Mergers and Acquisitions
2 Groningen, August 2007
Author Hero W.B. Knol
Student number 1212656
Thesis for Drs. Economics
Specialization Finance Faculty of Economics University of Groningen
Supervisor Prof. Dr. L.J.R. Scholtens
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Preface
You have started reading my thesis on the value creation of mergers and acquisitions. I have written this thesis as a conclusion of my study Economics, Business Administration. With this research I want to attribute to the ongoing debate whether or not mergers and acquisitions are value-creating.
When I started with the gathering of information to choose a subject for my thesis around October 2006 I never expected that I would not finish it before August 2007. Looking back, I can say it has been a real experience on which I worked with varying effort throughout the year. There have been moments that I did not know what direction to take. Especially in the beginning, the mass of opportunities seemed overwhelming. This led to gathering a lot of information, but not really processing it. On a certain point in time, I made decisions as to which research method I was going to use and for which time period I wanted to conduct research. From that point on there came structure in what I had to do and it became clearer, to me, what I had to do.
I would like to thank everybody who has contributed to my graduation period and who has helped me in the process of writing this thesis. Specifically, I want to thank my parents, brother and friends. They were always interested in the progress I made. Also, when I had a rough time with my thesis, they encouraged me to keep on going.
Hero Knol
4
Abstract
Companies participating in mergers and acquisitions always claim that the new entity will be worth more than the separate values of the two entities. In this thesis an insight is given in the rationale behind mergers and acquisitions. There is attention for corporate governance and the legal implications that arise when companies enter a merger or acquisition. Furthermore, the literature already available is reviewed. This thesis uses an event study to analyze the short term changes in value that occur when companies announce a merger or acquisition. Over the years 1998 until 2006 the value change that companies experience are researched. This has been done for targets as well as acquirers. Mergers and acquisitions in countries in North Europe and between these countries are the subject. For the target companies the results are ambiguous. The significant results give a mixed picture over the large event window. The significant results of the small event window show a uniform picture in which all the cumulative abnormal results indicate value increase. The results for the acquirers also show a mixed picture. The signs of value change differ across countries and years. The overall results are indistinct, as converted from all the significant results, the data on targets show different signs of value change.
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Index
Preface ... 3 Abstract ... 4 Index ... 5 1 Introduction ... 7 1.1 Motive ... 7 1.2 Research question ... 7 1.3 Reading guide ... 9 2 Literature review ... 102.1 What are mergers and acquisitions? ... 10
2.2 Reasons for mergers and acquisitions ... 11
2.3 Corporate governance and legal implications of mergers and acquisitions ... 12
2.4 Previous literature on the performance of mergers and acquisitions... 14
2.5 Efficient market hypothesis ... 17
2.6 Determination of expected returns ... 17
2.7 Conclusion ... 19
3 Data and Methodology ... 21
3.1 Methodology... 21
3.1.1 The model to calculate the cumulative average abnormal return ... 21
3.2 Databases and data ... 23
3.3 Composition of the data sample ... 24
3.4 Data calculations ... 26
3.5 Conclusion ... 26
4 Results ... 28
4.1 The results of the research ... 28
4.1.1 The results of the targets ... 29
4.1.2 The results of the acquirers ... 31
4.1.3 The cumulative results... 33
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5 Conclusions ... 37
5.1 Conclusion ... 37
5.2 Reflection on research ... 38
5.3 Recommendations ... 39
5.3.1 Concerning the research and its conclusions ... 39
5.3.2 Concerning future research ... 39
6 Literature ... 40
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1 Introduction
1.1 Motive
An article in The Economist (25/11/2006) about the merger and acquisition market that is booming again, got my attention. The article tells about new records in prices paid for mergers and acquisitions. Also, it points out that in this boom deals in Europe are more important. In the dotcom mania of the late 1990s and early 2000s, almost half of the deals were in the United States of America.
The article and other recent mergers and acquisitions in the Netherlands (Air France-KLM, KPN-Telfort, F. Van Lanschot Bankiers-Kempen & Co) did me wonder whether mergers and acquisitions pay off. Often, among reasons given to participate in mergers and acquisitions value creation is an important topic, i.e. by economies of scale or cost savings. I am curious to see if mergers and acquisitions as a whole create or destroy value. The last merger and acquisition wave in the late 1990s and the early 2000s showed that, particularly towards the end, prices got to high and value was destroyed.
The companies that participate in mergers and acquisitions always claim that the new entity will be worth more than the separate values of the entities. Managers talk about new markets that can be entered because of the merger/acquisition and efficiency that will be increased. Also, cost savings are an important point that is mentioned. Research on this value creation has not been conclusive. Most research finds a positive abnormal return for the target shareholders (Bruner, 2001). In contrast, the return to acquiring shareholders is found to be negative or small positive (Bruner, 2001).
Many of the papers found in academic journals evaluate the North American market of mergers and acquisitions. Databases with only US firms are used to investigate what the effects of mergers/acquisitions are and if abnormal returns are earned when a M&A transaction occurs. In contrast to the North American market, the research about returns that arise from mergers and acquisitions in Europe is less developed. Therefore, it will be very interesting to do a research of the European market of mergers and acquisitions.
1.2 Research question
8 Leeuw (1996) a research question consists of the objective, the main question and the
limiting conditions.
The objective of this research is to give an insight into the value consequences that occur when firms participate in a merger or acquisition. This translates into the following main question:
• To what extent do mergers and acquisitions in the European Market influence the value of the companies involved?
To answer the research question the sub questions written below are answered during the research.
1. What are mergers and acquisitions?
Mergers are defined as deals where the involved companies are roughly of equal size. Acquisitions are deals in which the acquirer is larger than the target. The detailed answer to this question can be found in chapter 2.
2. Which announcements of mergers and acquisitions have been made in the European market?
In this thesis the reactions to announcements of mergers and acquisitions that took place in the Netherlands, France, Germany and the Scandinavian countries (Norway, Sweden, Finland and Denmark) are analysed. In chapter 3 it is described how the sample has been composed.
3. What abnormal returns do mergers/acquisitions earn?
Abnormal returns are defined as the difference between the normal return according to the Capital Asset Pricing Model (CAPM) and the realized return. This is done for the combined firms. This is because the total wealth creation is the subject of this research. If abnormal returns are found, it is important to determine if they are statistically significant. The research of this thesis is directed to answer this question. In chapter 3 the methodology is laid out. In chapter 4 the results of the research, as to whether or not abnormal returns are earned, have been displayed.
Limiting conditions in this research are: The data available
The choice to diminish the research to six countries (Netherlands, Germany, France, Denmark, Norway, Sweden and Finland)
The time period over which the research is conducted
9 of Thomson Financial. Also, the Beta and market value variables are extracted from
Datastream. This leads to a sample of 83 announcements.
The methodology is that by means of an event study the abnormal returns that occur will be analyzed. The implication of an event study is that the markets are efficient. The effects of an event will immediately be reflected in asset prices (Campbell et al., 1997).
The intention of this thesis is to shed some more light on the question if mergers and acquisitions in Europe create or destroy value. Of course, there already has been quite a lot of research in this area. However, a large amount of research focuses on the United States. The contribution to the literature is that a very recent period is investigated, from 1998 until 2006. Research on the value creation or destruction of mergers and acquisitions has to be revised constantly. The environment changes, think of globalisation and corporate responsibility. During the literature search, the investigator has not found research that investigates the period of 1998-2006 and the countries researched in this thesis.
1.3 Reading guide
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2 Literature review
This chapter is structured as follows: paragraph 2.1 begins with a narrowing down of the definition of mergers and acquisitions. What are mergers and acquisitions and how is dealt with the different forms in this thesis? In paragraph 2.2 reasons to take part in mergers and acquisitions are revealed. This is from a theoretical background. Then, in paragraph 2.3, there is attention for corporate governance and legal issues that might affect the decisions and outcomes of mergers and acquisitions. Paragraph 2.4 reviews a selection of previous literature on studies that researched the performance effects of mergers and acquisitions. The efficient market hypothesis, an important assumption for an event study, is described in paragraph 2.5. Paragraph 2.6 treats two models to calculate expected returns. In the determination of abnormal returns a model to calculate the return that would have been expected is important. The chapter is concluded with paragraph 2.7.
2.1 What are mergers and acquisitions?
It is quite straightforward what mergers and acquisitions are. However, it is important to make clear what is understood by the terms in this thesis. Usually, mergers are deals in which both entities are roughly of equal size. In most acquisitions the target is smaller than the acquirer.
It happens that companies announce a deal as a merger while, according to the definition above, it strictly is an acquisition. An example in this light is the merger between Air France and KLM. KLM was, as a separate entity, considerably smaller than Air France. To overcome this fiddling with definitions, in this thesis mergers and acquisition are not treated separately.
Mergers and acquisitions sometimes include mergers, acquisitions, divestitures, alliances, joint ventures, restructuring, minority investments, licensing and franchising as well as international activities (Weston et al., 2004). That will not be the case in this thesis. Mergers and acquisitions are admitted into the data sample only when it is a merger, a hundred percent acquisition or an investment which gives the acquirer more than 50% of the shares; then it is assumed that the acquirer has the power to exert control over the new investment.
11 starts the information phase, in which the information memorandum that the target itself
prepared is received by the acquirer. The information memorandum consists of an analysis of the company together with future expectations. With the information memorandum as a basis the acquirer makes an indicating offer. When both parties think that there is room for negotiation the transaction phase will be entered. In the transaction phase the acquirer starts a due diligence investigation to prepare a final offer. When the target and acquirer negotiate a price, the offer is announced. Shareholders of the target are then able to offer their shares to the acquirer. When the acquirer makes its offer unconditional, the takeover process will be entered. In this process all assets of the target are transferred legally to the acquirer. After the takeover process the post-merger integration starts. The phase of post-merger integrations consists of the integration of the target into the acquirer and the realisation of the synergies becomes clear.
2.2 Reasons for mergers and acquisitions
Standard reasons for mergers and acquisitions are economies of scale and synergies. There are different theories about the value of the new entity that is created through a merger or acquisition. Weston et al. (2004) describe three different theories:
Value-increase
In this theory value is increased through synergies. Several synergies can be brought up: economies of scale, efficiency measures, improvement of production techniques and a combination of complementary resources.
Value-reduction
Free cash flow might cause value-reducing mergers and acquisitions. When a firm has a high free cash flow, it might be tempted to participate in projects with a negative net present value.
Another theory of value-reduction through mergers and acquisitions is that managers make themselves more valuable to the company by investing. Managers then make investments to lower the likelihood of their replacement.
Managerial hubris
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2.3 Corporate governance and legal implications of mergers and acquisitions
To protect shareholders from managerial decisions that decrease value, corporate governance systems have been created. Corporate governance is a system which states how companies are directed and controlled. It specifies how rights and responsibilities are divided among managers, shareholders and stakeholders. The decision making process is an important component of a corporate governance system.
Becht et al. (2005) have identified the following reasons as to why corporate governance is a prominent issue:
The worldwide privatisation wave that occurred the past two decades
This raised the question of how the privately held companies should be owned and controlled;
Pension fund reform and the increase in private savings
Pension and mutual funds have large sums of money under control. These funds invest them and they are large enough to influence corporate governance;
Takeover waves in the 1980s and 1990s
Hostile takeovers during these waves stimulated the public debate on corporate governance. Also, newly created giants that have a large stake in society were an important issue;
Deregulation and the integration of capital markets
Equity capital has been raised from increasingly different sources through cross-listing. This led to companies that had to follow foreign standards to be accepted; The Asia crisis in 1998
This showed that also in emerging markets a strong system of corporate governance is necessary to protect shareholders;
The USA scandals and corporate failures
Worldcom and Enron were very large companies that became notorious when it came to light that they overstated their earnings vastly in their accounts. That resulted in large losses and lawsuits against the managers.
13 Becht (2003) has written about the Takeover Directive of the European Commission.
This is a directive that aims to make control of European corporations more contestable. Also, minority shareholders and employees should be protected. The European Commission wanted a European Directive to smooth the progress of corporate restructuring. To establish that goal, it was believed that common rules and procedures for the whole European market should be necessary. The result of a directive would help to achieve a single capital market and enhance European competitiveness, innovation and growth.
Features:
1. Mandatory bid rule to protect minority shareholders; 2. Squeeze-out provision allowing bidders to go private;
3. Board-neutrality rule, to quickly put the bid to the shareholders instead of the board going bargaining.
It was a framework, thereby giving member states considerable freedom. Many member states already made legislation regarding takeovers that exceeded the requirements of the directive. However, reciprocity in takeovers was demanded. Reciprocity means that only companies that are subject to the same takeover rules can participate in mergers and acquisitions.
There are two models of corporate control and each of them has two options: Blockholder model: individual, group or organisation hold many of the votes.
o One-share-one-vote o One-share-more-votes
Corporation model: large number of small shareholders who, individually, hold a small number of votes
o Open to hostile takeovers o Not open to hostile takeovers
Reciprocity in takeovers can be achieved by making sure that the control of takeover targets is contestable. Furthermore, it is important that only companies which are equally vulnerable to contestable control are capable of participating in takeovers. Statutory takeover protections must be absent to reach this goal, but there are alternative solutions. It is also possible to make legislation that allows to break takeover protections.
14 takeovers. However, the blockholder controlled company cannot be taken over due to
the blockholders.
The Portuguese proposal requires that blockholder controlled companies become widely held companies, by applying the one-member-one-vote principle. The current proposal, that combines the Takeover Directive with the Winter and the Portuguese proposal, will not ensure full reciprocity. Becht describes several important precedents of laws and regulations that exist already in member states. Further, it is explained that full reciprocity limits the possibilities for mergers and acquisitions. Full reciprocity means that only companies that are open to hostile bids are allowed to participate in mergers and acquisitions.
In 2004, the European Commission accepted a version of the Takeover Directive. It has to be effective as of June 2006. In the final Takeover Directive that is accepted the freezing of extraordinary rights is made optional. Recommendations made in the Winter proposal have been taken into account in the accepted version (europa.eu, 06-07-2007).
2.4 Previous literature on the performance of mergers and acquisitions
The twentieth century has seen five great merger waves (Gugler et al., 2003). They occurred during the beginning of the century, in the 1920s, the 1960s, the 1980s and towards the end of the 1990s. The main characteristics of the waves were (Kleinert et al., 2002) (beechmontcrest.com, 12-08-2007):
1897-1904: the industrial revolution, this enabled high scale economies with the use of the steam engine. It is the emergence of heavy industries. Merger activities were mainly horizontal;
1920-1929: vertical and conglomerate mergers, thereby forming oligopolies;
1965-1975: this merger wave was about the exploitation of economies of scale by mass production. Diversification of products and acquiring firms from other markets was seen to create large conglomerates;
1984-1988: in Europe firms wanted to convert national champions into international ones. This was to prepare for the completion of the single market. Synergies were expected from the merging of production activities from related technologies. Merger and acquisition targets were very large and debt came into play to finance deals;
15 The first waves took place mostly in the United States and the United Kingdom. The last
wave of the twentieth century, in the end of the 1990s, was worldwide. However, it was limited to the industrialized countries.
Gugler et al. (2003) researched the profitability development of mergers and acquisitions by comparing accounting values (profit and sales) to a benchmark of comparable companies. For the sample as a whole, they found that the difference between the projected and actual profit is positive in every single of five years. On the other hand, the difference between the projected and actual sales was negative for the five years after the deal was completed. This was explained by an increase in market power of the new entity. Had the deal increased the efficiency of the merging firms, then profit and sales both should have increased. When a deal decreases the efficiency, the expectation is that profit as well as sales should have declined. In a breakdown of the results they showed that the expectations are met.
An important source of information for companies that are negotiating for a merger or acquisition is the market. Luo (2005) has researched if companies learn from market information during the process. The outcome of this research shows that merging companies learn from the market in that abnormal returns around the announcement date of the merger or acquisition predict if the deal will be consummated.
Loughran and Vijh, (1997) found that the market sees a strong signal in the way that a merger or acquisition is paid for. They find that returns are greater for tender offers that are paid with cash than for merger offers that are paid for with stocks. Loughran and Vijh give two explanations for these effects. Tender offers which are usually hostile to incumbent managers, could realize wealth gains because of the appointment of more efficient managers as proposed by Martin and McConnel (1991). Second, it is more likely that payment in stocks is chosen when managers feel that the stocks are overvalued.
As mentioned before, there have been numerous studies to determine the value creation of mergers and acquisitions. In 2002 Bruner put the results of 128 studies next to each other. The investigated studies were published between 1971 to 2001. Bruner (2002) used a benchmark, the return on projects with similar risk that investors could have earned. The return of the benchmark was compared with the return on the merger or acquisition. Bruner used event studies, accounting studies, surveys of executives and clinical studies for his research.
16 Event studies show that the returns to target firms deliver a positive abnormal return
to the target firms;
In event studies the abnormal return to the buyer firms is, on aggregate, zero; The net economic gain in event studies is positive;
Analyses based on reported financial performance are not conclusive and an aggregate conclusion cannot be extracted from it;
Diversification is a value-destroyer, while focus conserves value; Expected synergies are important wealth creation drivers;
Value-oriented buyers (low book-to-market) pay off and glamour-oriented buyers (high book-to-market) destroy value;
Enhancing the market position through M&A does not pay; Stock-based deals underperform;
Regulation of mergers and acquisitions is costly;
Using a high free cash flow to perform deals destroys value; Tender offers create value;
The higher risk for the manager, the more value is created; Initiation of M&A programmes is associated with value creation.
Surveys of executives reveal that in the bulk of the deals at least the cost of capital is earned;
In clinical studies possible drivers of return from acquisition are listed. Strategic, financial and organizational issues play an important role.
Andrade et al. (2001) give an overview of the trends and characteristics of mergers and acquisitions over the last decades. They show that several theories for why mergers occur are provided: economies of scale, efficiency reasons (synergies), attempts to create market power, market discipline, to take advantage of opportunities for diversification. Some of these theories are more relevant in certain time periods. Since the 1960s there have been three major waves of takeover activity in the United States. In time there have been differences in the method of payment for mergers/acquisitions. The method of payment in the 1990s was stock for about 70% of the mergers or acquisitions. Hostile bids almost disappeared in the last decade. In the 1990s the trend that both parties in a merger or acquisition are in the same industry has been continued. Andrade et al. (2001) further hypothesize that merger waves might be due to industry-level shocks. Deregulation has been such an industry-industry-level shock that has been a key driver in merger activity over the last decade.
17 predominantly in the United States and the United Kingdom. Also, these countries have
markets that are very liquid and well-developed. Only the last merger wave in the 1990s and the current merger wave are worldwide oriented (in the industrialized countries). A reason that the last waves also occur in the European countries can be the disappearance of protection constructions that made it difficult or even impossible to takeover. The privatisation of state companies are a vivid example of this phenomenon.
There has been research that subjects the European market. Goergen and Renneboog (2004), for example, investigate the European market of mergers and acquisitions. They find that synergies are the prime motivation for mergers and acquisitions. Also, wealth effects are shared between the bidders and the targets. The method of payment (cash or equity or a combination) is a factor in the short-run wealth effects that occur around the time of the offer. These short-run effects, measured by calculating the cumulative average abnormal returns, tend to be positive.
2.5 Efficient market hypothesis
For an event study it is important to assume that markets are efficient. An efficient capital market means that all available information is reflected in the stock prices (Elton and Gruber, 1995). There are three categories of efficient markets:
Weak form efficiency: all information in historical prices are reflected in current stock prices;
Semi-strong form efficiency: all publicly available information is reflected in stock prices;
Strong form efficiency: all information (also inside information) is reflected in stocks prices.
The efficient market hypothesis is an informational efficiency measure. This means it is a theory about the speed with which information is reflected in prices of stocks.
2.6 Determination of expected returns
To measure abnormal returns it is necessary to define how they are determined. Abnormal returns are actual returns in excess or shortage of the expected returns. There are different ways to calculate the expected return of a security. One can think of the Capital Asset Pricing Model (CAPM) or the Arbitrage Pricing Theory (APT) (Elton and Gruber, 1995). The CAPM is developed independently by Sharpe, Linter and Mossin. It is a simple model with stringent assumptions. However, it does a good job of describing prices in the capital markets. The assumptions underlying the CAPM are:
18 3. Personal income tax is absent;
4. An individual cannot affect the price of a security by its buying or selling action; 5. Investors make decisions solely in terms of expected values and standard deviations
of the return on their portfolios; 6. Unlimited short sales are allowed;
7. Unlimited lending and borrowing at the riskless rate is possible;
8. Investors are concerned with the mean and variance of returns and define the relevant period in exactly the same manner;
9. All investors are having the identical expectations with respect to the necessary inputs to the portfolio decision;
10. All assets are marketable.
The CAPM equation is: . The expected return of a security ( ) is a function of the risk-free rate ( ) and the systematic risk of the security ( ) times the risk premium (the market return ( ) minus the risk-free return).
The CAPM is a theory that has been very thoroughly tested. There is evidence that the CAPM does a good job at predicting expected returns. On the other hand, several anomalies in the CAPM have been discovered. Overall, the CAPM gives a good insight.
The Arbitrage Pricing Theory is a theory that uses a different approach to determine asset prices. It requires four assumptions (Grinblatt and Titman, 2002):
1. Returns can be described by a factor model;
2. There are no arbitrage opportunities (law of one price);
3. There are a large number of securities. This leads to the possibility to form portfolios that diversify the firm-specific risk of individual stocks. This allows to pretend that firm-specific risk does not exist;
4. The financial markets are frictionless.
The APT is more general. It requires that the returns on any stock is linearly related to a
set of factors. A standard APT equation is: (Elton and
19 The Capital Asset Pricing Model and the Arbitrage Pricing Theory both attempt to
determine asset prices. The CAPM is a fairly simple model with stringent assumptions. Nonetheless, it is a model which is thoroughly tested. Although the tests were not all in favour of it, the CAPM is believed to do a good job at determining expected returns. The APT is a model with less assumptions. However, the use of factors make it a lot more time-consuming to use when the expected returns of a variety of different securities has to be calculated. For every security (or at least for every industry) it would be necessary to estimate or identify the factors and the firm attributes that belong to them would have to be estimated.
The CAPM is chosen as the model to estimate expected returns. This is due to the convenience, the widespread use, the test results of the CAPM and the availability of the necessary data.
2.7 Conclusion
From the literature review there can be drawn conclusions that are of value for the rest of this thesis. It is clear that mergers and acquisition can be a variety of things. The narrowing down of the definition for the use in this thesis is useful. This is also necessary to answer sub question 1 of the research question: What are mergers and acquisitions? Mergers and acquisitions are recognized as being one only when it is a merger, a hundred percent acquisition or an investment which gives the acquirer more than 50% of the shares. The acquirer must gain such a share of the target that it can exhibit control over it.
In addition, legal issues arise when companies want to participate in mergers and acquisitions. The literature shows that legislation surrounding mergers and acquisitions has a goal of creating a takeover market that is flexible and competitive. The literature section in this chapter showed that past research often not agrees as to the value consequences of mergers and acquisitions. Disagreement stems from different measuring techniques, different time frames and different sample selections. Bruner (2002) found that event studies on the aggregate find positive abnormal returns to target shareholders, a zero abnormal return to buyer shareholders and that a net economic gain is obtained.
The concept of market efficiency is an important assumption in this thesis. Market efficiency is assumed to ensure that all information is reflected in the prices. In this thesis the semi-strong form of market efficiency is assumed. When information comes publicly available it is assumed to be reflected in the share price immediately.
20 has to be used in the CAPM and the clear definition of those data, the CAPM will be used
21
3 Data and Methodology
The data and methodology that are used in this thesis to conduct the research are discussed in this chapter. It begins in paragraph 3.1 with the methodology and its theoretical backgrounds. The databases that are used and the data extracted from them are the subject in paragraph 3.2. The second sub question: Which announcements of mergers and acquisitions have been made in the European market? is answered in paragraph 3.3. A detailed view of the final composition is shown. The way the calculations have been made and which software programs have been used is shortly described in paragraph 3.4. Finally, in paragraph 3.5 the main topics of this chapter are resumed in the conclusion.
3.1 Methodology
The methodology used in this thesis is an event study. An event study is an analysis of whether there is a reaction in financial markets to occurrences of a given type of event (merger or acquisition in this thesis) that is hypothesized to affect the public firms‟ market values (Grinblatt and Titman, 2002). Duso et al. (2006) have established that the event study methodology is useful for the competitive analysis of mergers and acquisitions. An event study is a short-term study. It captures the effects that are expected by investors. The knowledge of the market at the time of the announcement is incorporated. In contrast to an event study, long-term studies can be conducted to investigate the realized gains of the merger or acquisition. In a long term study, over several years, there are other factors that influence the performance of a merger or acquisition. Other factors include but are not limited to: the development of the economic state of the economy, terrorist attacks, competitors changing their strategy to cope with the new entity, disasters of any kind.
The usefulness of an event study lies in the assumption that the effect of an event will be reflected immediately in asset prices in the marketplace (Campbell et al., 1997). The assumption of market efficiency is important in this respect. On the rumour or announcement date of a merger or acquisition, the prices will immediately change to reflect the new information.
3.1.1 The model to calculate the cumulative average abnormal return
22 examined to determine if there are abnormal returns. The first is from 20 trading days
before the announcement until the day of the announcement (-20,0). The second time frame is shorter and ranges from five trading days before the announcement until one day after the announcement date (-5,1). The large time frame (-20,0) is chosen to detect rumouring before the announcement date. Often it is seen that before the announcement of a merger or acquisition there are signs in that direction. That might lead to abnormal returns earned before the announcement date. The small time frame (-5,1) is chosen to focus on the reaction to the real announcement.
With:
= Abnormal Return = Actual return = Expected return
The actual return of the security is calculated with the use of the closing price of the stock. This is done on a daily basis.
With the help of the CAPM model the expected return is calculated. The CAPM model as shown in chapter 2 is used. The equation is: .
With:
= The 3-month LIBOR
= The beta of the stock 3 months prior to the announcement derived from Datastream
= The return of the market index. In this calculation the market index is the leading market index of the country in which the stock is traded.
In this thesis the interest lies in the value creation or destruction. Therefore, the cumulative abnormal return (CAR) is calculated.
After that, the cumulative average abnormal return (CAAR) is calculated to give an insight into the net value change.
With:
= Market Value
23 The test statistic used to assess the significance of the results is (Kothari and Warner,
1997):
.
In this test statistic, the is an estimator of the standard deviation of the CAR. This leads to an estimation of the variance of the CAR: . The significance for the aggregated CAR is also of importance. The aggregation of the cumulative abnormal results takes place following MacKinlay (1997): . For the aggregated CAR the test statistic is: . The estimation of the standard deviation of the aggregated CAR is: . The test statistic gives a t-value with which it is possible to assess if the abnormal returns deviate significantly from zero. Statistical significance means that the statistical evidence suggests there is a difference (Moore and McCabe, 2000). In this test the significance shows if the CAR deviates from zero. The test executed is two-tailed, since positive as well as negative results are of importance. This test can be executed because normality is assumed to exist in stock price returns due to the central limit theorem (Lewis-Beck, 1993).3.2 Databases and data
The databases used to extract data on deals are Zephyr and Datastream. Zephyr, a database of Bureau van Dijk electronic publishing, is used to acquire a database of companies that participate in mergers and acquisitions.
In Zephyr, there were several problems that arose while trying to extract data on mergers and acquisitions. An attempt was made to extract data on rumours of mergers and acquisitions and on announcements. Then, a comparison between the abnormal results could have been made (if found). Also, it would be possible to assess the power of rumours alone. The problem that arose was that in the announcements sample, the rumours that were followed by an announcement were included. In those cases, only the date of announcement was mentioned. This meant that the two samples were very alike and on the date of the announcement/rumour a distinction could not be made.
Second, there has been a search on the method of payment (cash/shares/mix). The problem with this search was that Zephyr only distinguished that cash had been part of a (proposed) payment. So, when the method of payment for a deal was cash and shares, the deal would show up in all three samples. This too led to samples with a lot of overlap and this search therefore was not useful.
24 Also, a search where a minimum deal value was specified failed, because of lack of data.
The problems that arose when using Zephyr led to a data sample based solely on announcements. Of 136 deals data was extracted out of Zephyr. In Zephyr, the criteria that had to be met were:
Both the acquirer and the target had to be listed;
Only deals that occurred in or between Norway, Sweden, Finland, Denmark, The Netherlands, Germany and France are included;
The announcement of the deal had to be made between 1998 and 2006.
Datastream has been used to search for the necessary data to calculate the expected return and the cumulative average abnormal return. The data that had to be extracted were:
The 3-month LIBOR values;
Values of the main indices of the countries;
o Norway: Oslo SE OBX;
o Sweden: OMX Stockholm 30;
o Finland: OMX Helsinki 25;
o Denmark: OMX Copenhagen;
o The Netherlands: AEX;
o Germany: XETRA DAX 30;
o France: CAC 40;
Stock prices; Market values; Betas.
After a search in Datastream full data was found on 83 deals. This means that the data sample that is used for the research is composed of 83 mergers and acquisitions.
3.3 Composition of the data sample
25 Table 1 – sample composition
Announcements Total sample 83 Domestic 64 Cross-border 20 Country The Netherlands 3 France 21 Germany 11 Norway 2 Sweden 13 Finland 10 Denmark 3
From the table it can be seen that most deals happen domestically, 64 out of 83 deals are domestic of nature. 20 mergers and acquisitions are international, between the countries in the sample. When looking to the countries where the domestic mergers and acquisitions took place, it is noticed that in The Netherlands, Norway and Denmark only a few deals took place. These small samples might be explained by the size of the countries. This might lead to less domestic deals, international deals that involve other countries than taken into account in this research and deals that are exercised outside the stock markets. France is the most active market, followed by Sweden, Germany and Finland.
The research conducted in this thesis is based on deals on the period of 1998 until 2006. In table 2 the amount of deals per year are shown. Zephyr has data on mergers and acquisitions since 1998.
Table 2 – deals per year Year Number of announcements
26 In 1998 only one deal is recorded. This might be due to the fact that Zephyr has a base
date of 1998. Also, the few number of deals in 2004, 5, attract the attention. For the other years in the sample, at least 8 deals per year are recorded.
It must be borne in mind that this sample consists of deals where both the target and the acquirer are listed. The list is not exhaustive, as deals where private parties (think of private equity funds or family-owned companies) are not included. This is due to the non-availability of data on deals where such companies are involved.
The risk-free rate used in this research is the 3-month LIBOR. The Beta of the security is extracted from Datastream. The Beta used is the Beta calculated three months before the announcement date. This is to rule out influences of rumours that perhaps there will be a merger or acquisition. Because the Beta in Datastream is calculated over a large timeframe, the influence of this on the Beta is likely to be small. However, it is better to prevent such an influence by using an earlier calculation of Beta. The market return is the return of the market in which the security is traded. A European benchmark for the market return has been considered but has not been used, due to the fact that the trading place of the security is of importance to the return.
The closing prices of the securities, that are used to calculate the actual return, are also extracted from Datastream.
3.4 Data calculations
In this thesis the calculations have been done with a software program. For the actual return calculation and the expected return calculation Microsoft Office Excel 2007 has been used. Excel is a spreadsheet application which features calculation and graphing tools. In Excel the actual return is calculated with the following formula:
. For the calculation of the expected return the CAPM formula has been used. In paragraph 3.1 the data used to calculate the expected return already has been explained. The test statistics also have been calculated with the use of Microsoft Office Excel 2007. These have been done as is laid out in paragraph 3.1.
3.5 Conclusion
27 market expects if the merger or acquisition will create or destroy value. The test
statistics serve to determine whether the abnormal returns differ significantly from zero. To calculate the overall wealth creation of the merger or acquisition the cumulative average abnormal return is calculated. In the CAAR the market values of the target and acquirer are taken into account and this gives an insight in the total wealth creation of the merger or acquisition.
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4 Results
In chapter 3, the methodology of the research has been explained. Also, the data used for the research, where it is extracted from and how the calculus is done is laid out. In this chapter the results of the conducted event study are shown and the last sub question: What abnormal returns do mergers/acquisitions earn? is answered. In paragraph 4.1 the results of the research are treated. The results are broken down in different tables and explained likewise. Paragraph 4.2 concludes this chapter and summarizes the main results.
4.1 The results of the research
The results of the research will be discussed as following: in paragraph 4.1.1 the results of the targets are displayed. The results are broken down to countries and time period in years over which the calculations have been made. Paragraph 4.1.2 shows the cumulative abnormal returns of the acquirers. And in paragraph 4.1.3 the overall results are shown. These are the cumulative average abnormal returns that are of importance to answer the main question of this thesis. In the appendix all deals are summarized.
29 4.1.1 The results of the targets
The cumulative abnormal results that the targets realized in this research are shown and described in this subparagraph. It starts with table 3, where the cumulative abnormal returns of the target are displayed per country.
Table 3 – results per country of the targets
Event window CAR (-20,0) t-value CAR (-5,1) t-value
Norway 25,96% 1,105 27,26% 1,316 Sweden 12,86% 1,106 30,04% 2,825*** Finland -43,01% 3,393**** 2,93% 0,265 Denmark -21,35% 1,715 22,05% 1,048 The Netherlands -16,34% 3,334* -3,78% 0,980 Germany 10,46% 2,197* 6,33% 1,682 France -11,50% 3,873**** -2,79% 1,444 International deals 19,94% 3,773**** 14,86% 3,809**** significance level: * = 0,10 level ** = 0,05 level *** = 0,02 level **** = 0,01 level
The table shows that for the CAR (-20,0) the Finnish, Dutch, German, French and International values differ significantly from zero. These values do not give a unambiguous result. In Finland the value of target decreases by up to 43%. The Netherlands show a comparative image of value decrease for a target. However, the results are better than in Finland with a value decrease of 16%. In the other countries, Germany and France, and the International deals the results show a value increase. In Germany and France this increase is around 10%, while targets for which an international deal is announced show a value increase of almost 20%.
30 In table 4 the cumulative abnormal results per year realized by the targets are shown.
Table 4 – results per year of the targets
Event window CAR (-20,0) t-value CAR (-5,1) t-value
1998 -64,42% 1,854 0,56% 0,018 1999 -21,76% 2,763*** 2,13% 0,580 2000 -15,63% 1,407 12,12% 1,261 2001 41,45% 4,887**** 25,08% 3,962**** 2002 12,78% 0,257 17,38% 1,424 2003 0,43% 0,055 13,46% 1,995* 2004 -19,78% 5,052**** -6,58% 2,593* 2005 3,07% 1,172 3,41% 1,307 2006 1,28% 0,254 4,01% 0,927 significance level: * = 0,10 level ** = 0,05 level *** = 0,02 level **** = 0,01 level
Not all calculated values over the different years show significant results. For 1999, 2001 and 2004 it is determined that the results for CAR (-20,0) deviate significantly from zero. In 1999 a decrease in value occurs of 22%. However, 2001 targets experience a value increase of 41%. The 2004 value again scores a negative value of minus 20%. The CAR (-5,1) values are as well significant for three years. These are 2001, 2003 and 2004. The 2001 and 2003 values show an increase in value over the period of respectively 25% and 13%. In contrast to those findings, in 2004 the value of merger or acquisitions targets decreases over the period with 7%.
Table 5 – mean results over the whole sample period
Event window CAR (-20,0) t-value CAR (-5,1) t-value
Target 0,15% 0,057 10,21% 4,482**** significance level: * = 0,10 level ** = 0,05 level *** = 0,02 level **** = 0,01 level
31 In this subparagraph the cumulative abnormal results of the targets have been given.
Due to the low number of significant result it is hard to draw a conclusion. For the deals in table 3, the targets in International deals score significant for both event windows. It can be seen that the value increase for the CAR 20,0) is higher than for the CAR (-5,1). A lower CAR for the short event window might be caused by anticipation of a deal. The division in years shows for 2001 and 2004 significant values over both event windows. Here the years show different results. In 2001 the results show that the value increase over the large event window is larger than the value increase over the short event window. The 2004 results on the other hand, are negative for both event windows. However, the short event window value decrease is lower than that for the large event window.
The mean results over the whole time period show an increase in value over the CAR (-5,1)
4.1.2 The results of the acquirers
In this subparagraph the cumulative abnormal results of the acquiring firms in the sample are described. As in paragraph 4.1.1 it starts with the cumulative abnormal returns realized per country. These are shown in table 6.
Table 6 – results per country of the acquirers
Event window CAR (-20,0) t-value CAR (-5,1) t-value
Norway 58,74% 5,033 7,09% 1,776 Sweden -20,60% 4,645**** -7,44% 2,900*** Finland -55,21% 14,232**** -17,48% 9,128**** Denmark 2,61% 0,684 4,33% 1,168 The Netherlands 25,26% 7,697* 7,46% 3,892 Germany 33,90% 11,047**** 9,68% 4,012**** France 8,62% 3,899**** 3,19% 2,782*** International deals 9,63% 4,054**** 3,90% 2,752*** significance level: * = 0,10 level ** = 0,05 level *** = 0,02 level **** = 0,01 level
32 deals can be compared too, in both cases the value increase for CAR (-20,0) is 9% and
10%, respectively.
Significance is reached for the CAR (-5,1) in the same countries as the CAR (-20,0) with one exception: the CAR (-5,1) for The Netherlands is not significant. All values for the short event window show the same sign as the results for the long event window. Finnish and Swedish acquirers show less negative value decreases as for the long event window, respectively 7% and 17%. In Germany the CAR (-5,1) is positive and the value increase is almost 10%. France and International deals also show comparable increases in value of respectively 3% and 4%.
In table 7 the cumulative abnormal returns for the two event windows that the acquirers realized is shown per year.
Table 7 – results per year of the acquirers
Event window CAR (-20,0) t-value CAR (-5,1) t-value
1998 -79,92% 8,317 -17,84% 2,543 1999 -30,41% 10,142**** -10,37% 4,309**** 2000 -16,43% 3,715**** -8,04% 3,439**** 2001 26,35% 7,434**** 9,42% 4,688**** 2002 6,84% 5,354**** 9,76% 3,742**** 2003 -3,81% 1,078 0,31% 0,155 2004 4,08% 1,446 0,19% 0,140 2005 50,99% 19,431**** 17,25% 11,649**** 2006 17,38% 6,293**** 5,46% 3,275*** significance level: * = 0,10 level ** = 0,05 level *** = 0,02 level **** = 0,01 level
The results of the acquirers are for the CAR (-20,0) significant in six out of the nine years. In 1999 and 2000 the acquirers suffer a value decrease of 30% and 16% respectively. In these years perceptions of investors towards mergers and acquisitions are negative. This might be due to the winner‟s curse, while in these years the market of mergers and acquisitions was exploding. The cumulative abnormal results were positive in 2001 and 2002. However, in 2001 the value increase is 26% and on 2002 7%. In 2005 the increase in value is 51%. This is a high value and in 2006 it is not matched, the increase is then 17%.
33 the value increase over the CAR (-5,1) is 9% which is a smaller increase than over the
CAR (-20,0). The 2002 10% increase in value over the short event window is larger than the increase over the large event window. This might indicate that the deal was not anticipated. 2005 and 2006 show a comparable pattern as 2001 with the CAR (-5,1) lower than the CAR (-20,0). The increases are 17% and 5%, respectively.
Table 8 – mean results over the whole sample period
Event window (-20,0) t-value (-5,1) t-value
Acquirer (CAR) 2,53% 2,242** 0,58% 0,882 significance level: * = 0,10 level ** = 0,05 level *** = 0,02 level **** = 0,01 level
Table 8 shows the mean cumulative abnormal return for acquirers over the whole sample period. In the table it can be seen that the CAR (-20,0) is significantly different from zero. Over the event window, the increase in value for acquirers is 3%. This abnormal return is fairly small.
The cumulative abnormal returns for the acquirers give more significant results than those for the targets in paragraph 4.1.1. The Scandinavian countries with significant results, Sweden and Finland, suffer from negative cumulative abnormal results over both event windows. International deals and deals in the Northwest of Europe, Germany, France and The Netherlands for the CAR (-20,0) show positive value increases. The value increase for the CAR (-5,1) is smaller than for the large event window. A possible reason is that investors anticipated the announcement or that perhaps the proposed price is higher than expected.
The results when grouped per year show results in line with the grouping per country. Over the large event window the value increases or decreases are larger than over the short event window. An exception in this respect is 2002. This year, the CAR (-5,1) is larger than the CAR (-20,0). An explanation might be the unexpectedness of the announcement.
Here, the mean results for the acquirers display a small increase in value for the CAR (-20,0)
4.1.3 The cumulative results
34 measurement of the cumulative average abnormal returns, the returns of the target and
acquirers are weighed according to their market value. The cumulative average abnormal returns per country over the whole time period are displayed in table 9.
Table 9 – CAAR per country
Event window CAAR (-20,0) CAAR (-5,1)
Norway 44,22% 11,39% Sweden -21,44% -2,32% Finland -51,80% -13,66% Denmark 2,09% 8,41% The Netherlands 14,90% 5,42% Germany 24,97% 7,03% France 4,42% 1,81% International deals 12,25% 5,72%
The Norwegian CAAR (-20,0) and CAAR (-5,1) are positive and the CAAR (-20,0) is larger than the CAAR (-5,1). Swedish deals show a negative cumulative average abnormal return for the long event window. The result for the CAAR (-5,1) is a positive value. Finnish deals are perceived to negatively affect the value of the new entity that will be created. This perception is seen when measured over both event windows. Finland is the only country where the CAAR 5,1) is negative. In Denmark the CAAR (-20,0) is negative with a -10%. However, the CAAR (-5,1) is only small, but positive. The Netherlands show a positive CAAR (-20,0) and a small positive CAAR (-5,1). Germany shows a very large positive CAAR (-20,0) and a small positive CAR (-5,1). France shows a positive CAAR (-20,0), the CAAR (-5,1) is also positive. International deals are also believed to create wealth, with a CAAR (-20,0) that is positive and a CAAR (-5,1) that is small positive.
35 Table 10 – results per year
Event window CAAR (-20,0) CAAR (-5,1)
1998 -75,60% -12,71% 1999 -29,51% -8,87% 2000 -17,44% -4,58% 2001 23,41% 9,04% 2002 -3,07% 2,90% 2003 -5,69% 2,91% 2004 1,05% -0,14% 2005 38,63% 13,58% 2006 16,91% 6,01%
In 1998 the CAAR (-20,0) is negative, and the CAAR (-5,1) is negative, too. 1999 and 2000 show a large negative CAAR (-20,0) and a smaller negative CAAR (-5,1). The year 2001 shows a very large CAAR (-20,0) of almost 45% and a positive CAAR (-5,1). In 2002 and 2003 the CAAR (-20,0) is negative, whereas the CAAR (-5,1) is positive. The CAAR (-20,0) and CAAR (-5,1) in 2004 lie very near to each other, with the first being small positive and the second about zero. 2005 and 2006 then show large positive CAAR (-20,0) values and smaller positive CAAR (-5,1) values. For both event windows, the 2005 CAAR values are larger than the 2006 values.
Figure 1 gives a graphical reproduction of the results in table 10. From the graph it can be seen that over the years there are considerable differences in the cumulative average abnormal returns that are earned. The 1998 value is based on only one observation, so this value should not be looked at as important.
Figure 1 – results per year
36 Table 11 – cumulative average abnormal results for the sample as a whole
Event window (-20,0) (-5,1)
CAAR 0,38% 1,71%
For the CAAR the mean results over the whole sample and time period have been calculated. These are a mean CAAR (-20,0) of 0,38% and a mean CAAR (-5,1) of 1,71%. Due to the fact that no significance statistics are available for the cumulative average abnormal returns, no conclusions can be based upon them.
4.2 Conclusion
The results of the research that has been laid out in chapter 3 have been given in this chapter. These make it possible to answer the third sub question: What abnormal returns do mergers/acquisitions earn?
For the targets the results are ambiguous. When looking at the results per country the significant results give a mixed picture over the large event window. The significant results of the small event window show a uniform picture in which all the cumulative abnormal results indicate value increase.
The results for the acquirers also show a mixed picture. When looking at the results per country as well as the results per year the signs of value change differ across countries and years.
The cumulative average abnormal results are also inconclusive. Here, the remark that there has not been calculated a test statistic must be made. This means that no significance-based conclusions can be drawn from the cumulative average abnormal results. The calculated CAARs differ through countries and time. The overall CAAR shows very small but positive results for acquirers as well as targets.
37
5 Conclusions
In this chapter the results of the conducted research in the previous chapters have been used to answer the research question, as it is formulated in chapter 1 of this thesis. Paragraph 5.1 starts with a conclusion. First, the objective and research questions are repeated. Then, an answer will be formulated. In paragraph 5.2, a reflection is given on the method of research and the results. Finally, in paragraph 5.3, recommendations for future research are formulated.
5.1 Conclusion
The goal of this thesis was to assess the value consequences that occur when firms participate in a merger or acquisition. There was a main question formulated and three sub questions to reach the stated objective. The main question is: To what extent do mergers and acquisitions in the European market influence the value of the companies involved?
The goal of this thesis has been to shed light on the influence that a merger or acquisition has on the value of the involved companies. From the research it can be concluded that there cannot be drawn a uniform answer to the question as to in what direction mergers and acquisitions influence the value of the target companies involved. As an overall answer, converted from all the significant results, the data on targets show different signs of value change. This is for the different countries and years. The value change of the acquiring companies show the same picture. Where both event windows are significantly different from zero, the long and short event window show the same sign of value change. However, the short event window shows cumulative abnormal returns closer to zero than the long event window.
38 explained. After gathering all information data is found on 83 announcements of mergers
and acquisitions. All gathered information was then put through Excel to calculate the abnormal returns that were earned and the test statistics. The results of the calculations are described in chapter 4. This answers the last sub question: What abnormal returns do mergers/acquisitions earn? For both the targets and the acquirers the results are ambiguous. For the targets, when looking at the results per country the significant results give a mixed picture over the large event window. The significant results of the small event window show a uniform picture in which all the cumulative abnormal results indicate value increase. The results for the acquirers show, when looking at the results per country as well as the results per year, that the signs of value change differ across countries and years.
5.2 Reflection on research
In this research with a quantitative method a study has been conducted into the change in value of companies that participate in mergers and acquisitions. The methodology of an event study has been chosen as a method to research the influence of mergers and acquisitions on the value of the involved companies. Furthermore, choices for the database have been important for the results that have been achieved.
Looking back to this thesis and the conducted research, several reflections can be made. There were things that went well. However, some problems came to light, too. In conducting the research performing the calculus went good. In the Datastream database in almost all cases the necessary data was found, when there was data on a firm.
39
5.3 Recommendations
The research process and the research data give room for two sorts of recommendations. First, these are recommendations concerning the research and its conclusions. Second, there are recommendations concerning future research.
5.3.1 Concerning the research and its conclusions
Being a target is more profitable than being an acquirer. A manager is able to earn positive abnormal results when its company is an attractive target;
When an acquirer participates in a merger or acquisition, it is important to be cautious of the price paid. The cumulative abnormal return of acquirers are lower than that of targets;
The use of a more extensive database might have led to a larger sample.
5.3.2 Concerning future research
Extent the research to take into account the different sectors in which the mergers and acquisitions occur;
Extent the research so that it takes into account the means of payment;
Perform similar research with a different database to get round the problems that came to light with the use of Zephyr;
Research the rationale behind abnormal returns to assess whether the announcement is the only event that influences the stock price;
40
6 Literature
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Campbell, J.Y., Andrew, A.W., MacKinlay, A.C., 1997, The Econometrics of Financial Markets. New Jersey: Princeton University Press
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41 Kleinert, J., Klodt, H., 2002, „Causes and Consequences of Merger Waves,‟ Kiel Institute
of World Economics, Kiel Working Paper 1092, January 2002
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Internet
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7 Appendix
In this appendix the data of all the deals are displayed. For anonymity reasons, the names of the companies have been deleted. When the reader needs the company names, these can be acquired from the author of this thesis. A request to this purpose can be made by sending an e-mail to s1212656@student.rug.nl.
