Between Newly Public and Mature Bidder Firms
A Master’s Thesis By Ewald Modderkolk
H.E. ModderkolkRijksuniversiteit Groningen S1580760
Abstract
I examine abnormal returns following acquisition announcements by newly public and mature bidder firms. I construct a sample of 494 acquisition announcements for domestic targets by Western European firms during the years 1999-2009. I control for method of payment and target type as warranted by previous research. On the one hand the infusion of cash after an IPO could lead to higher agency problems and lower abnormal returns for newly public bidder firms. On the other hand over-optimism towards newly public bidder firms can lead to higher abnormal returns following acquisition announcements. When bidder firms acquire public targets with cash newly public firms experience significantly higher announcement returns than mature firms do. For newly public bidder firms the runup variable capturing over-optimism is positively related to the abnormal returns for both public and private target deals. Mature bidder firms show a positive relationship between runup and abnormal returns for private target deals and a negative relationship for public target deals. Overall these results suggest that newly public bidder firms are to some extent positively influenced by shareholder over-optimism.
Keywords: Acquisition, Announcement returns, IPO, Mature Firm, Newly Public Firm JEL Classification: G10, G14, G34
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I. Introduction
There is a large body of research devoted to both the Merger and Acquisition (M&A) and the Initial Public Offering (IPO) subjects. Several recent papers have put their focus of research on the intersection of these two subjects and study the acquisition behavior of newly public firms. From a theoretical perspective several authors have surveyed CFOs in order to assess the motivations underlying the going public decision. One main reason for a privately held firm to go public is to facilitate a M&A strategy (Bancel and Mittoo, 2009; and Brau and Fawcett, 2006). This finding is confirmed by other papers taking an empirical point of view (Celikyurt, Sevilir and Shivdasani, 2010; and Hovakimian and Hutton, 2009). The latter also stipulate that IPOs facilitate M&A activities by providing cash from the IPO, better access to the capital markets and also an equity method of payment. Wiggenhorn, Gleason and Madura (2007) state that the shareholders of newly public firms reward M&A activities with positive announcement returns.
There are several reasons to suspect that the differences in the nature of mature and newly public firms can lead to differences in announcement returns. One of the main arguments in favor of higher announcement returns for newly public firms is the valid growth strategy. Jain and Kini (2008) state that newly public firms require growth in order to survive. Acquisitions provide valid growth opportunities by enabling firms to grow at a fast pace. Celikyurt et al. (2010) confirm this conjecture as their results prove the importance of acquisitions in the growth process of newly public firms. A main argument leading to lower announcement returns to newly public firms relates to the availability of managerial resources. The new environment of being a public company puts additional rules and limitations onto firms. Management of newly public firms must adjust to coping with these requirements and overextension of managerial resources might occur when another firm is acquired. In addition management might lack the experience of integrating other firms which diminishes efficiency even more (Wiggenhorn et al., 2007). One characteristic of an IPO, the infusion of cash, can lead to conflicting outcomes due to the free cash flow problem described by Jensen (1986). When management of newly public firms employ this cash reserve for financing acquisitions this may render positive announcement returns. Shareholders favor the use of cash for acquisitions rather than other purposes which might not be in their best interest. On the other hand the large cash reserve can lead management to engage in value-decreasing investment projects or at least make shareholders suspicious (Wiggenhorn et al., 2007). This will depress the announcement returns to newly public bidder firms.
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put a special emphasis on the comparison of results between newly public and mature bidder firms. The univariate analyses show that the only significant difference between abnormal returns to newly public and mature firms exists in the public target financed by cash deals subsample. In this case newly public bidder firms experience significantly higher abnormal announcement returns than mature bidder firms do. The cross-sectional regression analysis shows that newly public firms experience higher abnormal announcement returns after a runup in their share price irrespective of target type and also when acquiring relatively large target firms. Mature firms on the other hand are not rewarded for acquiring relatively large target firms. For mature firms a runup in the share price delivers higher returns to private target deals than public target deals. These results are in line with the over-optimism argument that newly public firms are more sensitive to sentiment but they do not lead to higher overall announcement returns compared with mature firms.
I contribute to the existing literature in two ways; First, I make a comparison between the announcement returns of newly public and mature bidder firms to determine whether they experience different share price reactions. To the best of my knowledge, a direct comparison of this kind has not been done yet. Second, I compare my results with the findings in the existing announcement return literature and with those of Wiggenhorn et al. (2007) to determine whether a first preliminary conclusion can be formulated. Third, I contribute to an area of research which has a relatively low amount of research devoted to it in comparison with other fields.
A limitation of this paper is the small sample size and especially so in the subsample of newly public firms acquiring public targets. This could bias the results explained here and could be addressed by future research.
The structure of this paper is as follows: Section 2 will cover the related literature to provide
insights into theory and their empirical results. Section 3 provides information about the data sample collection as well as some sample statistics. The methodology used in this paper will be explained in section 4. The results will be presented in section 5 and the paper is concluded afterwards in section 6.
II. Previous Research
i. The Going Public Motive
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develop an acquisition strategy in order to attain growth. If managers view M&A as an important element in the decision for taking their firms public, this might also partly influence the attitude of shareholders towards acquisition announcements. Whenever managers are confident that M&A is an integral part of their going public decision than shareholders might react positively to acquisition announcements made by newly public firms.
The ways in which IPOs can facilitate subsequent M&A activities are pretty straight-forward. First there are the proceeds from the sale of the offered shares. This infusion of cash can be used as the method of payment for acquiring another firm. Secondly the creation of publicly traded shares provides another method of payment which can be used to acquire target firms. A third way to obtain financing for an acquisition deal is the increased access to the financial markets, which enables firms to raise additional funds (Hovakimian and Hutton, 2009). The fourth facilitating method is the reduction of uncertainty about the firm value after the IPO. The market value can be used to assess the optimal capital structure and hence whether to use cash or equity as the method of payment. (Bancel and Mittoo, 2009; and Celikyurt et al., 2010).
Prior research shows that NEWLY PUBLIC firms are far more active as acquirers than as targets in the M&A market (Brau, Couch and Sutton, 2010; Brau and Fawcett, 2006; Celikyurt et al., 2010; and Hovakimian and Hutton, 2009). Celikyurt et al. (2010) research the influence of the IPO on the acquisition behavior of newly public firms. They construct a data sample of all US IPOs during the years 1985-2004 with total proceeds of $100 million or more. Their results show that the probability of a (cash-)merger occurring are positively related to the amount of the IPO proceeds. Their results also show that IPOs facilitate easier access to the capital markets and that this easier access to debt (equity) capital is associated with a higher probability of making a cash-based (equity-based) acquisition. In addition, the publicly traded shares of the newly public firm provide managers with a method of payment as well as a mechanism to reduce valuation uncertainty. Hovakimian and Hutton (2009) conduct a similar research as Celikyurt et al. (2010) but use a longer sample period, 1980-2006, and do not impose a lower limit on the IPO proceeds. Their findings show similar results to Celikyurt et al. (2010). In addition, Hovakimian and Hutton (2009) find evidence for the market timing hypothesis stating that managers of acquiring newly public firms make equity offers when they believe shares or overvalued and cash offers otherwise.
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public is to create an equity method of payment for acquisitions. Almost 60% of the respondents agree with this motivation. The second most important reason given for going public is to establish a market valuation for the firm. The market valuation of the firm allows the managers to determine the over- or undervaluation of their shares and subsequently the choice to use equity financing or not. Brau and Fawcett (2006) report that other reasons for going public like cost of capital, exit strategies for founders and venture capitalists or diversifying holdings are far less important to US CFOs as previously thought. In a later paper by Bancel and Mittoo (2009) a similar study is conducted by surveying CFOs from 12 European Countries. The main reason for listing given here, with over 80% of European CFOs strongly agreeing, is to increase firm visibility and reputation/image. This in turn broadens their shareholder base and lowers their cost of capital. The M&A opportunities provided by the IPO decision are less important for European CFOs. Although not one of the top motivations for going public, the M&A strategy still finds support by more than half (56%) of the CFOs. In addition they also recognize that going public provides a market valuation for their firm and equity for future acquisitions. Although these results are not as strong as in Brau and Fawcett (2006) they too provide evidence that the going public decision is strongly motivated by M&A motives.
These findings show that managers of newly public firms believe acquisitions are an important motivation for going public and that a M&A strategy is thought to be a valid avenue of growth. As management of newly public firms believe acquisitions to be positive events and project this attitude onto the market the shareholders might be positively influenced in their posture to said events. The newly obtained opportunities, mainly financing, an IPO presents for pursuing acquisitions might also positively reflect on shareholders as it is always better to have multiple alternatives for financing acquisitions rather than one. The confidence that management projects in going public can spill over to shareholders and cause (over-)optimism. This reasoning could lead shareholders to favor acquisitions made by newly public firms more than those of mature firms and this is mainly caused by the sentiment created around the newly public firm.
ii. Announcement Returns
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negative. These differences can to a large extent be explained by two deal characteristics: The method of payment and the target firm’s type, publicly or privately held.
A paper by Draper and Paudyal (2006) is one of the more recent papers discussing the private versus public distinction in acquisition announcement returns to bidder firms. They formulate three hypotheses as to how target status might affect the announcement returns to bidder firms. The managerial motive hypothesis states that managers can be motivated by expanding their own private benefits and prestige instead of maximizing shareholder value. They engage in empire building by increasing firm size and subsequently demanding a higher compensation. Publicly traded firms provide a better means of attaining these goals as these firms are typically larger and more visible than private firms. This leads shareholders to be skeptical of the motivations of management whenever they announce an acquisition of a public firm. Private firms on the other hand provide less opportunities for managers to enlarge their reputation and are more likely motivated by synergy and shareholder value considerations. In addition, the non-public nature of the negotiations with private firms allows managers to initiate or end these negotiations at any time without losing face to the public (Kohers, 2004). This theory predicts that announcement returns to bidder firms will be larger in private target than in public target deals. The liquidity hypothesis is based on a argument provided by Chang (1998). Compared to private firms the shares of public firms are more easily traded and also the available amount of information is larger. This puts private firms at a disadvantageous bargaining position by making the competition in takeovers for private firms lower. This enables bidder firms to benefit from this situation by negotiating a discount on the offer price. This underpayment for private firms leads to a more favorable announcement return to bidder firms when acquiring private instead of public targets. The Bargaining Power Hypothesis states that private firms typically have a more concentrated ownership structure than public firms do. This strengthens the bargaining position of private firm’s managers as they can more easily align their interests. This will also motivate managers to secure the best price possible as this is in their own interest (Kohers, 2004). This will result in lower returns to the bidder firm because of the lower discount they can negotiate.
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undervalued, they will offer cash as the method of payment. The use of equity as the method of payment signals that management believes their shares are overvalued and these can be used as a cheaper form of financing. From the perspective of the outside investor the cash deals provide more certainty and therefore will receive higher returns at the time of the announcement than equity deals will. The Corporate Monitoring Hypothesis (or information hypothesis) extents the asymmetric information hypothesis. When the bidder firm offers equity to the shareholders of a privately held target firm there may also be an exchange of inside information. This can be used by the target’s shareholders to assess the health of the bidder firm because they will become significant shareholders in the new firm. Whenever they accept this offer they signal to the market that they view this deal as favorable. This assures investors that the shares of the bidder firm are not overvalued and the accompanying announcement return to the bidder firm will be positive.
Several papers provide evidence on the difference in share returns to bidder firms with regard to the private or public nature of the target firm. The results show consistently that bidder firms acquiring private targets receive a significant and positive return during the announcement period ranging from 0.85% to 2.70%. The results regarding the public targets are mixed with most authors reporting significantly negative returns ranging from -0.42% to -1% (Conn et al., 2005; Draper and Paudyal, 2006; Fuller et al., 2002; and Kohers, 2004) and one paper stating insignificant returns (da Silva Rosa et al., 2004). These results provide support for the managerial motive hypothesis as shareholders believe private targets are chosen by acquiring firms’ management for a value-creating motivation. In addition it also provides support for the liquidity hypothesis.
One of the earliest papers to address the method of payment influence on the returns to bidder’s shares in the immediate period surrounding an acquisition announcement is Travlos (1987). He reports that equity offers receive a significant mean return of minus 1.47% whereas the mean return for cash offers is insignificant. The evidence on method of payment in isolation is not consistent however as other papers report significant and positive mean returns for both cash and equity offers (Goergen and Renneboog, 2004) or significant and positive mean returns for cash offers and insignificant mean returns for equity offers (Draper and Paudyal, 2006).
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Conn et al., 2005; Draper and Paudyal, 2006; Fuller et al., 2002; and Kohers, 2004). This supports the asymmetric information hypothesis originally formulated by Myers and Majluf (1984). Shareholders seem to believe that management will use the equity method of payment whenever the shares are overpriced. The response from the market leads to a drop in the share price. These results also show that the negative overall return to bidder firms for public targets is caused by the equity offers subgroup. The overall positive return to bidder firms acquiring private targets is caused by both the cash and the equity offers. Some papers report that both the cash and the equity offers are significantly positive with the equity offers having the largest returns (Conn et al., 2005; Draper and Paudyal, 2006; and Fuller et al., 2002). Chang (1998) reports insignificant returns for the cash offers and a significant return of 2.64% for the equity offers. This result is somewhat biased as Chang (1998) defines equity offers as those offers using some amount of equity. Kohers (2004) reports for a two-day announcement period significant returns of 1.05% for cash offers and 0.92% for equity offers. Overall the equity offers receive larger returns than the cash offers do. This provides support for the corporate monitoring hypothesis.
As the previous analysis shows it is vital to distinguish between public versus private and cash versus equity offers as these variables have significant influence in explaining announcement returns. The results of the various papers on the interaction-effects are largely consistent and highly significant and most authors agree on the explanations given by the asymmetric information and corporate monitoring hypotheses. Given this amount of evidence I expect newly public firms to experience abnormal returns for equity offers in the same direction as predicted by these hypotheses. That is, I expect newly public firms acquiring public targets with equity to experience significant negative returns and acquirers of private firms with equity to experience significant positive returns. The (over-)optimism argument made earlier can make these abnormal returns larger in magnitude than those of mature firms. The evidence on cash offers is less consistent and the fact that newly public firms experience a large cash infusion might also influence shareholders’ attitudes one way or the other, a point I will address later on.
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shareholder to the announcement of an acquisition. When they split their sample according to the method of payment they find that cash offers receive a significant 2.67% return whereas equity offers receive an insignificant 1.66% return. The separation of the sample into public or private deals show similar results as other studies mentioned earlier. Newly public firms acquiring public targets have a significant return of -4.41% while private target deals rewards them with a significant 3.80% return during the announcement period. A dummy variable capturing private target deals is significant in the cross-sectional analysis and Wiggenhorn et al. (2007) state that the creation of a blockholder may be especially important for newly public firms as older blockholders (founders, venture capital firms) may cash out. The sustainment of blockholders and thereby monitoring activities might give newly public firms additional credibility, a feature that mature firms most likely already posses. These results all provide some insights into the reaction of shareholders to acquisition announcements by newly public firms but Wiggenhorn et al. (2007) do not control for interaction-effects between method of payment and target type, which clearly is warranted given the significant results from the separate analyses. The results presented here show that the returns for newly public firms have the same sign as other studies have but the magnitude of the abnormal returns is significantly larger for newly public firms. This could indicate that newly public firms are more subject to sentiment than mature firms are, leading shareholders to overreact in both positive and negative directions.
iii. Theoretical Arguments
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insurance against value-destructing acquisitions (Wiggenhorn et al., 2007). Fourth, the IPO will provide a newly public firm with an abundant amount of cash. Shareholders might favor using this cash for acquiring firms in order to grow instead of using it for other alternatives, especially when these alternatives are not in the interest of all shareholders.
On the other hand several theoretical arguments can be made as to how acquisitions may not be favored by shareholders. First, the new environment imposes additional rules and limitations upon newly public firms. Examples are mandatory reporting requirements, increased monitoring, changes in capital market conditions making financing harder to obtain, loss of flexibility in quick strategic decision-making etcetera (Jain and Kini, 2008; and Xie, 2010). All these elements put additional strain on managerial resources preventing the newly public bidder firm from efficiently integrating the target firm. On a similar note a second problem might be the lack of expertise and experience of management of newly public firms. This will increase the strain on managerial resources and diminish the efficiency gains from takeovers even more (Wiggenhorn et al., 2007). Third, the agency costs related to the free cash flow problem as described by Jensen (1986) may be severe for newly public firms as they have a large cash reserve following the IPO. Managers may opt for acquisitions or investment projects that are not value-increasing but serve as a form of empire-building in order to increase managerial prestige and compensation (Wiggenhorn et al., 2007). Acquisitions do not have to be value-decreasing per se but the suspicion of such actions on part of the shareholders can be enough to depress announcement returns.
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overall announcement return from Wiggenhorn et al. (2007) provide an argument to suspect that the acquiring newly public firms in my sample could have better announcement returns than the mature firms will.
The literature discussed in this section makes clear that managers of newly public firms see an IPO as an important necessity in order to pursue acquisitions in the most favorable way. Survival of newly public firms is dependent on growth meaning that M&A could be a valid growth strategy for said firms. The relatively large announcement return results of Wiggenhorn et al. (2007) show that shareholder sentiment is a relevant factor in determining abnormal returns. Brau et al. (2010) also provide evidence on over-optimism with regard to newly public firms in the first year of going public. The positive announcement return on cash deals could mean that shareholders favor the use of the IPO proceeds for cash acquisitions instead of other, perhaps value-decreasing, alternatives. These arguments can make the observed announcement returns for newly public firms larger than those of mature firms. By making a direct comparison between newly public and mature firms I study whether an actual difference exists.
III. Data and Methodology
i. Data
The acquisitions used for this study and their financial data are taken from the Zephyr database by Bureau van Dijk. The sample that I have constructed consists of acquisition announcements made by Western European Firms1 between January 1, 1999 and December 31, 2009. Conn et al. (2005) report that cross-border acquisitions receive lower announcement and long-run returns than domestic acquisitions do, I therefore only include domestic acquisition announcements making my research more focused and preventing biased results due to omitted variables. Only the deals with a minimum deal value of 1 Million Euros and with a pure cash or pure equity method of payment are included. In addition the acquisitions considered are those in which the bidder firm owns less than 50% of the targets’ outstanding shares before the acquisition and ends up with at least 50% after the acquisition is made. The IPO dates are also taken from Zephyr and a firm is characterized as an newly public firm whenever the announcement date of the acquisition is within one year from the IPO date. Additional data on market value, the market to book value, share prices for bidder firms and returns on local equity indices
1
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are taken from the Datastream database of Thomson Reuters. Entries with missing values in the relevant variables to be analyzed are excluded from the sample, the same goes for multiple announcements in the five day period surrounding the announcement. Lastly, in order to assure that the acquisitions made are of material proportions to the bidder firm, I only use acquisitions with a deal value equal or above 5% of the bidder firm’s market value 1 month before the announcement (similar to Conn et al., 2005). Whenever a firm makes multiple bids for the same target firm only the first bid announcement is included. This prevents the inclusion of follow-up bids that have less information content and are less unexpected thus dampen the results. My final sample consists of 494 acquisition announcements.
ii. Methodology
In order to measure the market response with regard to the acquisition announcements I will use Brown and Warner’s (1985) market-adjusted event study methodology. Abnormal returns for the three days surrounding an announcement are calculated by subtracting the return on the local country index from the return on the shares of the bidder firm. Summing the abnormal returns for days -1 to +-1 constructs the cumulative abnormal return (CAR) for said announcement. I do not use the mean adjusted returns or the OLS market models as they require an estimation period for their parameters. As my study focuses on newly public firms that acquire other firms within 1 year of their IPO the required estimation period might well be too short to provide reliable results. As Conn et al. (2005) also point out many firms made multiple acquisition announcements during the period of my sample. This makes it probable that another announcement is present in the estimation period and this will bias the results. This results in the following formula for the abnormal returns of each acquisition announcement:
AR
i,t= R
i,t– R
m,t(1)
where ARi,t is the abnormal return for acquisition announcement i on day t, Ri,t is the return on the bidder
firm’s share price for acquisition announcement i on day t, and Rm,t is the return on the local market
index of the bidder firm on day t. The cumulative abnormal return for each acquisition announcement is calculated as follows:
CAR
i= ∑ AR
i,tfor days t = -1, … +1 and acquisition announcement i
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To correct for outliers I winsorize my sample at the 1% level so the sample size will not be reduced (Sudersanam and Mahate, 2003). After calculating the CARs for all announcements I will assign every announcement to a subgroup on the basis of mature or newly public bidder firm status. Announcements made by firms that are less than 1 year active on the stock market will be marked as announcements made by newly public firms, as in line with Brau et al. (2010) and Wiggenhorn et al. (2007). Afterwards all announcements will also be divided in additional subgroups based on target type, i.e. public or private.
Wiggenhorn et al. (2007) use a sample of only newly public firms in their study. To make my results comparable to theirs I first perform a general analysis in which I split the total sample in subgroups on the basis of bidder type, IPO or mature, and target type. This allows me to compare the abnormal returns to newly public firms grouped by target type with those reported by Wiggenhorn et al. (2007). Next I decompose the subgroups even further by introducing the method of payment variable. This makes analysis of the interaction-effects between method of payment and target type possible and also the comparison with the results of previous research. For all these analyses I focus on the differences between the CARs of newly public and mature firms. To test whether a significant difference exists I first split the sample according to the relevant variable, i.e. the IPO dummy. I employ an ANOVA F-test to determine significance of differences in means and a Wilcoxon/Mann-Whitney to test for the differences in the medians.
iii. Cross-Sectional Regression Analysis
Another method I employ in order to estimate the abnormal returns for acquisition announcements and what characteristics drive them is a cross-sectional ordinary least squares analysis. The univariate analyses provide some preliminary insights and this section tries to evaluate and add support to them. The dependent variable will be the mean cumulative abnormal returns of the announcements for the three-day period surrounding the announcement. The explanatory variables will be the variables mentioned in the univariate analyses as well as other control variables detailed above. I run the regression on the full sample as well as separately on an newly public bidders subsample and on a mature bidders subsample. I run multiple regressions per sample in order to account for several interaction-effects.
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which equals one if the acquisition announcement is a full equity offer and zero when the offer is cash only. PRIVATE equals one if the target firm is privately held and zero if it is a public firm. The other variables I include are:
1. Bubble period
During the bubble period the amount of IPOs soared and the overall sentiment was positive, almost euphoric. share prices exploded and growth possibilities were abundant. Whenever a firm went public it was thought to be the next best thing and accordingly prices rose immense amounts. Loughran and Ritter (2004) show that the average underpricing jumped from 15% during 1990-1998 to an average of 65% in the years 1999 and 2000. The bubble period might influence M&A activity and announcement effects in several ways. First because of the unusually high share prices firms have more potential acquisition funds to rely on. They can either use equity directly as the method of payment or issue a SEO and use the cash proceeds to finance the acquisition. A second reason why a bubble period might inflate M&A activity is the positive energy it emits. Firms experience positive investor sentiment and perceive this as an indication of high future growth possibilities. This boosts confidence, perhaps into overconfidence, and leads management to an expansionary strategy whether intrinsically justified or not. Although the definitions of the internet bubble period differ to some extent regarding the start or end date, most authors agree that 1999 and 2000 were part of this phenomenon (e.g Brau, couch and Sutton, 2010; Loughran and Ritter, 2004; and Wiggenhorn et al., 2007)2. In most analyses the bubble period does not seem to have significant effects on announcement returns (e.g. Brau et al., 2010; and Goergen and Renneboog, 2004). Only the analysis by Wiggenhorn et al. (2007) of the announcement effects of newly public firms provides some evidence that the bubble period has less favorable results than the non-bubble period has. The reason that I do decide to include a bubble period dummy has to do with investor sentiment. Although overall market sentiment was high during this period, the sentiment regarding newly public firms was even higher as shown by the large underpricing percentage. Mature firms are more stable and not perceived as refreshing as new firms are. Because I divide my sample into mature and newly public firms, and others did not, it may well be the case that I will find (some) evidence of bubble period influences, like Wiggenhorn et al. (2007) did. I include a dummy variable BUBBLE with the value 1 whenever an acquisition announcement is made during the years 1999 or 2000, or zero otherwise.
2 Wiggenhorn, Gleason and Madura (2007) also employ alternative definitions of the bubble period. They conclude
[15] 2. Credit Crisis Period.
In a similar vein I control for the credit crisis period of the recent years. As the sentiment in the markets drops to all time lows investors perceive newly public firms too weak to survive, also caused by the lack of growth as pointed out by Jain and Kini (2008). Mature and stable firms have larger reserves to absorb the blows delivered to the financial system for a longer period of time than newly public firms can. To determine whether this hypothesis is true I include a dummy variable CRISIS equal to 1 for announcements made during the years 2007-2008 and zero otherwise. These years are thought to be the most extreme during the crisis as “the banking sector suffered losses not observed since the Great
Depression” (Fahlenbrach and Stulz, 2010).
3. Size
Smaller firms may benefit from acquisitions in a way that this provides them with valid and rapid growth opportunities. A failed acquisition could have disastrous effects on smaller firms hence making them more cautious about their choices. An advantage they have is less bureaucracy and therefore better and faster coordination in integrating a target firm into their own. Moeller, Schlingemann and Stulz (2004) examine whether there exists a size effect in acquisition announcement effects. For every year, the NYSE firms with a market capitalization above the 25th percentile are classified as large firms. The firms with a market capitalization equal to or less than the 25th percentile are classified as small firms. They find that small firms earn a significant 2.24% higher abnormal announcement return than large firms do and that this result is permanent. Wiggenhorn et al. (2007) report that smaller newly public firms experience more favorable announcement returns of 1.1% in comparison with larger firms. To control for size effects I include the natural log of the market valuation 1 month before the announcement.
4. Market-to-book value
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glamour firms. A rational investor should respond to this by favoring acquisitions made by value firms and rejecting those made by glamour firms. Previous research shows however that investors fail in this respect as glamour firms receive higher announcement returns than value firms do (Rau and Vermaelen, 1998; and Servaes, 1991). This also shows that acquisition announcements are influenced by the current sentiment regarding bidder firms. To control for this sentiment I include a variable MTBV which is the market-to-book value of the bidder firm one month before the announcement of the acquisition.
5. Overextension
Just as larger target firms relative to the bidder firms could have a negative influence on the ability to integrate them, the number of acquisitions made in the previous years could put a strain on the efficiency of management and the firm as a whole. Wiggenhorn et al. (2007) discuss several articles in which the link between the number of acquisitions made and bidder returns are studied. The overall conclusion is that multiple acquisitions, especially after the fourth, put more stress on the managers and lead to lower returns. They define a Dummy variable OVEREXT with the value of 1 whenever an acquisition followed two or more prior acquisitions. Their results show that this variable is significantly negative for all the regressions employed. I will use this same definition for a dummy variable OVEREXT in my regression analysis.
6. Relatedness
Both Wiggenhorn et al. (2007) and Conn et al. (2005) did not find significant results with regard to industry relatedness between the bidder and the target firm. The study of da Silva Rosa et al. (2004) did also not find significant results in the immediate announcement period ranging from day -2 till +2. But in an extended announcement period ranging from day -10 till +10 they did find that bidder firms earn significantly higher returns when the target firm is unrelated. I include a dummy variable RELATED equal to one when the bidder and target firm have the same 2 digit SIC code.
7. Relative Size
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enabling them to pursue acquisitions. In this case an acquisition announcement of a large target can be followed by a negative effect on the announcement return. Two, survival of newly public firms is dependent on successful growth as stated in the literature section (Jain and Kini, 2008). Acquisitions provide a rapid means of growth especially when the target firm’s size is large relative to the bidder firm. If shareholders are confident that the firm can integrate a target firm efficiently an acquisition announcement can be followed by a positive effect on the announcement return. Although previous research did not find significant results (e.g. Chang, 1998; Conn et al., 2005; Servaes, 1991; and Wiggenhorn et al., 2007) I do take this variable into account for the reasoning mentioned above. The variable RELSIZE is defined as the ratio between the market value of the bidder firm 1 month before announcement and the deal value reported by Zephyr as proxy for target firm value.
8. Runup
A runup in the price of the shares of a bidder firm could lead to higher announcement returns on two different grounds. First, Wiggenhorn et al. (2007) state that whenever a firm announces an equity financed acquisition after a runup in the share price it is rewarded with a higher announcement return for using the stronger currency as the method of payment. Secondly, share prices are not only determined by fundamental variables but also by investor sentiment. These beliefs held by investors about the future of a firm are not necessarily close to reality. This can bias share price reactions both upwards and downwards even without the occurrence of significant events. If the market views the current state and future possibilities of a firm as positive, signaled by a positive runup, it is possible that an acquisition announcement will deliver higher returns than a firm with neutral or negative sentiment (runup) might get. Wiggenhorn et al. (2007) find the relationship between runup and abnormal announcement returns to be positive and significant and dedicate this to the strong currency hypothesis. In line with their study I define RUNUP as the abnormal return of the 30 days before the announcement period.
9. Technology
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literature. The characterization of a firm as being technology-based is done in line with Loughran and Ritter (2004). The dummy variable TECH will be one whenever a firm is technology-based and zero otherwise.
10. Interaction Variables
To account for interaction effects among variables I employ several interaction-variables. Given the significantly positive result from the univariate analysis that private target deals financed by equity experience higher abnormal returns I include private*shares to determine the explanatory power of this variable to abnormal returns. To control for the possibility that the effect of newly public firms on the announcement returns is evident only in one of the subgroups of method of payment or target type I include both ipo*private and ipo*shares in the full sample regressions. Especially the equity deals by newly public firms experienced lower, and insignificant, abnormal returns compared with the mature bidder firms. Runup can be seen as a proxy for contemporaneous sentiment regarding a bidder firm. In addition to the Runup variable in isolation I also include private*runup to determine whether a possible runup effect on abnormal returns is more significant for private target than for public target deals. Last but not least I include ipo*runup as a proxy for over-optimism towards newly public firms. A positive coefficient indicates that newly public firms experience higher abnormal returns than mature firms after a runup in the share price.
The definition of these variables results in the following regression for the full sample while including all variables:
CARi = α + β1BUBBLEi + β2CRISISi + β3IPOi + β4MVi + β5MTBVi + β6OVEREXTi + B7PRIVATEi
+ β8RELATEDi + β9RELSIZEi + β10RUNUPi + β11SHARESi + β12TECHi + β13PRIVATE*SHARES
+ β14PRIVATE*RUNUPi + β15SHARES*RUNUPi + β16IPO*PRIVATEi + β17IPO*RUNUPi
(3)
+ β18IPO*SHARES + β19IPO*PRIVATE*SHARESi + β20IPO*RUNUP*SHARESi + ε
V. Results
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first focus on the results in general and afterwards on the comparison of newly public and mature firms. Last, I provide the results and an accompanying discussion of the cross-sectional regression analysis.
i. Sample Statistics
Sample statistics are presented in table 1 below. The numbers of acquisitions show that the greater part of the sample consists of private deals, accounting for 81% of the total number of deals. Previous studies find similar percentages of private target deals in their samples (Capron and Shen, 2007; Conn et al., 2005; and Draper and Paudyal, 2006). The mean number of acquisitions per firm is virtually equal to 1, indicating that the sample consists of almost all unique bidder firms. The median acquirer sizes show that the mean acquirer sizes are biased upwards due to some (very) large firms. The median sizes also show that bidder firms acquiring public targets are roughly twice the size of bidder firms acquiring private targets; which is to be expected as the median deal value for public targets is also larger than for the private targets. The median deal values show that the mean deal values are also biased upwards due to some very large deals. The choices for the method of payment are evenly balanced between 42% and 58%. The related variables show that firms chose to acquire related targets in almost 50% of the cases. Bidder firms thus have a 50-50 preference for either increasing their scale or diversifying their companies’ business lines.
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Table 1
Sample Statistics
Mature public Mature Private IPO Public IPO Private
Number of Acquisitions 73 317 19 85
Mean Number of Acquisitions per
Acquirer 1.03 1.13 1 1.02
Mean Size of Acquirer (€ Millions) 769 375 94 195
Median Size of Acquirer (€ Millions) 64 31 61 34
Mean Deal Value (€ Millions) 821 138 25 37
Median Deal Value (€ Millions) 19 9 13 10
Mean Relative Size (€ Millions) 0.46 0.41 0.47 0.5
Median Relative Size (€ Millions) 0.29 0.2 0.36 0.26
Mean Market-to-Book Ratio 1.48 1.96 2.83 1.99
Method of Payment
% of
Announcements
Cash 0.33 0.51 0.47 0.41
Shares 0.67 0.49 0.53 0.59
Related Acquisitions (2 digit SIC) 0.59 0.53 0.58 0.51
Notes: This table reports sample statistics for a sample of domestic acquisition announcements made by Western European firms. Acquisition deals and financials were taken from the Zephyr Database by Bureau van Dijk. Additional data is taken from the Datastream database by Thomson Reuters. The countries included in this sample are Austria, Belgium, Denmark, Finland, France, Germany, Greece, Great Britain, Ireland, Italy, The Netherlands, Norway, Portugal, Spain and Sweden. Acquirer size is the market value of the firm one month before the acquisition announcement. Relative size equals Deal Value divided by acquirer size. Market-to-book ratio is taken one month before the acquisition announcement.
ii. Univariate Analysis of Target Type
The results of the univariate analysis while controlling for target type are presented in table 2. The overall mean CAR to bidder firms acquiring public targets is a significant -1.89%, the private target deals yield a significant 2.64% abnormal return to the bidder firms. These results are in line with the results of previous research, indicating that public target deals receive a significantly negative return whereas private target deals receive a significantly positive return. The magnitudes of the returns are fairly similar to existing evidence though they are in the higher end of the range of results.
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deals and a significant 2.39% abnormal return for private target deals. The assumption that newly public firms might be subject to over-optimism by shareholders does not receive support from my results. The insignificant CAR for the public deals is contrary to existing evidence and could indicate that shareholders are positively positioned towards acquisitions by newly public firms and hence provide some support for the valid growth strategy argument. On the other hand, the sign of the CAR is negative as expected indicating that the insignificance can be caused by the limited number of observations of this subsample.
Table 2
Mean and Median CARs to Bidder Firms by Target Type
Panel A: Mean and Median CARs to Bidder Firms by Target Type
Public Private All
Mean Median Obs. Mean Median Obs. Mean Median Obs.
All -1.89** -1.20** 92 2.64*** 0.57*** 402 1.79*** 0.22*** 494
Mature -2.22** -1.43** 73 2.70*** 0.57*** 317 1.78*** 0.10* 390
IPO -0.62 -0.55 19 2.39* 0.57** 85 1.84 0.56* 104
Panel B: Differences in CARs to Mature and Newly Public firms on the Basis of Bidder type
Mean Median Obs.
Mature - IPO | All -0.06 0.46 494
Mature - IPO | Public Targets -1.60 -0.88 92
Mature - IPO | Private Targets 0.31 0.00 402
Notes: Panel A reports the mean and median cumulative abnormal returns (CAR) for acquirers during the days -1, 0 and 1 with 0 being the day of the announcement. Abnormal return is calculated relative to the return on the local market index. The CARs are reported in percentages. Panel B reports the probabilities of an ANOVA F-test for equality between mature and newly public bidder firms. *,**,*** refers to 10%, 5% and 1% significance levels.
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iii. Univariate Analysis of the Method of Payment
Although the results from the previous analysis already provide some insights into bidder returns following acquisition announcements it is essential to distinguish between cash and equity deals. The existing literature already clarifies that the interaction effect between method of payment and target type is a highly significant determinant of the announcement returns to bidder firms. This section provides evidence on whether the confirmed hypotheses in previous research also find significance for the newly public firm subgroup.
Previous research is consistent on the fact that public target deals paid for with cash produce small and insignificant abnormal returns to bidder firms and that the public target deals paid by equity are rewarded with significantly negative abnormal returns. The abnormal returns to bidder firms acquiring private targets are reported to be positive and significant for both cash as well as equity deals, where the latter have the larger magnitude of return (See, among others, Chang, 1998; Conn et al. 2005; Draper and Paudyal, 2006; and Kohers, 2004). Table 3 panel A presents the abnormal returns to bidder firms with the inclusion of the method of payment variable. Let us first focus on the overall results. Most of these results are consistent with the existing evidence as bidder firms acquiring public targets with cash receive insignificant abnormal returns of -0.31%, public targets paid for with equity deals receive significantly negative returns of -2.62% and bidder firms acquiring private targets paid for with equity have a significantly positive return of 4.19%. The abnormal return associated with private target deals paid for with cash is positive but not significant in the mean. The reported value of the median CAR is positive and significant however indicating that this group is biased by outliers. For the overall group the results of my sample are consistent with the existing evidence.
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The only subgroup providing significant differences in the abnormal returns to bidder firms is the public target and cash method of payment subgroup. Mature firms acquiring public targets with cash receive an insignificant -2.15% mean return which is consistent with previous evidence. In contrast, the newly public firms acquiring public targets with cash receive a significant 8.53% mean return. This difference in mean abnormal return is significant at the 5% level as panel C shows. This large return can be caused by the fact that shareholders favor the use of the cash proceeds of the IPO for acquisitions in order to grow instead of allocating this cash to the reserves. A large cash reserve might induce managers to increase their private benefits instead of maximizing shareholder value. The private target cash deals for newly public firms do not exhibit significant and positive returns however. A reason for this difference can be the information asymmetry related to private targets as this does not allow shareholders to evaluate these deals as thorough as public target deals and determine whether they are value-increasing. Public targets on the other hand can be evaluated more easily and apparently are in the interest of all shareholders. The sample statistics reported in table 1 show that newly public firms acquiring public targets have higher market-to-book ratios than newly public firms acquiring private targets have. This higher ratio reflects a more positive attitude of shareholders towards a firm and could indicate that newly public firms acquiring public targets are subject to overreaction or over-optimism as proposed by Brau et al. (2010) and Wiggenhorn et al. (2007). This is only the case in cash acquisitions and thus probably the use of the IPO proceeds. In summary, the highly significant return for newly public firms acquiring public targets with cash can be explained by two intertwined arguments:
1) Shareholders reward newly public firms for using their excess cash, either from the IPO or not, for acquisition activities instead of creating a reserve which is sensible to manipulation. 2) A. Shareholders can evaluate public target firms more easily than private targets and hence
reward public target deals with higher abnormal returns.
B. Newly public firms acquiring public targets have higher market-to-book values than newly public firms acquiring private targets and hence are subject to over-optimism.
Table 3
Mean and Median CARs to Bidder Firms by Method of Payment Panel A: Mean and Median CARs to Bidder Firms by Target Type
Public Private All
Mean Median Obs. Mean Median Obs. Mean Median Obs.
All | Cash -0.31 -0.10 33 1.00 0.46* 196 0.83 0.19 229 All | Equity -2.62** -2.29** 59 4.19*** 1.09*** 206 2.60*** 0.22* 265 Mature | Cash -2.15 -0.54 24 1.04 0.47 161 0.62 0.06 185 Mature | Equity -2.27* -2.45** 49 4.42*** 1.01*** 156 2.82*** 0.15 205 IPO | Cash 8.53* 6.21 9 0.82 0.38 35 1.78 0.52 44 IPO | Equity -3.90 -1.80 10 3.49 1.58* 50 1.88 1.06 60
Panel B: Differences in CARs to Mature and Newly Public firms on the Basis of Bidder type and Method of Payment
Public Private All
Mean Median Obs. Mean Median Obs. Mean Median Obs.
Mature - IPO | Cash -10.68** -6.75** 33 0.22 0.09 196 -1.16 -0.46 229
Mature - IPO | Equity 1.63 -0.65 59 0.93 -0.57 206 0.94 -0.91 265
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iv. Cross-Sectional Regression Analysis
The results from the cross-sectional regressions are presented in table 4. The main question of this paper is whether shareholders react differently when acquisition announcements are made by newly public firms or by mature firms. For the full sample regressions (1-5) the IPO dummy is consistently positive but never significant however. This supports the findings of the previous univariate analyses that for the overall sample the abnormal returns to newly public firms are similar to the abnormal returns to the mature firms. The positive sign is consistent with the over-optimism hypotheses formulated by Brau et al. (2010) and Wiggenhorn et al. (2007) and more in-depth analysis might reveal some basis for this.
The first regression consists of only the basic variables without any interactions. In line with Wiggenhorn et al. (2007) the coefficient on the Bubble dummy is negative and significant indicating that shareholders were aware of overvaluation of shares during this period and hence skeptical towards acquisition announcements. The significantly negative coefficient on the crisis dummy provides support for the assumption that shareholders were more cautious during the crisis years towards acquisition announcements. The private target dummy is significantly positive as expected on the basis of previous research and the univariate results that bidder firms acquiring private targets have higher abnormal returns than bidder firms acquiring public targets. All the other variables in this first regression have their expected signs but are not statistically significant.
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variable is significant and reveals that newly public firms that experience a runup in the share price prior to an acquisition announcement receive higher abnormal returns than mature firms do.
In regression 5 two interaction-variables are included to capture additional effects of newly public firms. As regression 2 till 4 show abnormal returns are higher after a runup in the share price of the bidder firm when deals are financed by equity or when bidder firms are newly public. Regression 5 includes the interaction-variable IPO*Runup*Shares to capture these effects into one variable. Although the coefficient is large and positive it cannot be concluded that after a runup in the share price of the bidder firm, newly public firms acquiring target firms with equity have higher abnormal returns than other deals after a runup have. The interaction between IPO, private target and shares is also not significant.
The results of regression 6 and 8 show some distinctive differences in determinants of abnormal returns between newly public and mature firms. First off, mature firms are more subject to cautious shareholder reactions during the credit crisis period as witnessed by the significantly negative coefficient. Newly public firms also have a negative coefficient but it is not statistically significant from zero. This can be an indirect indication that shareholders are a bit more optimistic towards acquisitions made by newly public firms regardless of the overall market conditions. Another striking difference is the fact that the private target dummy is significant for mature firms but not for newly public firms. The univariate analysis related to target type, table 2, shows that private target deals have higher abnormal returns than public target deals, even for newly public firms. It might well be the case that the significant public target-cash deals subsample of newly public firms depresses the private dummy in these regressions.
Cross-sectional Regression Analysis of the Announcement Period Abnormal Returns
(1) Full Sample (2) IPO Bidders Only (3) Mature Bidders Only
(1) (2) (3) (4) (5)
(5) (6)
(7) (8) Constant 0.046 0.070 0.040 0.068 0.060 0.033 0.140 0.042 0.061 Bubble -0.042 -0.038* -0.029 -0.026 -0.027 -0.006 -0.004 -0.041 -0.042 Crisis -0.028 -0.026* -0.028** -0.027** -0.027** -0.014 -0.019 -0.030** -0.027* IPO 0.014 0.014 0.045 0.044 0.089 X X X X ln(MV) -0.005 -0.005 -0.005 -0.005 -0.005 -0.002 -0.005 -0.005 -0.004 MTBV -0.002 -0.002 -0.003* -0.003* -0.003* -0.004 -0.004 -0.003 -0.003 Overextension -0.017 -0.017 -0.018 -0.018 -0.016 -0.009 0.004 -0.021 -0.022 Private target 0.042 0.013 0.050*** 0.016 0.026 0.014 -0.073 0.051*** 0.028 Related -0.007 -0.006 -0.006 -0.005 -0.005 -0.005 0.007 -0.010 -0.011 Relative Size 0.001 0.001 0.001 0.000 0.000 0.013*** 0.010** 0.000 -0.000 Runup 0.023 -0.255*** -0.014 -0.275*** -0.233*** 0.194*** 0.03 -0.012 -0.246*** Shares 0.010 -0.009 0.014 -0.016 -0.002 -0.019 -0.136 0.015 -0.001 Technology 0.013 0.011 0.011 0.010 0.009 0.034 0.029 0.009 0.008 Private target*Shares 0.022 0.033 0.018 0.137 0.017 Private target*Runup 0.246*** 0.231*** 0.214*** 0.033 0.231*** Shares*Runup 0.104* 0.100* 0.063 0.227 0.063
IPO* Private target -0.029 -0.032 -0.084
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Notes: This table reports the results from the cross-sectional ordinary least squares regression analyses. The dependent variable is the abnormal return for the three day announcement period. Bubble equals one when the announcement is made in the years 1999 or 2000, zero otherwise. Crisis equals one when the announcement is made in the years 2007 or 2008, zero otherwise.IPO equals one when an announcement is made within one year of the IPO date of the bidder firm, zero otherwise. SIZE is the natural logarithm of the market value of the bidder firm one month before the announcement. MTBV is the market-to-book value of the bidder firm one month before the announcement. Overextension equals one whenever the acquisition announcement is preceded by two or more acquisitions, zero otherwise. Private target equals one when the target’s type is private, zero if public. Related equals one when bidder and target firm have the same first two digits of the SIC code, zero otherwise. Relative size is the ratio of the deal value and the market value of the bidder firm. Runup is the abnormal return for the bidder firm for the thirty days preceding the announcement period. Shares equals one if the method of payment is equity, zero if the method of payment is cash. Technology equals one if the bidder firm is a technology firm according to Loughran and Ritter (2004), zero otherwise. The interaction-variables are the products of the respective variables. *,**,*** refers to 10%, 5% and 1% significance levels.
arguments: First, using the strong currency in equity financed deals is rewarded. Second, the runup can be a proxy for (increasing) positive sentiment towards a firm by the shareholders. As positive sentiment grows shareholders will buy (more) shares of the firm. This drives the share price up. When an acquisition is announced shareholders are confident that the firm will efficiently perform this acquisition. The positive relationship between runup and abnormal returns for newly public firms therefore also supports the over-optimism hypothesis described by Brau et al. (2010) and Wiggenhorn et al. (2007).
The interaction variables in regressions 7 and 9 provide some additional insights in the differences between newly public and mature firms. The Private target*Shares variable is not significant as was also the case in the full sample regressions. It can therefore not be concluded that bidder firms acquiring private targets with equity receive higher abnormal returns than other deal combinations. The insignificant coefficient of Private target*Runup in regression 7 makes it clear that the positive relationship between runup and abnormal return for newly public firms is similar for both private and public target deals. In contrast, for mature firms this coefficient is significantly positive indicating that after a runup in the share price private target deals by mature firms receive higher abnormal returns than public target deals do. The positive sentiment argument for newly public firms thus finds support irrespective of the type of target firm. Previously regression 2 and 4 showed that in the full sample bidder firms are rewarded for using strong currency as the method of payment. The bidder firm subsamples are not able to support this finding as the shares*runup variable is now insignificant.
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After a runup of the share price mature firms acquiring private targets receive statistically significant higher returns than when acquiring public targets.
VI. Conclusion
In this paper I study abnormal announcement returns to Western European bidder firms announcing an acquisition with a particular emphasis on the separation of newly public and mature bidder firms. I construct a cumulative abnormal return for the three-day announcement period (-1,0,1) with zero being the day of the announcement. Afterwards I employ two univariate analyses and several cross-sectional regressions to determine differential results between newly public and mature firms. After controlling for the target type and method of payment I find most abnormal returns accruing to bidder firms to be equal for both newly public and mature firms. Only the subsample of public targets acquired with cash delivers significantly different results. Mature bidder firms experience insignificant and negative abnormal returns, similar to the results of previous research, whereas newly public bidder firms experience significantly positive abnormal returns. This can be caused by the assumption that shareholders favor newly public firms using their (excess) cash from the IPO for acquisition activity rather than value-decreasing activities. The fact that this is only true for public deals can be explained by the more difficult evaluation of private firms due to lack of information. In addition, newly public firms acquiring public targets have higher mean market-to-book ratio which indicates that they are subject to over-optimism and hence receive higher abnormal returns than newly public firms acquiring private targets do. The cross-sectional regression analysis reveals that newly public firms receive higher abnormal returns when target firms are larger and when these newly public firms have experienced a runup in their share price. Abnormal returns to mature firms are not influenced by the relative size of the target firm and a runup in the share price benefits private target deals more than public target deals.
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acquiring larger target firms and a runup in the firm’s share price leads to higher returns for private target deals than public target deals. Brau et al. (2010) and Wiggenhorn et al. (2007) concluded that newly public firms are subject to over-optimism. My results confirm these findings to the degree that newly public firms are more sensitive to contemporaneous sentiment. But this does not result in higher overall announcement returns to newly public firms relative to mature firms, only one subsample provides evidence on this.
A limitation of this study is the lack of public target deals in general but specifically for the newly public bidder firms’ subsample. As noted this could bias the significant result from the univariate analysis and the corresponding explanatory argument made. Future research can fill this gap by performing a similar study with a larger sample. The runup and relative size variables are also elements which could be addressed more specifically in the future.
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