Abandoned takeovers and their effect on the performance of the target firm

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Abandoned takeovers and their effect

on the performance of the target firm

Master thesis

MSc International Business and Management –

International Financial Management

Author: Xin Ming Yu s1842048 Supervisor: Dr. W. Westerman Co-assessor: Dr. H. Vrolijk

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Abstract

This paper studies the effects of abandoned takeovers on the performance of target firms after the withdrawal. In a sample consisting of target firms with their headquarters located in the Eurozone, the performance is measured and analyzed as well as a possible change in management structure after the bid withdrawal. It is hypothesized that the threat of a possible takeover increases the performance of the target firm afterwards due to a more efficient management. For targets that stayed independent after the attempt, this cannot be verified as no significant influence of management change on returns is found. However it must be noted that those firms indeed improve their performance after the takeover attempt compared to before. For firms that are subsequently acquired after the initial withdrawal the hypothesis can be confirmed.

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1 Introduction

Observations have shown that mergers and acquisitions come in waves. Up until now six global waves have been measured with the last one ending in 2007 (DePamphilis, 2009, Moschieri and Campa, 2009). The early waves of the 1900s, 1920s, 1960s and 1980s showed major merger activities in the US and the UK. The 1990s wave however can be considered as particularly remarkable in terms of size and geographical dispersion. Firms from Continental Europe were heavily involved this time and their M&A activities were at a similar level as those in the US. The introduction of the Euro, the globalization process, technological innovation, deregulation and privatization as well as the boom of the financial markets are drivers for European companies to participate in takeovers during the 1990s (Martynova and Renneboog, 2011). The recent global merger wave with its peak in 2007 ended due to a lack of credit, plunging equity markets and the financial crisis. Currently, merger activities show slight increases again which might indicate the start for a new wave in the near future (The Economist, 2010, De Pamphilis, 2009).

1.1 Problem statement

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European Union and examining their stock returns (Mandelker, 1974, Martynova and Renneboog, 2011).

1.2 Theoretical background

Integration problems, a poor strategy or an overestimation of the anticipated performance in the post-merger period are all factors which can lead to failure of M&As and the new firm’s performance is rather decreasing than increasing (DePamphilis, 2009). Problems can also occur in the pre-merger period. Especially in hostile takeovers, target firms might use defensive tactics to protect themselves, which can result in a bid withdrawal by the acquirer. In the UK, for example, 18,7% of the bids that were made between 1989 and 1995 were abandoned while the 1980s showed a failure rate of 25,2% (O’Sullivan, Wong, 1998, Holl, Kyriazis, 1996). It is empirically proven that takeover announcements do have an effect on the stock returns of target and bidder firms. However results are mixed, with some studies indicating positive results for bidder and target, some indicate negative, ones while some state no effect at all. Furthermore one has to distinguish between the effects on the target, which are often different than the effects on the bidder firm, and between completed and abandoned takeovers.

1.3 Research questions

As the theoretical background already states, different effects in form of stockholder returns can be determined after a takeover. As this research attempts to discuss the returns for abandoned ones with a focus on the target firms the following main research question has been developed:

What effects does an unsuccessful takeover attempt have on the subsequent performance of the target firm?

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24 months of the bid abandonment for target firms in the UK (O’Sullivan, Wong, 2001). In the US results are more mixed, as target firms which were subsequently acquired by another firm in a later period showed positive abnormal returns, reflecting the anticipation of the market, while firms that stayed independent showed negative ones (O’Sullivan, Wong, 2001). Based on this notion the following sub-question is:

Does an unsuccessful takeover attempt lead to a subsequent performance increase of the target firm?

The above mentioned positive performance development can partly be explained by the inefficient management hypothesis, where some firms become targets due to a weak performance caused by an inefficient management. For these firms, the threat of a takeover attempt can lead them to improve the performance afterwards which can be caused by a change in its strategy and management in order to prevent further interrogations (Bradley, 1980, Dodd and Ruback, 1977, Baron, 1983, Pickering, 1983, O’Sullivan and Wong, 2001). Although several factors can influence the performance of a target after a failed takeover, management turnover is considered to be one of the major factors (Fabozzi et. al, 1988, Holl and Pickering, 1988, O’Sullivan and Wong, 2001). Management change does not only occur when the merger is completed but also when it is abandoned, as targets realize their inefficiencies in management and change it subsequently in order to increase the overall performance. Thus the second sub-question is:

In case of a performance increase, is this caused by a subsequent management change after the takeover attempt?

1.4 Data collection

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before the announcement, also defined as the past performance of the firm in this study, the second one is the announcement period followed by the third one measuring the performance during the withdrawal and ends with the fourth period, which measures the performance after the withdrawal. The whole sample will be split into two sub-samples, one consisting of target firms that stayed independent after the takeover attempt and one with the remaining ones that were taken over within one year after the withdrawal. Due to this split comparisons can be made between the two sub-samples and possible differences and similarities can be detected. The second steps will examine the determinants of performance with a special focus on management turnover. It is assumed that management turnover will show a significant influence on the stock return and will also be the variable with the most explanatory power.

1.5 Further proceedings

The remainder of this paper will be structured as follows. The next section will provide the relevant theoretical background on the motives of M&A activities as well as the determinants of success and failure followed by the hypotheses development. Section three will deal with the applied methodology and data collection, whereas section four will display the results from the empirical analysis and relevant explanation. The conclusion and implications can be found in the last section.

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2 Literature review

The United States has always been considered as the most active M&A market. In Europe only the United Kingdom showed its participation in several M&A deals. This situation however has changed. In the last two merger waves Continental Europe showed a similar level of M&As as the US indicating an increase in the future. Part of this development can be explained by the challenges brought about by the creation of a single European market and the introduction of the Euro in the 1990s. Especially fragmented and mostly domestically European firms chose for a takeover as a means to survive the tougher regional competition created by the new market. The introduction of the Euro has put additional pressure on the companies as it eliminated the currency risks within the Eurozone and reduced the home-bias of investors. Cross-border acquisitions can be seen as a possibility to yield cost advantages and to expand their businesses more rapidly abroad. Moreover, takeover activities were encouraged by the creation of a liquid European capital market, which provided firms with new sources of financing (Martynova and Renneboog, 2011).

2.1 Motives for M&A

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from either factor and from improved managerial practices. Empirically these synergies are supposed to be important determinants of shareholder wealth creation (DePamphilis, 2009). Economies of scales refer to the reduction of the average costs due to an increase in volume. Especially companies with substantial fixed overhead expenses can benefit from economies of scales. These can be realized when the companies are in the same line of business. Horizontal mergers can then eliminate duplication and concentrate a greater volume of activity into a given facility. Vertical mergers can lead to the designated benefits when a company expands forwards towards the customer or backwards towards the source of raw material by giving the acquiring company control over distribution and purchasing. Furthermore costs of communication, various forms of bargaining and opportunistic behavior can be avoided or reduced by vertical integration. Economies of scope on the other hand refer to the usage of a specific set of skills or an asset, currently employed producing a specific product or service to produce related products or services (Machiraju, 2003). This situation can occur if it is cheaper to combine two or more product lines in one firm than to produce them in different firms (DePamphilis, 2009). Diversification can be mentioned as a second major motive for M&As. Companies acquiring a different line of business can reduce the instability of earnings by combining two unrelated cash flows, which may be less volatile than their cash flows viewed separately. Furthermore investors may require a lower rate of return in a combined firm. Another reason for a company to diversify is to move from the acquiring company’s core product lines or markets into those that have higher growth prospects. However empirical research suggests that investors do not benefit from diversification. They tend to perceive companies diversified in unrelated areas as riskier because they are more difficult for management to understand. It has also been proven that unrelated acquisitions are more likely to be divested than related ones (Machiraju, 2003, DePamphilis, 2009).

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firm tend to be over optimistic in valuating potential synergies and thus are easily trapped in the so-called winner’s curse. In an auction environment with many bidders, the existence of a wide range of bids for a target company is very likely. The result is a winning bid, often substantially in excess of the expected value of the target. This situation occurs due to the competitive nature of the process and the difficulty experienced by the bidders in estimating the true value of the target. In the end the winner is cursed in paying more than the company is worth and the feeling of remorse in doing so (Machiraju, 2003, DePamphilis, 2009).

Tax considerations are also often mentioned as motive for M&As. Tax reductions can be achieved by a takeover in three ways. The first one is the use of tax losses. A firm with a profitable division and an unprofitable one will have a low tax bill, because it can use the loss in one division to offset the income in the other division. However, if those two divisions are separate companies, the usage of the loss is not possible. Thus by merging the two divisions a tax gain can be achieved. A second way is to activate unused debt capacity. Two cases exist where a takeover allows for increased debt and a larger tax shield. In the first case the target has too little debt and the acquirer can fill this gap with debt, generating a larger tax shield. In the second case both firms, the target and the acquirer already have optimal debt levels. A merger can lead to a risk reduction, creating a greater debt capacity and thus a greater tax shield. A third way is to use surplus funds. A firm with free cash flows can either choose to pay dividends or to buy back shares. By choosing a third option, namely an acquisition, the shareholders of the acquiring firm can avoid the taxes they would have otherwise paid on dividends (Hillier et al., 2009).

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Mismanagement that occurs due to agency problems in the target firm can be another motivation for firms to consider an acquisition. These problems arise when goal incongruence between the firm’s management and its shareholders exists. Managers who serve as agents for the shareholders often may be more inclined to focus on job security or a luxurious life-style than on maximizing shareholder value. When the shares of a company are spread across a large number of shareholders, each shareholder only has to bear a small portion of the total agency costs. Thus mismanagement might be tolerated for a long period. According to the agency hypothesis, mergers take place to correct situations where there is a separation between the goals of management and owners. As a result of ongoing agency problems, firms often show a performance decrease in the form of low stock prices, which make them even more vulnerable for a takeover (DePamphilis, 2009). If the incumbent management does not succeed in taking actions to prevent a further downfall, a takeover can be seen as a correction of managerial failure (Weston et al., 2001). In this case takeovers take a disciplinary role in the so called market of corporate control. The acquirer searches for poorly-performing target firms and replaces management after the takeover or forces existing management to follow a profit maximizing strategy (Halpern, 1983, Parrino and Harris, 1999, Chen and Cornu, 2002, Martynova and Renneboog, 2011). Studies in the US showed that acquirers following this motive experienced a greater increase in performance during the post-acquisition period than firms following the synergy motive (Parrino and Harris, 1999).

2.2 The market for corporate control

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The market of corporate control operates within the firm as well as outside of the firm (Machiraju, 2003). One of the most important internal control mechanisms is the board of directors. The primary responsibility of the board is to monitor and assess the firm’s performance. One of the most powerful actions the board can take is the dismissal of the CEO or other members of top management. In order to perform its control function effectively, the board must be able to extract information about the true managerial performance of the firm from noisy and sometimes disguised or misleading accounting numbers. However, as several events in the past have shown, the board is not always efficient in fulfilling its control task. Sometimes the internal processes in large companies are too slow and costly to implement the required management changes. In these cases the market for corporate control may act as a “court of last resort” by providing a takeover as an efficient alternative to remove unresponsive managers, when the board is reluctant or unable to do so (Dayha and Powell, 1998).

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shown that hostile takeovers are usually associated with the disciplinary function of the takeover market (Hirshleifer and Thakor, 1994, Chen and Cornu, 2002, Kini, Karacaw and Mian 2004). However one should note that an interplay between the internal and the external control mechanisms exists. The takeover market is less active and less important when the board of directors is fulfilling its task of removing inefficient management. Conversely the board’s behavior is likely to be affected by its knowledge of an active takeover market (Hirshleifer and Thakor, 1994). Thus in periods with a less effective internal control mechanism, takeover activities are more intense and hostile, while periods with more evolved control mechanisms show a less active and friendlier takeover market (Hirshleifer and Thakor, 1994, Kini, Kracaw and Mian, 2004).

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exists (Kennedy and Limmack, 1996, Franks and Meyer, 1996). It can be argued that firms performing poorly because of an inefficient management before the takeover are more likely to become a target and experience a change in management after the takeover. The empirical results for this however are mixed. Martin and McConell (1991) found a strong link between the pre-takeover performance of target firms and a subsequent management change in the U.S. Chen and Cornu (2002) examined the pre-takeover performance of targets in hostile takeovers in comparison with targets involved in friendly takeovers and the overall market with the results that targets in hostile takeovers do significantly outperform the market but also significantly underperform their peers in friendly takeovers in the pre-takeover announcement phase. Hambrick and Canella (1993) reported that the turnover rate increases the greater the difference between bidder and target pre-takeover performance. Kini et al. (2004) state a weak significant negative relation between the probability of post-takeover CEO change and pre-takeover performance, indicating that the chances increase for a CEO turnover with a poor performance of the target prior to the takeover. However this result is only statistically significant for the first period of 1979-1988 and turns insignificant during the second period 1989-1998. In the UK only little evidence exists which supports this relationship. Franks and Mayer (1996) only provide little support of poor pre-takeover performance of targets when using Tobin’s q as a measure for performance. Dayha and Powell (1998) do identify a poorer pre-takeover profitability of targets involved in a hostile takeover compared with targets in friendly ones.

2.3 The effects of takeovers

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managed firms, but does not reward poorly managed firms taking over well-managed firms.

By only looking at bidding firm’s shareholders Jensen and Ruback (1983) found that shareholders in successful or completed takeovers realize significant positive returns ranging from 2,40% to 6,70%. However the results on bidding firm returns in mergers are mixed and the authors conclude that on the whole the returns for bidders are on average zero. Jarell, Brickly and Netter (1988) report declining returns for the bidding firm in the 1970s and 1980s compared to the returns in the 1960s. Several studies also state negative returns for bidding firm’s shareholders. Black, Carnes and Jandik (2001) suggest negative abnormal returns of -13,20% and -22,90% over a three and five year window for successful takeovers. By contrast surveys conducted by Bradley, Desai and Kim (1988) and Weston and Copeland (1992) report positive abnormal returns for bidder firms. This notion is also supported by Gosh (2002) who finds an average increase of the post-acquisition share of 20% for the acquirer when compared to the pre-post-acquisition level. Studies also exist which could only identify small or no return effects at all (Loderer and Martin, 1990, Maquieria et al., 1998, Eckbo and Thorburn, 2000). The research of Parrino and Harris (1999) shows a positive increase in operating cash flow return of 2,10% after a merger. Meta-analysis conducted by Bruner (2002) and Campa and Hernando (2004) note that negative returns can vary between -1% to -7%. Bruner (2002) comes to the conclusion that one third of the observed studies show value destruction, one third show value conservation and one third shows value creation. A study by Goergen and Renneboog (2004) analyzing the European M&A market indicate a positive announcement effect for the shares of the bidding firm of 0,70%. Overall the evidence about returns achieved by bidding firms is inconclusive with reports of negative, zero and positive returns (Soongswang, 2009).

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stock price one month subsequent to the execution of the takeover. In his sample bidding firms paid target shareholders an average premium of 49% for the shares they purchased during the takeover process. After the completed takeover the realized capital gain is 36% on the shares target shareholders retained after the completed takeover. In the period of 1963-1982, returns between 24% and 29% were found (Jarell and Poulsen, 1989, Servaes, 1991, Kaplan and Weisbach, 1992). In the 1990s the abnormal returns for targets remained on a similar level of 21% (Mulherin and Boone, 2000). High abnormal returns can also be found for the UK and Continental Europe. In the period from 1955-2001 returns varied between 13% and 24% (Franks and Harris, 1989, Danbolt, 2004, Goergen and Renneboog, 2004). These gains are not only limited to the announcement date but commence already in the days before the public announcement of the bid (Schwert, 1996). This implies that the bids are anticipated and result from rumors, information leakages or insider trading (Martynova and Renneboog, 2011).

2.4 Abandoned takeovers

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influences management’s reaction. It can be assumed that in general ownership structure and governance mechanisms have to be taken into account. Another factor which is also expected to be influential is the amount and method of payment chosen by the bidder. In order to convince the shareholders of the target to sell their shares to the bidder a premium is required in excess of the market share price. Therefore the acceptance of a bid also depends on the size of the premium. In addition, bidders can either purchase the target by offering a cash payment or the exchange of target shares for shares of the combined company. The relative certainty of the value of a cash payment compared to the uncertainty of the future value of the combined share is also likely to influence the bid acceptance of shareholders (O’Sullivan and Wong, 2001).

Despite of the dismissal of the acquisition, target firms can still gain after the termination. In the U.S a study of Dodd and Ruback (1977) suggest that target firms in unsuccessful takeovers are permanently revalued upwards. This result lead to them to the conclusion that the announcement of a takeover attempt represents positive information about the target firm leading to improved efficiency, possibly through a disciplining effect on management. Bradley at al. (1983) also examined target firms in unsuccessful takeovers. However they made a differentiation between targets that received another offer after the first cancellation and those that did not, with the result that only those targets with a subsequent bid obtained permanent gains while the others lost all former benefits again. Therefore the authors conclude that the permanent revaluation of a target requires a change in control. Fabozzi et al. (1988) and O’Sullivan and Wong (2001) state that all of the offer-based price increases of the target’s stock vanished once the offer was cancelled suggesting that the market reacts quickly to a failure. Furthermore they also found that the target’s return over the post-failure year shows no influence of the initial offer but even a small decline.

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period showed positive abnormal returns, reflecting the anticipation of the market, while firms that stayed independent showed negative ones.

2.5 Hypotheses

Existing literature generally agrees on the disciplinary role played by the market of corporate control on firms with inefficiencies. One of the reasons for those inefficiencies to occur is an incompetent management which is not able to create and increase shareholder wealth. Thus takeovers can be seen as a way to correct those inefficiencies resulting in a performance increase. This cannot only be achieved in successful takeovers but also in unsuccessful ones; namely those that were not completed. As the literature review shows, empirical evidence exists for a performance increase of the target firm after an unsuccessful takeover attempt in form of positive effects on stock return (Dodd and Ruback, 1977, Bradley, 1980, Baron, 1983, O’Sullivan and Wong, 2001). Thus it can be argued that although the abnormal return of the bid announcement decreases again after the termination, target firms are still able to improve their performance in the long term due to e.g. correction of inefficiencies. Even in case of an unsuccessful bid it is still possible for the market of corporate control to exercise discipline over the target. Once an offer is placed the management of the target firm may successfully reject it by for example raising dividends for the shareholders in order to receive their support. This can lead to a price increase of the target’s share, thus making an acquisition more expensive (Taffler and Holl, 1991). The actions of the target management can be regarded as a response to the discipline exercised by the market of corporate control. This discipline can be referred to corrective discipline (Holl, 1977). Another explanation for this corrective discipline is suggested by Bradley et al. (1983), stating that the new information provided by the target firm during the bid process stimulates target management to improve its financial performance after it has successfully resisted the bid. Thus the following hypothesis states:

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Studies examining the returns of target firms involved in a successful takeover indicate that those firms realize a substantial and significant increase in their stock prizes in the post-acquisition period (Jensen and Ruback, 1983). In a four year period after the takeover, Cosh and Guest (2001) find a statistically significant abnormal return of 5,4% for the combined firm in hostile takeovers, whereas friendly takeovers generated a significant negative return of -9,3% in the UK. In the US studies tend to show an unchanged profitability of bidder and target firm or a significant improvement after the takeover (Heron and Lie, 2002). For Continental Europe a significant decline in post-acquisition sales of the combined firm could be documented, but also an insignificant increase in post-acquisition profit (Gugler et al., 2003). For targets that stayed independent after a takeover attempt mixed results are found as well in the long-term. According to Fabozzi et al. (1988) all excess returns which were realized during the announcement period were close to zero in the year after the withdrawal. Holl and Pickering (1988) did not find any improvement of the target’s financial performance three years after the takeover failure compared to three years before. However Limmack, (1991) as well as Parkison and Dobbins (1993) showed a permanent positive revaluation of the target firm after the bid withdrawal. All in all target firms seem neither to gain nor to loose despite being involved in a successful or failed takeover. As in both cases positive and negative performances were found, in total the independent targets should show a similar return as acquired ones, which leads to the following hypothesis:

H1b: The performance of independent target firms after the takeover attempt is comparable to the performance of acquired targets.

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performance and discipline underperforming top management (Fama, 1980). An effective board would then replace top managers if they show a poor performance for a certain period. However when the internal control mechanisms fail because of for example a lack of knowledge or information to assess executive performance, external disciplinary mechanisms become necessary. The announcement of a takeover attempt intended to discipline underperforming managers can push internal monitors to end their tolerance of poor performance or their reluctance to exercise their responsibilities (O’Sullivan, Wong, 2001, Tannous, Cheng, 2006). This notion leads to the second hypothesis:

H2a: Target companies change the composition of management after an unsuccessful takeover.

Takeovers that occur out of the inefficient management motive are aimed at improving the performance in terms of stockholder returns in the post-takeover period. In completed ones this is then done by changing the target management and replacing it with managers capable of increasing shareholder wealth. In case of abandoned takeovers, it can be argued that an unsuccessful takeover attempt can still function as an incentive for the target firm to change its management by itself in order to achieve better future performance (Franks and Mayer, 1996, O’Sullivan and Wong, 2001, Tannous and Cheng, 2006). Thus the following hypothesis states:

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3 Data, Sample statistics and Methodology

In order to test the above mentioned hypotheses the event study method using the market model and a regression analysis will be performed. The event study is a statistical method to assess the impact of a particular event on the value of a firm, in this case indicated by the stock price. In this case it will be used to measure the actual effect of the announcement event on the company’s stock by calculating the cumulative abnormal returns. The regression analysis will use the Ordinary Least Square method to determine the variables which influence the stock return.

3.1 Sample selection

The sample consisting of European acquisitions launched between 1999 and 2009 are selected from the Zephyr database, which provides detailed financial information regarding the actual deal and the parties involved. The chosen period begins with the introduction of the Euro and ends with the financial crisis; two important events which had a major influence on the European economy. As the research is focused on abandoned acquisitions, only those takeover bids are selected which were withdrawn again. Furthermore the interest is in examining the performance of target companies therefore the selection only includes targets located in the Eurozone. As the main focus of this research is the takeover market of Europe, targets from the first member states of the European Union are chosen as representatives for Europe. However the UK is excluded as already extensive research has been done for its well developed takeover market. This restriction does not hold for the bidding companies as it enhances the chances of more cross-border acquisition attempts if e.g. the US is also included. The resulting list consisted of 920 M&A announcements.

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measurement will be based on the abnormal returns, therefore private target firms not listed on a stock exchange are excluded from the sample. For a better comparability of the returns the targets also have to be listed in a stock exchange which is denoted in Euro. With the use of one common currency possible influences on stock prices caused by exchange rate volatility are avoided. Moreover to avoid biases amongst the results, acquisition attempts of bidder firms increasing their already existing stake in the target are excluded as well. Firms who had stakes in the target before the acquisition attempt might have already influenced the management or strategy of the target which could have affected the performance before the announcement.

The market return and the share prices of the firms are gathered from DataStream. However the required information could not be found for every selected company from Zephyr, thus further reductions had to be made and the final sample after all exclusions consists of 101 companies.

3.2 Sample statistics

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Table 1: Countries Country Number of observations France 19 Germany 16 The Netherlands 15 Italy 13 Spain 13 Austria 7 Ireland 6 Belgium/Luxembourg 5 Greece 3 Portugal 2 Finland 2 Total 101

Table 2: Takeover characteristics

Number of observations

Domestic bids 65

Cross-border bids 30

Domestic and cross-border bids 6

Rumours 21 Announcements 80

Hostile bid 68

Friendly bid 33

3.3 Methodology

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returns (AR) in this case are defined as the difference between the realized return (R) and the expected return (ER), which is the return without the acquisition attempt:

ARit= Rit - ERit (1)

with i being the firm’s security and t the being the time period. In order to adjust the returns for dividends and stock splits a return index is used instead of actual stock prices, which can be obtained from DataStream (Martynova and Renneboog, 2011). As not every company is necessarily listed on the stock exchange with its actual name, the company website and the relevant stock exchange websites were used as well to find the ISIN code of the relevant company to ensure the correctness of the returns for the companies.

In the existing literature the expected return is usually calculated by the market model, the market adjusted model or the Fama-French model. This research will use the market model for obtaining the benchmark return by conducting an OLS regression:

BRit= αi + βiRmt + εit (2)

with Rmt being the market return on day t. The coefficient αi is the intercept term for the

regression equation related to the target’s stock. βi is the coefficient that captures the

systematic risk of the target’s stock. For the market return the index of Standard and Poor’s Europe 350 is used. With the estimation of α and β the abnormal returns can then be calculated as follows:

ARit= Rit - αˆ −βˆ Rmt (3)

However as not all firms in the sample showed a significant β during the estimations, only the significant ones are included in further calculations. Thus the sample had to be reduced to 58 firms. The total effect of the event on the stock price can then be obtained by computing the cumulative abnormal returns (CAR).

∑

= = =t t2 t1 t t t2) (t1, AR CAR (4)

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period between -245 until -6 will be used to measure the past performance of the company approximately one year before the announcement. The days surrounding the event in this case the announcement of a bid offer will be used as an indicator for the immediate effect (-5 to +5).

Figure 1: Time line announcement

The event period is displayed in the following figure. Day -245 is the starting point for past performance measurements and lasts until day -5. The time period around event 1 refers to the announcement period.

Period 1: Past performance Period 2: Event 1

Days -245 -5 0 +5

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Figure 2: Time line withdrawal

The time line shows the second event period with the withdrawal as the event occurring on day 0 and day -5 to +5 measuring the returns around the event. The subsequent performance after the withdrawal is measured until day +495.

Period 1: Event 2 Period 2: Subsequent performance

Days -5 0 +5 +495

To test the significance of the cumulative abnormal returns the usually used parametric t-test is calculated (see appendix A).

In a second step a cross-sectional analysis will be performed to test whether management turnover has an influence on the stock return obtained from the above mentioned method. The used variables are summarized in the following table and explained in more detail later in this section.

Table 3: Definition of variables

This table lists the variables used for the cross-sectional analysis and the way they are included within the regression. The predicted relation indicates whether the variable is expected to have a positive or/and negative influence on the returns.

Definition Predicted relation to CAR

Dependent variable:

CAR: Cumulative abnormal returns calculated by using daily stock returns Independent variable:

MAN: Management turnover as a dummy variable with 0=no change and 1=change

Positive Control variables:

SIZE: Natural logarithm of the firm’s operating revenues in the year of the

takeover Positive

FIC: Financial crisis dummy variable with 0=no crisis and 1=crisis Negative ACE: Acquisition experience dummy variable with 0=no experience and

1=experience

Positive ACN: Nature of the acquisition dummy variable with 0=friendly bid and

1=hostile bid Positive

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In order to perform the above mentioned analysis the following regression is used:

CARit= α1 + α2MANi + α3SIZE i + α4FICi + α5ACEi + α6ACNi + α7DV + α8OWN + εi

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CARit is the cumulative abnormal return for the target. Here the return measured in the

last period (period after the withdrawal) will be used as the dependent variable as target management is most likely to change after the withdrawal. MANi is the dummy variable

that equals 1 when a change in management occurred and otherwise 0. This is the main independent variable as significant results would suggest that management turnover does have an influence on return. All other included variables will act as control variables. SIZE i refers to the target firm’s size which can be measured as its market value of equity

or the natural logarithm of its operating revenues (Goergen and Renneborg, 2004, Martynova et al., 2006). FICi is the dummy variable for the financial crisis taking the

number 1 for the period of 2008-2010 and 0 for the remaining periods. Although the sample only consists of firms that experienced a takeover attempt until 2009, return measurements also occurred in 2010 as an indicator for post-acquisition performance. As a takeover procedure including negotiations, bidding etc. can take around 9 or 10 months, effects of the financial crisis on M&A activities are lagging. Therefore the time period chosen for this variable is postponed for one year after the here defined start of the financial crisis in 2007. As the majority of companies experienced a performance decline during the financial crisis it is included as a control variable. ACEi is the general

acquisition experience of the target, which equals 1 if another acquisition attempt has been conducted after the original one and equals 0 if it did not become a target anymore. Many firms acted as a bidding firm before they received an offer or become a target after the withdrawal again. If the first takeover attempt is a failure the market might expect another bid, which is valued as a positive expectation and thus returns might remain higher than without that expectation. However if the market does not anticipate another bid the target will return to its former performance (O’Sullivan, Wong, 2001). For companies that acted as an acquirer before the observed event proved that they have the ability and resources to take over another company, which can be seen as a sign for financial strength and therefore should be valued as positive. ACNi refers to the nature of

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one. A hostile takeover attempt is more likely to perform the disciplinary role mentioned before and put pressure on the target to improve its performance in order to prevent future acquisitions. Friendly takeovers are agreed by the acquirer and the target and therefore provide less incentive for the target for restructuring and improvement (Franks, Mayers, 1996, Tannous, Cheng, 2006). DV refers to the deal value of the planned acquisition, which is measured as the natural logarithm of the value. As the deal value reflects the price the acquirer is willing to pay for the target, it can influence the target’s return as well. The more an acquirer is willing to pay the more positive should the effect be on the target. The market can see a high value as a positive sign for the target’s true value, which might not have been visible before. The last control variable OWN is associated with the ownership structure of the target. A differentiation is made between inside and outside ownership, where inside ownership consists of directors and senior management of the firm and their families and outside ownership refers to the remaining ones such as financial institutions or other corporations. With inside ownership target management might not always act in the shareholders best interest and thus choose the option that gives themselves the greatest benefits. These decisions must not always be beneficial for the firm and as a result returns can decrease. On the other hand managerial ownership also implies more dominance and power during a takeover process that could lead to better conditions for the target firm and influences returns positively. Outside ownership on the other hand is more focused on monitoring the firm and trying to push management into value-maximizing decisions. Although this kind of control can be costly, the overall gain often exceeds the costs and therefore can have a positive effect on returns (Dayha, Powell, 1998, Bauguess et al., 2009). In order to measure the ownership structure a dummy variable has been created with inside ownership being marked as 1 and outside ownership being marked as 0.

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signs. The Mann-Withney U test does not show any extraordinary or new results as well as the univariate analysis (see appendix B and D). All variables are tested for correlation. For those variables that showed a slight correlation the same regression was conducted again without them. However as it did not show any difference compared to the results before, they were included again (see appendix C).

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4 Empirical results

The following sections display the calculated abnormal returns as well as the results from the cross-sectional analysis which was conducted to test the hypotheses.

4.1 Abnormal returns

In order to get an extensive overview of the performance of abandoned target firms, the abnormal returns for the time period before, during and after the bid offer and withdrawal are measured.

Regarding the return before the bid offer announcement, 33% (19 firms) showed positive CARs, while 67% (39 firms) showed negative ones. For the positive returns the average CAR is 22,16%, whereas for the negative ones the average is -18, 69%. When taking the whole sample together (58 firms), the average CAR is -5,31%. These results are consistent with existent literature as most researches show mixed results. In this case the majority shows a negative performance in form of stock returns, while less firms show a positive one.

Table 4: Descriptive statistics

The results displayed in this table refer to target returns before the announcement and after the withdrawal. For every sub-sample of independent target firms, acquired ones and all targets the corresponding positive, negative and total returns are shown. For the announcement and withdrawal period only returns for all targets are shown.

Past performance Performance after takeover attempt

Independent Acquired Total Independent Acquired Total

Positive 21,95% (2,894)* (8,026)*** 22,81% (8,298)*** 22,16% (6,296)*** 38,82% (4,451)*** 16,05% (6,696)*** 21,60% Negative -21,26% (-5,493)*** (-3,795)** -15,68% (-6,653)*** -18,69% (-7,005)*** -30,17% (-3,797)** -17,17% (7,393)*** -25,59% Total -13,62% (2,804)* 1,16% (3,270)** -5,31% (-2,610)* -3,07% (-3,715)** 5,67% (-3,797)** 0,09% (3,231)** *Significant at a 10%,**5% and ***1% level respectively

Announcement Withdrawal Positive 13,71% (5,477)*** 14,7% (3,479)** Negative -7,32% (-3,477)** (-3,893)*** -12,41% Total 4,93% (2,658)* (-2,991)* -6,33%

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more pessimistic view by this information or lose their trust in the company, leading to even more negative returns. Generally positive returns during the withdrawal period can occur if the takeover is seen as a mistake and investors gain confidence again if the takeover is abandoned. Within the firms that experienced a positive return 54% (7 firms) showed a higher return during the withdrawal than the bid offer announcement. The remaining ones (6 firms) realized a lower return compared to the bid offer return. However these firms were all taken over within the next year after the withdrawal, thus the market might have already anticipated a future possible takeover by another acquirer and therefore the target still achieved a positive return, although lower than before.

From all observed firms 43% (25 firms) stayed at least independent for the chosen post-acquisition period of 490 days after the withdrawal. For those firms the performance after the withdrawal was measured as well. The majority of the firms (62%) showed negative abnormal returns in the period after the withdrawal, while 38% showed positive ones. As the first hypothesis states that target firms perform worse before the takeover attempt than after, the average return is compared. As not all firms from the initial sample stayed independent, only the past performances of the independent firms were taken and compared to the performance after the withdrawal. The calculated past average return for the 25 independent target firms is -13,1%, while the performance in the period after the withdrawal is -3,07%. Although the returns are negative in both periods, the target firms still show a clear improvement of nearly 10% in their post-takeover performance. For them the hypothesis can be confirmed as they showed a weaker performance before the bid offer and improved it afterwards. Here the performance improvement can be a possible result of the disciplinary effect of the market as takeovers act as a threat to firms that want to stay independent and thus leading them to improve their performance after the bid failure to prevent future bids. Also targets willing to be taken over might want to push the bid offer price or wait for another more suitable acquirer and therefore trying to achieve better results in order to promote the firm.

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afterwards. Furthermore if restructuring was the primary motive, the target management can fulfill this task by itself after rejecting the bid and gain from it (O’Sullivan and Wong, 2001). When looking at the firms with negative CAR, the independent targets also underperform the acquired ones by -13% (-30,17% compared to -17,17%). The negative returns for independent firms can result from the rejection of a value-maximizing takeover or the release of negative information about the company during the initial bid. For acquired companies negative returns can occur if the combined management is not able to integrate both firms properly and efficiencies cannot be used. Bradley et al. (1983) find similar results when observing two samples consisting of subsequently acquired firms and independent firms. Targets that were acquired after the initial withdrawal enjoyed positive CARs of 15,63% for the one year period and 17,35% for the two year period. In contrast, independent targets showed negative CARs in the post-abandonment period of -22,44% for the one year and -27,47% for the two year period. Taking the whole sample of the independent and the acquired firms the tendency is the same as in the study of Bradley et al. (1983), although the numbers are lower. However as the former mentioned study was conducted in 1983, market situations have changed and due to recent conditions such high abnormal returns are not as common as before. Furthermore the sample covers a time period of 11 years, where possible extremely high CARs might be offset by extremely low ones.

4.2 Management turnover and performance

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order to prevent more takeover attempts. The remaining 3 firms with a friendly takeover attempt experienced a management change due to the resignation of top managers. In friendly takeovers target’s top managers have a strong interest in its success and work hard to achieve it. If the takeover then ends in abandonment because of e.g. shareholder’s opposition, managers often feel betrayed by its shareholders or not rewarded for their work and thus leave the firm voluntarily.

Compared to a recent research by Tannous and Cheng (2006) the general management turnover rate found here is about 20% lower. However it has to be noted that the former mentioned research is based on the Canadian takeover market, which is likely to be influenced by the more developed and experienced US market. Studies conducted in the US in the past have proven the effectiveness of the takeover market as an instrument to discipline underperforming firms often with a change in management in successful as well as in unsuccessful takeovers. Europe started to participate actively in the takeover market only in the late 1990s, therefore the market is less developed and experienced than the US one and might not fully fulfill its role as control mechanism for inefficient firms yet. However this situation can change as the European takeover market develops further in the future and turnover rates might rise. Firms that kept their top management teams might have also experienced other difficulties which were not the fault of an inefficient management, but for instance caused by a downturn in the economy, new regulations etc. The second hypothesis can be partly confirmed, as a nearly half of the firms changed its management composition, while the other did not. As a comparison with the sample consisting of acquired firms, only 38% changed their management after the takeover. This can be explained by the limited observed time period, as most acquirers tend to keep the current management first for the integration process. They can be crucial for the success of the combined firm as they possess the relevant knowledge about the structure and working habits in the target. A change often occurs to a later point of time when the acquirer’s own management is familiar enough with the target to replace it.

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of those firms also changed their top management team. The M&A literature sees the takeover market as an external control mechanism for inefficient firms to discipline them. In the cross-sectional analysis this is tested by using management turnover as the main independent variable for explaining the dependent variable cumulative abnormal returns. Several control variables were included as well. The table below shows the results from the cross-sectional analysis for the whole sample and the two sub-samples consisting of independent targets and acquired targets. As the univariate analysis did not show any relevant differences, the results are not displayed.

Table 5: Cross-sectional analysis results

This table shows the results from the cross-sectional analysis with the coefficients and t-statistics for independent, acquired and all targets. Corresponding R-squared and adjusted R-squared results are displayed for every sub-sample as well.

Variables Independent targets Acquired targets All targets

Coefficient t-statistic Coefficient t-statistic Coefficient t-statistic

MAN _{0.090202 0.564192 0.118115 2.136.447* 0.070088 0.782604} SIZE _{0.211658 2.343.219* -0.064103 -1.209.156 0.036995 0.806453} FIC _{-0.436376 -2.035.343* 0.025729 2.256516* 0.110026 2.044.791*} ACE _{-0.102134 -0.529959 -0.025039 -0.225639 -0.021058 -0.236149} ACN _{-0.061200 -0.323407 0.021971 0.207972 -0.050390 -0.610546} DV _{-0.103283 -1.195.329 -0.019705 -0.335763 -0.031397 -0.612319} OWN _{0.120844 0.810948 0.009003 0.076204 0.092086 2.039.414*} R-squared _0.351549 _0.215919 _0.285414 Adj. R-squared _0.284540 _0.181938 _0.145241

*Significant at the 10% level

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can be explained as follows: Larger target firms are often able to negotiate a better deal during the announcement period and have the financial sources available to turn around their company after a failed takeover, such as restructuring or expand by acquiring firms themselves (Kiymaz and Baker, 2008). In contrast the coefficient of FIC is negative, which means that during the time period of the crisis, firms experienced a decline in return. This is not surprising as the crisis had and still has a major impact on the world economy. The majority of firms worldwide suffered from a decrease in returns. According to a KPMG study, including 170 deals worldwide during the period from January 2007 to mid-2009, a continuous downward trend regarding the takeover success could be found from the first quarter 2008 on (Kelleher, 2011). In times of a crisis the combined firm also has to struggle with its difficulties. As this research is focused on firms in Europe, where most of the countries were strongly affected by the crisis, firms with their headquarters located in this region are automatically affected as well. If they were performing weakly beforehand it is even harder to improve the performance during the crisis than in “normal” times. Furthermore the market tends to be more unstable and cautious during a crisis, thus making it difficult to achieve extraordinary returns in the long term.

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is seen as a positive sign by most investors, thus the market often rewards the firm with improved returns (Franks and Mayer, 1996, Tannous and Cheng, 2006). The second significant variable is the financial crisis, which in contrast to the first sample shows a positive coefficient. Although it seems odd at first glance, studies examining mergers and acquisition activities during crisis period still found small positive returns. According to Wan and Yiu (2009) corporate acquisitions were positively related to firm performance during the Asian economic crisis. They view the crisis as an environmental shock which should be seen as an opportunity for firms instead of a destructive situation. During an economic turmoil performance antecedents and outcomes may be reversed and industry boundaries redrawn or even obliterated. Former industry leaders can loose their dominance hence giving other companies the chance to gain strength through acquisitions. Overpayments are less likely during crisis periods due to deflated assets and stakeholders are more willing to accept restructuring processes enacted by the acquirer. Another research focused on the banking industry in the U.S. and Europe during the recent financial crisis shows small positive returns of 0,3% and 0,8% for acquiring firms (Bhuyan et al., 2010). Acquirers can gain or loose in a takeover process, target firms however usually gain from acquisitions. Thus it can be reasoned that if acquiring firms are able to achieve positive returns during a crisis, target firms should as well.

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returns before. Furthermore, inside ownership gives target’s management more negotiating power and therefore the possibility to extract greater benefits from the bidder for the target (Stulz, 1988). Mikkelson and Partch (1989) also found a positive relationship between managerial ownership and the probability of a change of control, thus if a target is being taken over because of an inefficient management, the probability of a change afterwards should be higher with an inside dominated ownership. The same holds for targets that stayed independent after the takeover attempt. A change can then be valued as positive information by investors and lead overall to an increase in return. Table 6: Definition of variables and outcome

This table lists the variables used for the cross-sectional analysis and the way they are included within the regression. The predicted relation indicates whether the variable is expected to have a positive or/and negative influence on the returns. The actual relation indicates whether the expectations were fulfilled or not. Definition Predicted relation to CAR Actual relation to CAR Dependent variable:

CAR: Cumulative abnormal returns calculated by using daily stock returns

Independent variable:

MAN: Management turnover as a dummy variable with 0=no change and 1=change

Positive Positive Control variables:

SIZE: Natural logarithm of the firm’s operating revenues in the

year of the takeover Positive Mixed

FIC: Financial crisis dummy variable with 0=no crisis and

1=crisis Negative Mixed

ACE: Acquisition experience dummy variable with 0=no

experience and 1=experience Positive Negative

ACN: Nature of the acquisition dummy variable with 0=friendly

bid and 1=hostile bid Positive Mixed

DV: Natural logarithm of the deal value of the observed takeover Positive Negative OWN: Ownership structure dummy variable with 0=outside and

1=inside Positive and Negative Positive

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5 Conclusion and implications

5.1 Conclusion

Takeovers have been discussed in literature as an external control mechanism which interferes if the internal control mechanisms in form of for instance the board of directors fail. It is often described as ‘the court of last resort’ when target firm’s management fails to increase shareholder value. In this situation takeovers can fulfill a disciplinary function as acquirers will change the inefficient target management after completion and help the firm to increase its performance again. However not all takeovers are completed, a certain number of acquisition attempts also ends in abandonment due to inconsistencies during the negotiation process or management and/or shareholder rejection and the target firm stays independent in the end. How does the abandonment affect the target firm? Is it possible to increase its performance afterwards?

This paper deals with these questions by examining the cumulative abnormal returns of a final sample consisting of 58 European target firms. In order to capture the disciplining effect the focus is on management turnover after an acquisition attempt and its effect on the target’s performance. By adopting the event-study methodology returns are calculated for the period prior to the takeover announcement as an indicator for past performance, the announcement as such, as well as the withdrawal and the post-acquisition period. The complete sample is then split into two sub-samples consisting of target firms that stayed independent after the withdrawal and target firms that were acquired within one year after the withdrawal in order to detect possible differences.

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Table 7: Hypotheses and outcome

This table shows the developed hypotheses in this paper and their outcome. The signs indicate whether the hypothesis can be fully or partly confirmed or cannot be accepted at all.

Hypotheses Outcome

1a: Target companies increase their performance after an unsuccessful takeover. + 1b: The performance of independent target firms after the takeover attempt is comparable to

the performance of acquired targets. -

2a: Target companies changed the composition of management after an unsuccessful

takeover. +/-

2b: In case of a management change a performance increase can be observed in the target firm.

+/-

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influenced later returns. During the financial crisis not only target firms experienced a downward trend in their returns. Stock markets were and still are very volatile leading to sometimes extremely negative returns. Especially Europe was strongly hit by the effects of the crisis and thus it is not surprising that it influenced the returns negatively. All in all the market for corporate control does not work in this observed sample, but still shows some disciplinary effects.

When taking the sample consisting of acquired firms as a comparison, different results occur. Here the takeover does function as an external control mechanism as management turnover and returns are positively related. Thus as the literature suggests acquirers do undertake takeovers due to an inefficient target management and change it afterwards in order to increase the performance. However only 38% changed their management within one year after the completed takeover, which can be explained with the integration process of the acquiring and the target firm where current management can play an important role. Nevertheless those firms with a turnover during the observed time period do confirm the suggested hypothesis. When comparing the past performance and the post-acquisition performance acquired targets show also show a small increase. The average return before the takeover was 1,16%, while afterwards it increased to 5,67%. The lower increase compared to the first sample could result from the costs of integration and the sharing of the total return with the acquired firm. The variable for the financial crisis also shows a significant positive coefficient, indicating that targets participating in completed acquisitions are able to achieve an increase in return even during crisis periods. In terms of the disciplinary function of the takeover market it can be concluded that it does work for targets in completed acquisitions.

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concluded that takeovers generally do have a positive influence on target performance which is also suggested by other studies. Two significant control variables were found in this sample with a positive coefficient for ownership structure and for the financial crisis. Inside ownership has a positive effect on returns due to higher negotiating power of the target and larger bid premiums paid by the acquirer. Although the crisis variable is negative for independent firms, it is positive for acquired firms. For the whole sample the crisis should be rather seen as a new challenge and opportunity for firms to deal with. Undertaking acquisitions are one way to cope with environmental shocks and uncertainties in order to survive. Large deals that occurred more frequently before the crisis become less during the crisis, instead smaller deals are more dominant as robust companies take the chance to buy competitors weakened by the economic turmoil.

Overall this paper has presented mixed results regarding the question whether the market for corporate control works for abandoned target firms. They do work in terms of management change, but they do not work in terms of management change and return. However target’s returns are influenced by the takeover attempt as an improvement in performance can be seen afterwards.

5.2 Implications

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Furthermore a control group of firms with similar size operating in the same industry that are not involved in a takeover could be taken as a benchmark for performance as it would be interesting to see how independent and acquired target perform before and after the takeover compared to the control group. Generally more or other control variables can be included in future research in order to identify more determinants for abnormal returns. As the financial crisis seems to have a great impact on returns, this should be researched in depth as well. Moreover emerging markets are beginning to participate in the takeover market as well, thus a similar study could be done for targets in emerging markets as well in order to reveal possible differences with Europe or the US.

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Abandoned takeovers and their effect on the performance of the target firm