CHAPTER 7

THE TIMING OF
MERGER ACTIVITY
Weston, Mitchell, Mulherin

Group 4 : Aileen, Fenny, Johanna

CONCEPTUAL FRAMEWORK
Coase (1937)
Technological change -> firm size
Merger will be related to technological change

Jensen (1993)
Associated merger activity with technological
change
Factors that influence merger : input prices,
legal/political/regulatory, innovations in
financing

EARLY MERGER
MOVEMENTS

Occurred when the economy sustained high

rates of growth and coincided with
developments in business environment.

Represent resource allocation and

reallocation processes in the economy.

Major merger movements in the U.S :

1895 1904 : Horizontal mergers
1922 1929 : Vertical mergers

EARLY MERGER MOVEMENTS

1895 1904 : Horizontal mergers

Resulted in high concentration in many

industries
The period was one of rapid economic
expansion
Ended in 1904 -> Sherman Act Section
I. However, in 1901 it began its
downturn because of failed
combination and recession in 1903.

EARLY MERGER MOVEMENTS

1895 1904 : Horizontal mergers

Accompanied by major changes in

economic infrastructure and
production technologies:
Transcontinental railroad system
Advent of electricity
Increase in the use of coal

Transformation of regional firms to

national firms

EARLY MERGER MOVEMENTS

1895 1904 : Horizontal mergers

Two motivational factors :

Economies of scale
Merging for monopoly (Stigler, 1950)
Producers of mergers : professional promoters

and underwriters (Markham, 1955)

Causes for failure (Dewing, 1953):

Lack of efforts to realize economies of scale

Increase in overhead costs
Lack of flexibility
Inadequate supply of talent to manage a large
group of plants

EARLY MERGER MOVEMENTS

1922 1929 : Vertical mergers

Also began with an upturn in business

activity
Ended with a severe
economic slowdown in 1929
Motivational factors :
Development in transportation,

communication and merchandising

Appreciate the advantage of integration
related to technological economies and
reliability.

THE CONGLOMERATE
MERGERS OF THE 1960S

Amendment of the Clayton Act 1914 to

close the asset purchase loophole

The period was also one of a booming

economy
Ended in 1969 due to general
economic activity slowdown

THE CONGLOMERATE
MERGERS OF THE 1960S

Weston and Mashingka (1971) suggest

that the conglomerate were
diversifying to avoid :

Sales and profit instability

Adverse growth development
Adverse competitive skills
Technological obsolence
Increased uncertainties associated with
their industries

THE CONGLOMERATE
MERGERS OF THE 1960S
P/E MAGIC
Buyer
(1)

Seller
(2)
10

Combined
(3)
20

Explanation for
(3)

P/E

20

Assumed

Net Income

$100 mio $100 mio $200 mio

(1) + (2)

Shares
Outstanding

20 mio

20 mio

32 mio

(1) + 0.6(20 mio)

EPS

$5

$5

$6.25

$200 / 32

MV per share

$100

$50

$125

20 X $6.25

THE CONGLOMERATE
MERGERS OF THE 1960S
P/E MAGIC
Buyer

Seller

Premerger Postmerge
r

Premerger

Postmerger

EPS

$5

$6.25

$5

$3.75

Market Price
per Share

$100

$125

$50

$75

Total Market
Value

$2 billion

$2.5 billion

$1 billion

$1.5 billion

THE DEAL DECADE,

1981 to1989

Economy and the stock market began to

surge upward in min-1982
Big deals -> facilitated by :
Raiders (underwrite the sale of high-yield junk

bonds)
Leveraged Buyouts (LBO)
Bustup Acquisitions

The end : powerful takeover defense,

state antitakeover laws, weakness in the
junk bond market, economic downturn

STRATEGIC MERGERS,
1992-2000

The gulf war was over and economic

recovery was strong
Major forces :

Technology (software, internet, fiber optics)

Globalization
Deregulation (increased competition)
The economic environment (low i, rising P/E)
The method of payment (stock for stock)
Share repurchases
Stock options

MERGER ACTIVITY AFTER

THE BUBBLE

M&A market was dampened by

corporate fraud and dismal record of
active acquirers

TIMING OF MERGER
ACTIVITY
TWO BROAD GENERALIZATION
:
Each of the major merger
movements reflected some
underlying economic or
technological factor
Some common economic factors are
associated with different levels of
merger activity

INDUSTRY CLUSTERING
1919-1930
3009 meRGERS

Others; 33%

5 industries; 68%

Mergers activity
cluster in time
and cluster in
specific industry
Eis(1969) and
Gort(1969) found similar
patterns in 1919-1930
and in the 1950s.

INDUSTRY CLUSTERING
(1980s)
Industry
Others; 33%

Broadcasting, Petroleum Producing, Air Transport; 67%

time

The rest; 50%

Adjacent 2 years period; 50%

Analysed by Mitchell and

Mulherin(1996)
Forces of change:
1. Industry deregulation
2. Oil price shocks
3. Ability to use public
markets for leveraged
financing
Combination of broad
underlying economic,
political, and financial
forces.

INDUSTRY CLUSTERING
(1990s)

Analysed by Mulherin and Boone(2000)

Half were acquired or engaged in divestiture

Merger and divestiture were clustered by industry:

banking&telecommunication, chemical&petroleum

Deregulation was an important force

Not isolated to low-tech industries

MERGERS AND
DEREGULATION
1980S
Deregulated; 15%

Analysed by Andrade,
Mitchell, and Stafford
(2001).

Not deregulated; 85%

After 1988

Not Deregulated; 50%

Deregulated; 50%

Industries with
substantial
deregulation:
1.Airlines (1978)
2.Broadcasting
(1984)
3.Utilities (1992)
4.Telecommunication

MERGERS AND DEREGULATION

(PERFORMANCE)
Deregulation led to greater
capacity utilization, lower firm
costs, reduced consumer
prices.

Winsto
n
(1988)

Deregulation generally followed by

merger activity->improve
corporate performance and
consumer welfare.

Bank mergers in 1990s improved

shareholder wealth. Combined
return to target and bidder
shareholders averaged 3.53%.
Becher
(2000)

INTERNATIONAL
PERSPECTIVES
Study by McGowan(1971): Merger activity
clustered in particular industries during sample
period.
M&A activity is determined by economic and
financial forces.

CHAPTER 8
EMPIRICAL TESTS OF M&A PERFORMANCE

COMBINED RETURNS IN M&A

Are mergers positive net
value investment?

Theories based on
synergy and efficiency

Theories based on
agency cost and
hubris

EVENT STUDY
1960

1970

1980

1990

2000

Bradley, Desai, Kim(1988):

Target shareholder gain 31.77%
Bidder shareholder gain 0.97%
Value weighted=7.43%
Kaplan(1991) and Weisbach(1992):
Estimated combined return=4%
Mulherin and
Boone(2000):
Positive combined return
Andrade Mitchell Stafford
(2001):
Combined return=2%

Mergers create value for the shareholders of combined firms

and results are consistent with synergistic theory of the firm.

ADDITIONAL ANALYSIS
Adding correlation
Berkovich and Narayanan(1993): distinguish
between synergy, hubris, and agency theory.
Result: 76% positive and significant

Banking industry
Becher(2000): bank mergers create wealth. For
time period 1980-1997, combined
return=3.53%.
Brook, Hendershott, Lee(1998): Study the period
of Interstate Banking and Branching Efficiency
Act in 1994. Takeover deregulation created
value.

FACTORS RELATED TO
TARGET RETURNS
1. Method of
payment
2. Number of
bidders

1. METHOD OF PAYMENT
14.40%
23.30%

Observation: 19771982

29.30%

13.90%
Cash deals create
more wealth for target
32.20%
Observation: 1973shareholders 27.50%

1983

20.50%
21.10%

Observation: 19721987

26.70%
13.00%

0.00%
Observation:

1973-

1988

20.10%
Cash

Stock

Combined

2. NUMBER OF BIDDERS
Before
Announceme
nt

25.98%
23.95%

Observatio
n: 19631984

46.12%when
On average, target returns are larger
After
26.65%
more than one firm publicly bids Announceme
for the
nt
30.50%
target.
Observatio

n: 19721987

20.80%

Before
Announceme
nt

12.70%

Observatio 13.40%
n: 19751991

After
Announceme
nt

18.20%

8.50%
Single

Multiple

TARGET RUN-UP
Takeovers target experience positive
stock return run-up prior to acquisition
announcement. On average: 11.8%

Why?

Keown and Pinkerton (1981):

Illegal insider trading
Sanders and Zdanowicz (1992):
Tied to the likelihood of actual cash
Meulbroek(1981):
Illegal insider trading account for half of run-up in the
sample
Jarrel and Poulsen(1989):
Media rumors and prebid share acquisition

TAKEOVER BIDDING AND

TAKEOVER PREMIUM
Target firms receive substantial
premium in tender offers.
Bradley (1980): Average premium 49%
Cotter and Zenner (1994): Final premium in takeover exceeds the
initial premium offered by first bidder
Betten and Eckbo:
Premium in a tender offer with single bidder = 51% > multiple bidder
= 45%

FACTORS RELATED TO
BIDDER RETURNS
Method of
payment
Single vs multiple
bidders

1. Method of payment
No. Of
Time Period Observation
s

Event
Window

Travlos (1987)

1972 - 1981

167

(-10,
+10)

Asquith et al. (1990)

1973 - 1983

186

(-1, 0)

Servaes (1991)

1972 - 1987

380

1973 - 1998

3.668

Research Paper

Andrade,
Mitchell
and Stafford (2001)

(-1,
resolve)
(-1, +1)
(-20,
close)

Cash
(%)

Mixed
(%)

Stock
(%)

-0,13

NA

-1,6

0,2

-1,47

-2,4

3,44

-3,74

-5,86

0,4

NA

-1,5

-0,2

NA

-6,3

Bidder has more negative return in stock

transactions compared with cash deals

contd
Andrade, Mitchell and Stafford (2001) :

100% cash deals are associated with

better bidder returns
Asymmetric information between
bidder managers and investors

2. Single vs Multiple Bidders

Research
Paper

Time
Period

No. Of
Obsrv

Event
Window

Singl Multip
e (%) le (%)

Bradley et
al. (1988)

19631984

236

(-20,+1)
(-20, +40)

2,75
2,97

-0,41
-0,21

Servaes
(1991)

19721987

384

(-1,
resolve)

-0,35

-2,97

Schwert
(1996)

19751991

1.523

(-42, +1)
(0, +126)

1,9
-0,4

0,2
-3,5

First
Bid
(%)
2,0

Late
Bid
(%)
-2,5

Bidder returns are lower when there are

multiple bidders

Contd
Bradley et al :

(1983) Unsuccessful bidders lost value

and successful bidders broke even.
(1988) Successful bidders lost wealth
during a multiple-bid takeover.

Contd
Do bad bidders become good
targets?
The more negative the market
response is to a firms acquisition, the
greater likelihood is that the firm will
become takeover target(Mitchell and
Lehn, 1990)

TAKEOVER REGULATION
AND TAKEOVER HOSTILITY
EFFECT OF THE WILLIAMS ACT
Bradley, Desai, and Kim (1988)
Combined return to takeovers did not change in the
period before and after William Act (1968), but the
distribution between targets and bidders was shifted.
Target premiums increased and bidder return fell.
EFFECT OF TAKEOVER IMPEDIMENTS IN THE 1980s
Schwert (1995)
The decline in the takeover market in the late 1980s
was due to general economic conditions rather than
factors such as state laws or poison pills.

Contd
TAKEOVER HOSTILITY
Hostile takeover means different things to
different people (Schwert, 2000)

Most of the characteristics of takeover

offers that are related to hostility seem to
reflect strategic choices made by the
bidder or target firms to maximize their
respective gains from potential transaction
(Schwert,2000)

POSTMERGER OPERATING
PERFORMANCE
Healy, Palepu, and Ruback (1992)
OCF for the merged firms increased
relative to industry benchmarks, driven
by an improvement in asset turnover
for the merged firms.
The announcement returns accurately
forecast postmerger performance
consistent with efficient markets theory

LONG-TERM STOCK PRICE

PERFORMANCE

Average long-term price performance following a

merger is insignificantly different form zero.

Long-term stock price performance following a cash

financed acquisition will be positive, and the longterm price performance following a stock acquisition
will be negative (Shleifer and Vishny,2003)

Value firms with high BM ratio have positive

performance following mergers, firms with low BM
ratio significantly underperform following mergers
(Rau and Vermalen, 1998)

EFFICIENCY VS MARKET
POWER
EFFICIENCY

Ellert (1976) : merger

facilitated the efficient
reallocation of resources across
firms

Stillman (1983) : merger

announcement had no
discernible effect on the
industry rivals.

Vertical merger result in

valuation increases comparable
to those in horizontal merger

MARKET POWER

Song and Walking

(2000) : other
industry member
experienced a
positive return at
the time of a merger
announcement in
the industry.

EFFECT CONCENTRATION
IMPACT ON MACROCONCENTRATION
Aggregate concentration has been virtually
unchanged or lower during the last two
decades despite increased merger activity.
IMPACT ON MICROCONCENTRATION
The weighted average level of
concentration stayed relatively constant
about 40% over decades of the 1960s and
1970s.