1. Introduction
There was a tidal current of mergers and acquisitions (M&A) which use equity as their payment methods in 1990s (Andrade, Mitchell, and Stafford (2001)). In the paper “Do Stock Mergers Create Value for Acquirers?”, Savor and Lu (2008) did some theoretical analysis and empirical investigations on whether the acquisition which use a company’s equity will benefit the long-term interest of the shareholders and whether there is any difference between the stock earnings of successful acquirers and the unsuccessful ones as well as between the cash acquirer and equity acquirer. Through their research, they find that the acquisition failure of companies whose stock is overvalued is costlier, and the target company will have a higher return. Besides, the unsuccessful companies tend to outperform the successful ones.
2. Theories
Firstly, Martin (1996) and Verter (2002) mentioned that there is a positive correlation between the companies’ stock valuation and their acquisition activity. Sheleifer and Vishny (2003) also observe that overvalued firm are more inclined to take a merger and acquisition activity by using its overvalued equity. Secondly, Savor and Lu intend to test Shleifer and Vishny (2003) and Rhodes-Kropf and Viswanathan’s（2004）market timing model which predicts that the acquisition will benefit the long-term shareholders of the valuation-driven acquirer. Thirdly, Savor and Lu want to test Mitchell and Mulherin (1996), Maksimovie and Phillips (2001), Jovanovic and Rousseau’s (2002) neoclassical theory of mergers which says that the mergers are efficiency-motivated responses to the ethnological, regulatory or economic shocks. Lastly, Savor and Lu intend to find some evidence about whether there is any difference between abnormal returns of equity bidders and cash bidders, as well as whether there is any difference between the successful acquirers and unsuccessful ones.
3. Data and Research Methods
3.1. Data
This paper uses a sample from the Centre for Research in Security Prices (CRSP) Merger Database and SDC Platinum and combines them together. The author picks the stock return, firm size and share type from CRSP and uses the factor returns and the NYSE size breakpoint from Kenneth French’s website to built a sample of 1773 US public companies through the period from 1978 to 2003. There are 1050 successful equity bidders and 723 cash bidders, and the unsuccessful sample consisted of 187 equity bidders and 168 cash bidders. The paper uses the company whose payment mode is all-cash or all-equity to take advantage of market-timing hypothesis. It is worth noticing that the paper chooses the target companies whose pre-announcement market value is not quite small because the very small company will bring just noise. In order to make sure no company will be include in the sample more than once, the sample excludes the companies which engage in another M&A activity in the previous three years by using the same consideration.
3.2. Research Method
Since the main project of this paper is to explore whether the M&A activities which use the equity payment will benefit the shareholder’s long-term interest. The first method is to take a look at long-term abnormal returns of these bidder companies and compare with the non-acquiring firms. In order to avoid the bias brought by the endogeneity of the acquisition decision, the authors take an approach, which is based on the assumption that the valuation of a company is unrelated to its acquisition result. By differentiating the successful acquirers from the unsuccessful ones, if the M&A activities really cater for the interest of shareholders, the unsuccessful ones should underperform the successful ones.
The analysis relies on that they use the performance of the unsuccessful acquirers as a measurement to the successful ones. There are two assumptions for the approach: Firstly, the decision of acquiring does not influence the acquirer’s stand-along fundamental value. Second, if the merger fails, it cannot engage in another acquisition activity.
In the definitions of the variables, the author assumes that market can get the financial statement four months after the fiscal year ends. The author uses an approach which is composed by two methodologies to analysing the long-term abnormal returns. One is to use the buy-and-hold abnormal returns, and the other one is to use the calendar-time portfolio approach raised by Fama (1998).
In the buy-and-hold abnormal returns analysis, the author uses the returns by book-to-market ratio, firm size, and industry. They first find companies with the same two-digit SIC code as well as the market value between 50% and 150% of the sample company. Then they choose 10 acquirer companies which have the close book-to-market ratio with the sample firm. After that, they build the matching portfolio. In the calendar-time portfolio approach, they build the portfolio in the holding period with all companies that have an eligible acquisition bid. Every month the portfolio will be rebalanced, if a firm is delisted before the end of the holding period, the author will pick the delisted return of the stock. When it comes to the problem that there is few of failed acquiring, the author builds the portfolio by using the 25% weight of each stock and use the weighted least square (WLS) regressions, where the weight is the number of the stock in the portfolio.
4. Results
From the outcome table, the author finds that the significantly negative return of the equity acquirer and the significantly positive preannouncement return directly support Shleifer and Vishny’s (2003) market-timing model which predicts that the acquirers are more overvalued than the target companies. As for the successful acquirers and the unsuccessful ones, one is that larger ones and those who attempt to do dig deals are always unsuccessful because of the antitrust authority issues. In terms of the cash payment ones, both acquirers and targets get a higher announcement returns than the failed ones.
To be more specific, in terms of the long-term buy-and-hold abnormal returns, both the successful ones and the failed ones perform a negative return and become steadily worse in the three years after the acquisition. However, in spite of the negative returns, the successful ones still outperform the failed ones. In the sample of All Failed Sample and Restricted Exogenous Failed Sample, the results hold the same.
In contrast, as the same prediction of the market-timing model, failed cash-payment acquires do not ted to suffer worse abnormal returns than the successful ones, because the negative impact tends to be more significant with the equity-payment acquirers.
As for the calendar-time methodology, successful equity payment acquirers show a noticeable negative calendar-time return, but as the previous findings, the failed ones suffer much lower abnormal returns. In terms of the cash -payment firms, the failed ones don not have underperformance with the successful ones.
The announcement returns around the termination announcement time are positive for the acquirers because investors like the abandon of the deal, although the deal will bring them long-term benefits. However, after the announcement of bid termination, the failed firms show a significantly negative long-term return. Unsuccessful stock acquirers continue to underperform after the bid termination announcement.
With particular attention, the glamour acquirers tend to underperform their valued counterparts, and the failure of the M&A is more costly for highly overvalued stock firms.
5. Conclusion
This paper supported the market-timing model’s prediction that overvalued firms benefit long-term shareholders through stock mergers because they convert their overvalued equities into the less overvalued hard assets. This phenomenon will create a strong incentive for the companies to raise their stock price, even though the process is costly. The manages might peruses the M&A activities even though the fundamental value of the two companies will reduce by combining them into one firm, as long as the gain will be large than the cost of the M&A activities.
There will be more negative post-event returns for stock acquirers because there is a positive correlation between the firm’s valuation and the tendency to make the bid. The failed acquirers will underperform the successful ones, and then the trend will persist with the length of the holding period. The market will give a positive reaction to the bid termination because they view it like a negative signal about the acquirer’s perspective.
From my perspective, if the mergers and acquisitions can indeed bring its long-term shareholders interest by the converting of the overvalued stock to hard assets, why investors cannot get the overvalue information when the M&A announcement is released? If the market can realise the opportunity of get abnormal earnings, the arbitrage activities would bring the price up in advance, which means the price should reflect all the information. Overall, I think the result of this paper does not consistent with the efficient market hypothesis, so maybe we should do more research on whether the M&A activities will bring benefits and whether it is the anomaly of the efficient market hypothesis.
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