The impact of the Great Financial Crisis on abnormal
returns of target firms
Amsterdam Business School
Name Maike Mareie Geerlink
Number 6044808
BSc in Business Economics Specialization Finance
Supervisor Ilko Naaborg Completion 01-07-2014
Abstract
This research paper examines whether the recent great financial crisis, which began in the summer of 2007 and came to an end in the middle of 2009 (Guidolin et al., 2013), has had an impact on the abnormal returns earned by a target firm at the time around an acquisition announcement. The research uses an event study methodology followed by a multiple regression model, using data between January 2000 and June 2014. This study finds no significant evidence that the recent financial crisis had any impact on abnormal returns earned by target companies.
Table of Contents
1. Introduction ... 2
2. Literature review ... 4
3. Hypothesis, Methodology and Data ... 11
3.1. Hypothesis and Methodology ... 11
3.1.1. Hypothesis ... 11
3.1.2. Methodology ... 11
3.2. Data and descriptive statistics ... 13
4. Empirical results ... 16
4.1. Empirical Results... 16
4.2 Robustness check ... 17
5. Conclusion and discussion ... 19
1. Introduction
This research paper examines whether the recent great financial crisis, which began in the summer of 2007 and came to an end in the middle of 2009 (Guidolin et al., 2013), has had an impact on the abnormal returns earned by a target firm at the time around an acquisition announcement. Guidolin et al. analyze
benchmark data from 2001 till 2011 and use the change in the yield spread index to perform their empirical research.
Previous studies find that abnormal returns can be explained by a few major factors, such as type of payment, takeover type, level of competition and buyer type (Huang and Walkling, 1987; DiGabriele, 2008; Wansley et al., 1983). The question is whether a financial crisis can also be an explainable variable for abnormal returns.
Although mergers and acquisitions have been an interesting subject for many researchers over the years, little is known about the impact of the recent financial crisis on the effects of M&A activities and the abnormal returns resulting from those activities. During the financial crisis the amounts of loans issued dropped dramatically. This drop in loans is also seen in the amount of money borrowed for restricting loans used for M&A among others (Ivashina and Scharfsteinb, 2010). In their research Ivashina and Scharfsteinb (2010) use data from Reuters’ Deal Scan database of large bank loans in the time period from 2000 till 2008. Knowing that there has been a drop in money borrowed for mergers and acquisitions, and knowing that acquisitions are costly, it is expected to see a drop in the amount of mergers and acquisitions completed during the crisis.
This research will examine if the financial crisis had any impact on the cumulative abnormal returns earned by target companies originated from the announcement of an acquisition.
For determining the effect of the crisis on abnormal returns an event study is used. In this situation acquisitions during the great financial crisis are compared with acquisitions during a period with no crisis. Data is collected using the databases Zephyr and CRSP (The Center for Research in Security Prices).
Using findings from previous studies the period from 01/06/2007 till 31/12/2009 is used to represent the period of crisis.
Since no research has been done regarding the effect of a crisis on abnormal returns, this study is relevant for both investors and managers of target firms. A takeover during crisis could affect investors return and managers can now use more information on whether or not to decline an offer during a period of crisis.
This research is organized as follows. In section two a literature review regarding this subject is presented. Using the literature in section two, a hypothesis will be formed and stated in section three. Section three will also cover the methodology used in this research. The fourth section summarizes the results of the research followed by a robustness check. Section five discusses and concludes the main findings in a summary.
2. Literature review
Mergers and acquisitions
In 1983 Halpern clearly states the definition and the difference between mergers and acquisitions:
‘Mergers occur when an acquiring firm and a target firm agree to combine under legal procedures established in the states in which the merger participants are incorporated. A tender offer is an offer to purchase a proportion of the outstanding shares of the target firm at specified terms on or before a specified date. Those shareholders not tendering their shares retain an ownership interest in the firm. The term "acquisition" is used in a generic sense to refer to any takeover.’
Since the research of Golbe and White in 1993, it is widely accepted that merger activities occur in so called ‘waves’. Their research is done using data on merger and acquisition activity obtained from the U.S. Federal Trade commission in a time frame from 1895 till 1989. Golbe and White find that Takeovers usually occur in periods of economic recovery and therefore tend to move together. The first event of a merger wave dates back to the beginning of the 20th century, followed by others in the 1920’s, the 1960’s, the 1980’s and the 1990’s.
The United States economy has experienced five clearly identifiable merger waves in the periods mentioned above. But since documentation of European merger activities only started in the 1980’s, no empirical research has been done about European mergers prior to the 1980’s (Martynova and
Renneboog, 2008). Although data is not available, Martynova and Renneboog (2008) believe, based on their literature research, that before the 1980’s merger waves may have also occurred in Europe during the same time span as in the United States. Since 1980, activity in the European M&A market kept growing and even reached levels similar to those documented in the United States by the end of the 1990’s. And since the merger wave in the 1990’s has been by far the largest in the American history, this was probably also the biggest ever seen in
Europe (Moeller et al., 2005). Figure 1 clearly shows the merger waves experienced in the United States (Martynova and Renneboog, 2008).
Figure 1: US merger activity since 1997
This figure shows the merger and acquisition activity in the U.S. from 1997 till 2000. The Y-axis represents the number of M&A’s.
Source: Martynova and Renneboog, (2008)
Takeovers can be divided into two categories; friendly takeovers and hostile takeovers. With a hostile takeover the acquiring firm makes an offer directly to the shareholders without consulting the current management of the target firm first. In this case shareholders can decide for themselves if they want to accept the offer or not. In a friendly takeover both the current management as the shareholders of the target firm are contacted to come to a mutual agreement. For this reason a hostile takeover is more likely to occur when the acquirer is uncertain about the information provided regarding the financial status of the target firm (Schnitzer, 1996). Hostile takeovers can thus be categorized as highly resisted takeovers.
Looking at the previous merger waves a clear distinction can be made between the last merger wave during the 1990’s and the one in the 1980’s. The last merger wave was characterized by mostly friendly takeovers while the wave in the 1980’s consisted of mostly hostile takeovers. During these hostile
takeovers, acquirers targeted undervalued firms, broke them down to divisions and sold them in pieces (Berk and Demarzo, 2007). Transactions during the takeovers in the 1980’s where mostly settled with cash instead of stocks (Shleifer and Vishny, 2003).
Acquisition Premium
Merger and acquisition movements can be distinguished by the fact that the management of the acquiring companies is willing to pay a substantially greater amount than the target firms’ market value. This amount is called an acquisition premium. Acquisition premiums can exist because management believes the expected synergy obtained by the acquisition is bigger than the premium (Nielsen and Melicher, 1973). The higher the premium, the harder it is for the acquiring firm to obtain value with the takeover. Logically, shareholders of the acquiring firm will bargain for the lowest level of premium possible. Since the premium is paid to the target firm, naturally the shareholders of the target firm will try to reach the highest level of the premium (Schoenberg, 2003).
Schoenberg obtains his findings using an event study consisting of 104 acquisition offers between 1962 and 1979.
Researchers do not agree about the purpose of the acquisition premium. While some see the acquisition premium as a compensation for the synergy earned after a takeover, many researchers attribute higher earned returns after a takeover to the shifting of the control from the target firm to better qualified management of the acquirer firm (Slusky and Caves, 1991). Using a sample of 100 U.S. acquisitions in the period from 1986 till 1988, Slusky and Caves do not obtain significant evidence for the existing of synergy. In this case it is not the target firm that adds essential assets to the value of a takeover, but it is the acquiring firm that does. That means a premium can be seen as a measure of low-quality decision making of the acquirer firm.
The level of an acquisition premium can be driven by multiple factors. A logical but not obvious factor is the level of resistance of the current
management of the target firm. Huang and Walkling (1987) find that resisting firms earn significantly higher premia than firms who do not resist. Here the question rises if resistance could also scare away potential bidders. Knowing that
when demand rises, all other things held constant, prices will rise too (and vice versa). Taking this into account, the absence of potential bidders could cause the opening bid to drop. This makes it harder to compare resisted acquisitions with acquisitions where management chose not to resist.
Like resistance, cash offers result in significantly higher returns, even after controlling for degree of resistance. The high returns on cash payments can be explained by tax effects. Taxes on capital gains resulting from takeovers with stock offers can be postponed until new stocks are sold, while capital gains originated from cash offers are taxed in the year of the event (Wansley, Lane and Yang, 1983). Wansley et al. obtain their results by performing a regression using data on 203 target firms acquired between January 1970 and December 1978. Figure 2 shows the significantly higher cumulative average returns on cash payments compared to payments involving stocks.
The rather difficult to measure variable ‘resistance’ and the easy to obtain variable ‘transaction type’ are the first obvious drivers of an acquisition
premium. DiGabriele (2008), finds that net sales of the target firm and company type of the buyer are two significant independent variables to explain the acquisition premium. He investigates 4239 companies from January 2000 till November 2006. After performing a moderated multiple regression analysis, DiGabriele concludes his research paper with the findings that the acquisition premium depends positively on net sales and is higher for the cases in which the target firm is bought by a private buyer rather than a public buyer. In his paper he too finds that the acquisition premium is higher when a transaction is completed with cash instead of stocks.
Figure 2: Cumulative abnormal returns by method of payment
This figure looks at the effect of method of payment on the level of cumulative abnormal returns earned by 203 target companies acquired between January 1970 and December 1978. Day 0 indicates the announcement day. Star (*) indicates payments settled with cash and diamond (⋄) indicates payments completed using securities.
Source: Wansley, Lane and Yang, (1983)
Great Financial Crisis
The failure of two hedge funds of investment bank Bear Stearns marks the
beginning of the financial crisis also known as the Great Financial Crisis or Global Financial Crisis in the summer of 2007 (Foster et al., 2009). The crisis did not come totally unexpected; in 2006 the real estate bubble burst, which had impact on the financial stability all over the world (Simkovic, 2013). The real estate bubble could exist due to rising house prices which reached unstable levels in 2006 and then radically declined, leaving home owners with underwater mortgages.
The fall of many highly regarded firms such as Lehman Brothers and Washington Mutual raised concerns about the stability of financial institutions. Even financial support from the government could not prevent that prices of
most asset classes fell dramatically and that financial market volatility rose to levels as high as ever seen. This resulted in a drop of syndicated lending in 2007, possibly explained by the level of distrust of banks in one another (Ivashina and Scharfstein, 2008). Figure 3 shows a clear view of the drop in loans during the crisis.
Figure 3: Loans issued during the crisis
This figure shows the number of loans issued between the first quarter of 2007 till the last quarter of 2008. Real investment loans are defined as those that are intended for general corporate purposes. Restructuring loans are defined as those that are intended for leveraged buyouts, mergers and acquisitions, or share repurchases. The Y-axis shows the number of loans issued in de U.S..
Source: Ivashina and Scharfstein, (2010)
The crisis did not only have an impact on financial institutions as
mentioned above, it also affected corporates in their ability to invest. Campello, Grahem and Harvey (2010) survey 1,050 Chief Financial Officers (CFOs) in the U.S., Europe, and Asia and find that more than half of their companies, who were financially constraint, were forced to cancel valuable investments such as
employment and capital spending. Not only did they cancel investments, most of them even sold more assets in order to fund their operations. Their research is conducted in the last quarter of 2008 and uses E-mail as interview medium.
To answer the question whether the great financial crisis has had an impact on the abnormal returns of target firms, the above mentioned studies on mergers and acquisitions, the financial crisis and acquisition premiums are combined. Duchin, Ozbas and Sensoy (2010) find that total corporate investment declined during the crisis. In their research they use data on publicly traded firms from 2006 till 2009 and exclude financial firms. In the above literature review it is mentioned that mergers and acquisitions are a valuable investment decision by the acquiring firm (Halpern, 1983). Halpern obtains his findings by doing a literature research. By combining these two researches a rough assumption can be made; when total corporate investment declined during the crisis, so did merger and acquisition activity, resulting in a declined level of competition and therefore a change in abnormal returns.
3. Hypothesis, Methodology and Data
In this section a hypothesis will be formed to answer the research question. This hypothesis is obtained using the above mentioned literature review. The
hypothesis is accompanied by an explanation of the methodology used. Furthermore description of the data will be given.
3.1. Hypothesis and Methodology 3.1.1. Hypothesis
This study analyses if the recent financial crisis has had an impact on the abnormal returns earned by target companies. As mentioned in the literature review, this study classifies mergers and acquisitions as valuable investments. Using this assumption and using findings from previous studies that show that corporate investment declined during the crisis it is expected that fewer firms will target other companies. This results in a lower competition level since there are less acquirers who do takeover another firm. These assumptions are shaped in the hypothesis as follows:
H1: The crisis will have a negative effect on the abnormal returns earned by target companies.
3.1.2. Methodology
For this research an event study will be used. An event study is a well-known methodology used to examine wealth effects on certain events (Fama et al., 1969). The concept of the event study is based on the efficient market theorem, which states that current market prices capture all information contained in past stock price and volume data (Fama, 1991).
The goal of this event study is to determine the extent to which abnormal returns around an event during crisis differ from abnormal returns around an event during a period where there is no crisis. In this research the acquisition is considered to be the event and the announcement day to be the event day. The
event window will be three days before the announcement until three days after the announcement. This time window is chosen to analyze immediate effects of the announcement on the stock prices (Mulherin and Boone, 2000).
The abnormal return and cumulative abnormal return of stocks are defined as follows respectively:
In these equations ARj,t shows the abnormal returns on stock from firm j at time
t. Rj,t indicates the expected return on stocks j at time t. Rm,t indicates the return
on stocks on the market m at time t. The intercept and the slope of the linear relationship between the return of stock j and the returns of the market are given by α and β, respectively. CARj,t gives the cumulative abnormal returns
calculated by the sum of the abnormal returns. To answer the research question, these equations are used to indicate whether the announcement of an
acquisition results in a significant CARj,t different from zero.
To estimate α and β, the following market model is used:
An estimation period of 300 days before the announcement until 46 days before the announcement is used. This time frame is chosen using the information provided in the CRSP database.
Using previous research on abnormal returns caused by an acquisition (i.e. DiGabriele, 2008), the following regression is formulated:
Where: CAR = Cumulative Abnormal Return
TransactionType = Method of payment, using 1 for cash
BuyerType = Company type of the acquirer, using 1 for listed companies and 0 for unlisted
companies
NetSales = Sales/Revenue of the target company
Adding the variable Crisis in the model gives the final regression that can be used to find if the recent crisis had any impact on the abnormal returns earned by target companies. With the dummy Crisis being 1 at time of crisis and 0 otherwise, the following equation is formulated:
Using a multiple model regression it is tested whether the dummy Crisis has an explanatory function as it comes to CAR. Taking the research of DiGabriele (2008) as a reference, the values of the beta’s for TransactionType and NetSales are expected to be positive. The beta of BuyerType on the other hand, is expected to be negative. With no empirical research done on the effect of the variable
Crisis on abnormal returns, no scientifically supported presumption can be made
about the value of the beta of Crisis. However, with the research of Campello, Grahem and Harvey (2010), it is known that a lot of companies were forced to cancel valuable investments during the crisis. Using this information the
assumption is made that the beta of Crisis has a negative value, causing the value of the cumulative abnormal returns to fall. If a significant value for the beta of
Crisis is found, this will answer the research question of this paper.
3.2. Data and descriptive statistics
To perform the research described in section 3.1.1. and 3.1.2., data is obtained using the Zephyr database and the CRSP database. The Zephyr database is a database containing detailed information on more than 500,000 M&As and IPO’s worldwide. The database CRSP (The Center for Research in Security Prices) contains American stock prices from 1925 till recent date. Accessing CRSP is done via the WRDS financial database (Wharton Research Data Services). Using
the data conducted from both Zephyr and CRSP the event study is done using Eventus.
Companies included in this research paper meet the following criteria:
- Target companies are acquired in the period between January 2000 and June 2014;
- Target companies are listed companies in North America;
- The acquisition is a hundred percent stake acquisition, this means the acquiring company had no initial stake in the target company;
- At this date, the deal status of the acquisition is ‘completed’;
- Target firms have available daily returns listed on the CRSP database file from 300 days prior to the announcement date to three days after the announcement date.
A total of 54 companies meet the above requirements. Of these 54 firms, 9 firms announced their acquisition during the financial crisis. Looking at the total time frame of 13.5 year and knowing the period of the financial crisis adds up to roughly 2.5 years, a simple calculation shows that the 9 firms acquired during the financial crisis is almost exactly what the expected amount would be in those 2.5 years. Figure 4 shows the dispersion of acquisition throughout the years used for this study. As seen in the figure, 2001 displays a high number of acquisitions. This could indicate an ‘acquisition boom’ in 2001, but since no empirical
evidence can be found it could also indicate that during 2001 relatively more acquisitions met the criteria stated above. The other years show an evenly distributed number of acquisitions over time.
Plotting the values of the obtained cumulative abnormal returns in a graph gives an insight in how the abnormal returns have changes over time. As seen in figure 5, the graph shows the highest value in January 2007. This value is caused by one acquisition in the event study, showing an extremely high value for the cumulative abnormal returns of 67.11%. Since the acquisition deal still meets the criteria and shows no signs of being untrue, this value is included in the research. Looking at the period of the financial crisis no real drop in
cumulative abnormal returns is seen. This indicates that there is no change in cumulative abnormal returns during a period of crisis.
Figure 4: Dispersion of acquisitions
This figure shows the dispersion of number of acquisitions in the time frame 2000 – 2014. The Y-axis represents the number of acquisitions in the given year.
Figure 5: Cumulative Abnormal Returns in acquisitions
This figure shows the CAR values in acquisitions from January 2000 till June 2014. Period of financial crisis is displayed between the red lines.
0 2 4 6 8 10 12 14
Acquisitions
Acquisitions4. Empirical results
In this section the results of the regression stated in section 3 will be given. In section 4.1 the regression is run using SPSS software. In the results a
significance check will be done to examine whether the obtained values of the coefficients of the variables can be interpreted as evidence of structural validity. In section 4.2 a robustness check will be done to test for robustness.
4.1. Empirical results
As mentioned in section 3.1.1. the hypothesis of this research is to examine whether or not acquisitions during a period of crisis result in a significant change of abnormal returns. Using previous research as a reference the following null hypothesis is tested:
H1: The crisis will have a negative effect on the abnormal returns earned by target companies.
Table 1 gives an overview of the output of the multiple regression used to check the null hypothesis. The table shows the estimated beta’s using the regression model stated in section 3.1.2.. The positive beta’s for both TransactionType as BuyerType support the findings of the literature review, claiming that cash payments and listed buyer firms have a positive effect on the level of abnormal returns earned by target firms. Meaning, bids performed using cash will offset higher abnormal returns for the target firm. The same goes for bids performed by buyers listed on the stock market, these bids too will offset higher abnormal returns for the target company. However, different than literature suggests,
NetSales has a negative beta, implying a negative effect on the abnormal returns
when the value of net sales increases. Looking at the dummy Crisis yet another surprising value of the beta arises. Expected was that the financial crisis would have negative effect on the abnormal returns, but the negative beta of Crisis suggests otherwise. That is, looking at the data, table 2 suggests that in a period of crisis the abnormal returns of a target firm will rise compared to abnormal
returns earned during a period whit no crisis. However, these results are not significant and can therefore not be considered as verity.
Table 1: Regression variables and their output
This table looks at the significance of the independent variables of model one and model two. With model one:
And model two:
Dependent variable: CAR
(1) (2) Transaction type 0.058 (0.052) 0.059 (0.052) Buyer type 0.080 (0.060) 0.078 (0.059) Net sales -0.188 (0.000) -0.178 (0.000) Crisis 0.151 (0.067) Constant 0.033 (0.062) 0.21 (0.063) R2 0.056 0.079 N 54 54 *** p= <0.01; **p=<0.05, *p<0.10 4.2. Robustness check
Table 1 shows that by adding the variable Crisis to the regression, the R-square of the model increases from a value of 5.6% to a value of 7.9%. The increase of 2.3% in this value shows the explanatory variance of the variable Crisis. That said, the table also shows non-significant value for both R-squares. This means no conclusion can be formulated concerning the explanatory value of Crisis.
Table 2 shows that when the regression is run multiple times the effect of
Crisis first stays at the same level and then weakens. This proves that the model
is not robust neither significant. This means that, looking at the data used in this research, crisis does not necessarily have an impact on the abnormal returns earned by a target firm.
Table 2: Regression performed multiple times
In this table the regression is performed multiple times, by excluding and then including control variables to check for robustness.
Dependent variable: CAR
(1) (2) (3) Crisis 0.152 (0.065) 0.152 (0.066) 0.151 (0.067) Net Sales -0.210 (0.000) -0.202 (0.000) -0.178 (0.000) Transaction type 0.044 (0.051) 0.059 (0.052) Buyer type 0.078 (0.059) Constant 0.053 (0.028) 0.045 (0.039) 0.021 (0.063) R2 0.213 0.528 0.550 N 54 54 54 *** p= <0.01; **p=<0.05, *p<0.10
5. Conclusion and discussion
In this research abnormal returns around the announcement of an acquisition were tested. Previous research showed that abnormal returns of a target firm are explained by several variables. The most commonly investigated variables are type of payment, net sales of the target firm and type of acquirer firm. Takeover bids done settled with cash are expected to generate higher abnormal returns for the target firm than bids settles with stocks. It is also expected that target firms that have higher net sales earn higher abnormal returns during a takeover announcement. Last but not least, listed buyer firms are expected to generate higher abnormal returns for the firm they target than private acquirers would.
Studies from inter alia, Mulherin and Boone (2000) and DiGabriele (2008) were used to come up with the following research question:
‘Can the financial crisis also be an explainable variable for abnormal returns?’.
Since no research had been done regarding the effect of a crisis on the abnormal returns earned by a target firm, literature on investments during the time of crisis is been used to perform the following null hypothesis:
H1: The crisis will have a negative effect on the abnormal returns earned by target companies.
This hypothesis is formed on the basis of the findings of Campello, Grahem and Harvey (2010), who find that, during the financial crisis, more than half of the financially constrained firms had to cancel their plans for investments.
This research did not find any significant evidence that the Great
Financial Crisis had any impact on the abnormal returns earned by a target firm. That being said, since this study only included 54 firms, which is just enough looking at the rule of thumb which requires at least 50 + number of independent variables, this could have tampered with the significance of the variables. The contribution of this study would have been significantly higher when more data
would have been available. For any future research on this subject it is highly recommended to extend the search for more companies. Perhaps the limitations followed by the criteria set in section 3.1.2. should be reexamined to see whether one or more of them could be left out. This will leave the researcher with a bigger database to perform the research.
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