealth effect, this means that on average the abnormal return of the

announcement of a cross border M&A deal differs not from zero.

The results in this paper are in line with the results found by Datta and Puia (1995), who also find negative abnormal return for different time frames. Comparing the research of Moeller and Schlingemann (2004) to this research is very interesting because they are also examining US bidding firms. Although their time period is different, the results are corresponding. Based on the results of this thesis as well as the paper of Moeller and

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Schlingemann we can conclude that the effect of an announcement for a merger or acquisition deal is negative for shareholders of the bidding firm.

Although the results provided in this paper are clear, there are some limitations to the research. First of all only the short term returns are obtained for this research. It can also be interesting to look at the long term returns. It could be possible that the synergies need some time to adapt in order to perform. This long term motive is supported by the research of Loderer and Martin (1990) who find on the long term a positive wealth effect for the bidding firm’s shareholders. Another limitation is that it is hard to compare this financial crisis with a future crisis. Firms may react different to this crisis compared to a future crisis.

From the results given in this thesis, some cautious conclusions can be drawn. Although there are some limitations the main implication for acquiring firms should be the possible negative wealth effect from a M&A deal. Bidding firms should be aware of

overpaying, especially during a financial crisis. As described in 2.3 managers could be obsessed with their bonus and agency problem might arise. Their hubris could cause overvaluation and overpaying for the target firm. In most cases this overpayment is in contradiction to the interests of the shareholders. Focusing on their own strength could provide a higher wealth effect than expanding their market share.

In further research it could be helpful to compare this financial crisis to a different time period, for example another financial crisis. Also it could be interesting to see if bidding firms in emerging countries react different on the announcement of a M&A deal than bidding firms in developed countries.

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A study into the abnormal returns of US acquiring firms after the announcement of a merger or acquisition between 2007 and 2009