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Advanced Corporate Finance 3. May 2010 Exam. No. 402387
Event study on the impact of mergers and acquisitions
Group member...
Advanced Corporate Finance 3. May 2010 Exam. No. 402387
Table of Contents
Event study on the impact of mergers and acquisi...
Advanced Corporate Finance 3. May 2010 Exam. No. 402387
This paper analyses the stock returns to shareholders of firms in ...
Advanced Corporate Finance 3. May 2010 Exam. No. 402387
shareholders, therefore this paper will focus only on acquirer sha...
Advanced Corporate Finance 3. May 2010 Exam. No. 402387
synergies between a firm with excess capital but small growth poss...
Advanced Corporate Finance 3. May 2010 Exam. No. 402387
dilute any possible gains from real synergies that might exist as ...
Advanced Corporate Finance 3. May 2010 Exam. No. 402387
3. Hypothesis
The theory and literature reviewed in section 2 poin...
Advanced Corporate Finance 3. May 2010 Exam. No. 402387
rational behaviour which talks in favour of a short event window s...
Advanced Corporate Finance 3. May 2010 Exam. No. 402387
incorporation of the constant mean return model. The market model ...
Advanced Corporate Finance 3. May 2010 Exam. No. 402387
4.4 Statistical test
To test the hypotheses stated in section 3, a...
Advanced Corporate Finance 3. May 2010 Exam. No. 402387
test proved to be power full on the thickly traded stocks. The Sig...
Advanced Corporate Finance 3. May 2010 Exam. No. 402387
5.1.4 Deal value
To further narrow down the samples in regards to ...
Advanced Corporate Finance 3. May 2010 Exam. No. 402387
The data set has been corrected for non-trading days and therefore...
Advanced Corporate Finance 3. May 2010 Exam. No. 402387
6. Empirical evidence
In this section the hypotheses will be teste...
Advanced Corporate Finance 3. May 2010 Exam. No. 402387
The results from the tests conducted only on the portfolio of UK a...
Advanced Corporate Finance 3. May 2010 Exam. No. 402387
6.2 Comparison to existing empirical studies
The findings of the e...
Advanced Corporate Finance 3. May 2010 Exam. No. 402387
activities despite unsure empirical evidence for the return of acq...
Advanced Corporate Finance 3. May 2010 Exam. No. 402387
8. References
Books
Copeland, Thomas. E, Weston, Fred. J & Shastri...
Advanced Corporate Finance 3. May 2010 Exam. No. 402387
Financial Economics, vol. 11, pp. 5-50.
Kiymaz, Halil and Baker, K...
Advanced Corporate Finance 3. May 2010 Exam. No. 402387
Appendix
Figure 6 – Selected companies domestic - 300 deals (UK fi...
Advanced Corporate Finance 3. May 2010 Exam. No. 402387
Page 21 of 25
Advanced Corporate Finance 3. May 2010 Exam. No. 402387
Figure 7 - Selected companies cross border -175 deals (UK firms ac...
Advanced Corporate Finance 3. May 2010 Exam. No. 402387
Page 23 of 25
Advanced Corporate Finance 3. May 2010 Exam. No. 402387
Figure 8 – Volume of stocks on UK firms acquiring domestic UK firm...
Advanced Corporate Finance 3. May 2010 Exam. No. 402387
Figure 10 – Cross sectional regression analysis
Page 25 of 25
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  1. 1. Advanced Corporate Finance 3. May 2010 Exam. No. 402387 Event study on the impact of mergers and acquisitions Group members in regards to collecting and programming: Exam No. 402380 Exam No. 402387 Page 1 of 25
  2. 2. Advanced Corporate Finance 3. May 2010 Exam. No. 402387 Table of Contents Event study on the impact of mergers and acquisitions..............................................................1 Table of Contents...................................................................................................................................... 2 1. Introduction........................................................................................................................................... 3 1.1 Problem statement ..................................................................................................................................... 3 1.2 Delimitation.................................................................................................................................................. 3 2. Literature review................................................................................................................................. 4 2.1 Motives for acquisitions............................................................................................................................ 4 2.1.1 Neoclassical theories.............................................................................................................................................. 4 2.1.2 Behavioural theories ............................................................................................................................................. 5 2.2 Empirical evidence on short term stock performance on announcement of acquisition.....6 3. Hypothesis.............................................................................................................................................. 7 4. Methodology.......................................................................................................................................... 7 4.1 The event window....................................................................................................................................... 7 4.2 The estimation period................................................................................................................................ 8 4.3 Abnormal return.......................................................................................................................................... 8 4.4 Statistical test............................................................................................................................................. 10 4.4.1 Parametric tests..................................................................................................................................................... 10 4.4.2 Non-parametric test............................................................................................................................................. 10 4.4.3 Cross sectional regression.................................................................................................................................11 5. Data........................................................................................................................................................ 11 5.1 Data collection........................................................................................................................................... 11 5.1.1 Selection criteria.................................................................................................................................................... 11 5.1.2 Deal status, type and final stake......................................................................................................................11 5.1.3 Banking, Insurance and Financial Services Companies.........................................................................11 5.1.4 Deal value ................................................................................................................................................................ 12 5.1.5 Datastream............................................................................................................................................................... 12 5.2 Thin trading................................................................................................................................................ 12 5.3 Data descriptive........................................................................................................................................ 13 6. Empirical evidence............................................................................................................................ 14 6.1 Test result................................................................................................................................................... 14 6.1.1 Cross sectional regression.................................................................................................................................15 6.2 Comparison to existing empirical studies.........................................................................................16 7. Conclusion............................................................................................................................................ 16 8. References............................................................................................................................................ 18 Abstract Page 2 of 25
  3. 3. Advanced Corporate Finance 3. May 2010 Exam. No. 402387 This paper analyses the stock returns to shareholders of firms in the United Kingdom, hereinafter referred to as the UK, acquiring domestic UK firms and cross border firms within the EU from 2006 until today (2010). The paper includes 92 acquisitions within the UK and 53 cross border acquisitions within the EU. The paper comes to the conclusion that listed firms have a significant positive impact on the acquiring shareholders wealth. The study concludes an overall significant abnormal return of 1,1499% for the entire portfolio. 1. Introduction Today, mergers and acquisitions, hereinafter referred to as M&A’s, are universal, with companies acquiring targets all over the world. Mergers and acquisitions represent massive reallocation of resources, both within and across industries and countries and therefore for many years has been the interest of empirical studies. There have been 3 merger waves in the 1960s with the conglomerate takeovers, in the 1980s with the hostile “bust-up” takeovers and in the 1990s the “strategy” or “global” takeovers. Historically, large number of these merger and acquisitions were concentrated in the USA and also in the UK. Extensive research has been undertaken on whether acquisition are wealth creating or wealth reducing events for shareholders and empirical studies have revealed that mergers appear to provide at best a mixed performance to the various stakeholders involved. Target-firms shareholders generally enjoy positive short term returns, while investors in the acquiring firms often experience share price underperformance in the month following the announcement of a merger. An interesting viewpoint is to look at the European Union with its single monetary union. This paper will look on the effect of firms in the UK acquiring domestic UK firms and cross border firms within the EU. 1.1 Problem statement The focus of this paper is to examining the effect of UK firms acquiring domestic UK firms and cross border firms within the EU from 2006 until today (2010). Has there been a wealth creating or wealth reducing outcome for the acquiring shareholders and is there a difference in the abnormal return in the acquisition of domestic or cross border firms for the acquiring shareholders. The empirical tests will be based on event study methodology. 1.2 Delimitation When examining the effect of mergers and acquisitions it can be done from different point of views of either the target shareholders, the acquiring shareholders or the firm as a hole. According to very clear empirical evidence stating that mergers and acquisitions are wealth creating for target Page 3 of 25
  4. 4. Advanced Corporate Finance 3. May 2010 Exam. No. 402387 shareholders, therefore this paper will focus only on acquirer shareholders where it seems more uncertain as to whether it creates or destruct wealth for the shareholders. There will only be looked at acquisitions and not on mergers. Many different factors can take part in explaining the abnormal return as for example firm size, payment method, debt to equity and merger waves. The paper will only focus on the short-term effects of an acquisition with a final stake of 100% leaving out acquisitions with a lower stake and mergers. The paper is also focusing on the effect in the domestic and cross-border variable meaning differences in returns between UK firms acquiring domestic UK firms and cross border firms within the EU. 2. Literature review The literature gives a brief overview of relevant theory and relevant empirical findings concerning mergers and acquisitions. 2.1 Motives for acquisitions Many different theories have been stated to explain the phenomenon of M&A and the reasons and motivations driving them. The theories can roughly be divided into the two main groups of neoclassical theories and behavioural theories where the first focus on the assumption of managers being rational and making rational choices in striving to maximize wealth for the shareholders and the second is based on the assumption that managers not necessarily are rational or representing the interests of the shareholders. These theories can furthermore be divided into internal and external motives. Where the internal motives such as hubris, synergy and agency costs can be influenced by that management and the external factors such as globalization, deregulation and technology cannot be influenced directly by management. 2.1.1 Neoclassical theories One of the motive theories under the neoclassical thoughts is the Synergy motive which assumes that managers only will engage in M&A’s if it results in positive gains for both the target and acquiring shareholders hence creating a synergy with positively correlated positive gains for both set of shareholders1 . In other words the synergy motive exists if the combination of the firms has a greater value than the two separate firms due to factors as improvements in efficiency and increases in market power of the combined firm. One of the most frequently mentioned synergies in respect to M&A motives is operating synergies as economies of scope and economies of scale for example being able to offer a wider range of products. Other kinds of synergies can for example be financial 1 Berkovitch, E. & Narayanan, M. P. (1993): Motives for takeovers: An empirical Investigation Page 4 of 25
  5. 5. Advanced Corporate Finance 3. May 2010 Exam. No. 402387 synergies between a firm with excess capital but small growth possibilities and another with large growth opportunities but a need for additional financing that together could reach greater results. According to Jarrad Harford, M&A can also partly be explained by technological, economic and regulatory shocks to the economy2 . If the environment of a firm changes the rational manager that is assumed to exist under the neoclassical theory will have to react to these changes in order to keep the firm performing effectively. If for example a new technologic is introduced in the market that a given firm does not have access to an M&A action between itself and another company with this technologic expertise could create positive synergies. 2.1.2 Behavioural theories Behavioural theories can be divided into agency motives where managers are still assumed rational but not representing the shareholder’s best interests or Hubris motives where managers are assumed non‐rational. Under the Agency theory problems arise because managers do not act in a way that maximizes value for the shareholders. The agency problems as described by Jensen and Meckling (1976) can arise due to managers only owning a small part of the ownership shares of a firm and other owners not owning a large enough share of the company to have sufficiently incentive to monitor the behaviour of the managers closely. Under these problems Managers may act to maximize their own interests rather than those of the shareholders for example to avoid control loss which could deprive them of private benefits and they may therefore settle for a low premium offer from a bidder in exchange for a share in management control of the merged company which in this case would dilute the gain to the target shareholders3 . Or management might be reluctant to pay out excess cash flows to shareholders because it will reduce the control of resources of the management and they will instead engage in takeover activities even though this might not maximize value for the shareholders. Another behavioural theory is that of empire building where managers will maximize the size of the firm by engaging in acquisition activities and thereby increase their personal compensation that might be coupled to firm size. Another dimension of the behavioural theories that does not assume rational managers is that of Hubris motives. Under this assumption acquisitions can be motivated by managers mistakes in for example valuation by being overoptimistic and therefore paying too much for a company which will 2 Harford, J. (2005): What drives merger waves? 3 Sudarsanam, Creating value from mergers and acquisitions (2003) p. 57 Page 5 of 25
  6. 6. Advanced Corporate Finance 3. May 2010 Exam. No. 402387 dilute any possible gains from real synergies that might exist as suggested by Roll (1986)4 . The Hubris motive therefore assumes that managers actually try to maximize shareholder value but due to irrationality isn’t capable of doing it. Shareholders of the acquiring firm will therefore experience negative returns since there is no real economic rationale for the acquisition and therefore no gains to offset costs of for example integration. 2.2 Empirical evidence on short term stock performance on announcement of acquisition Earlier conducted empirical studies have found evidence pointing towards that shareholders of target firms experience positive abnormal returns while shareholders of acquiring firms experience significantly lower returns, that if not negative, often at best is around break even. Jensen and Ruback (1983) for example concluded on the basis of their empirical studies that the shareholders of target firms earn significantly positive returns whereas the returns to the shareholders of the acquiring firms were close to zero5 . However the evidence concerning the acquiring firm’s shareholder return was less uniform and more dependent of the length of the event window so that the abnormal return detected for acquiring firm shareholders increased if expanding the window. These findings were backed by a study of returns conducted by Jarrell et. al6 . A study by Andrade et.al7 . found that average abnormal return to acquiring shareholders were equal to ‐ 0,7% but since this result wasn’t significant anything couldn’t be firmly concluded on whether acquiring shareholders were losers in the acquisition game. Another study by Moeller et.al.8 found that the average abnormal return to the acquiring firms shareholders over the period had been 1.1% but due to a small number of takeovers creating extremely large losses the total loss to the shareholders of the acquiring firms were 216 billion dollars from 1991 to 2001. Positive abnormal return can therefore not be inferred as meaning that the acquiring shareholders have necessarily gained from the acquisitions. A paper by Roades9 provided more diversified results for acquiring firms on the basis of 21 studies conducted in the period 1980-1993. He found that there were significant negative effects on the stock returns of the acquiring companies in seven of the papers, in seven others there were no effect, forgave mixed results and three found significant positive returns giving recognition to the synergy theory. 4 Roll.R., (1986)The Hubris Hypothesis of Corporate Takeovers p. 200 5 Jensen, M. C. and Ruback R.S., (1983),The market for corporate control: The evidence p. 22 6 Jarrell, G. A. et.al. (1988): The Market for Corporate Control: The Empirical Evidence Since 1980 p 51 7 Andrade, G., Mitchell, M. & Stafford, E: (2001): New Evidence and Perspectives on Mergers 8 Moeller, S. B. et.al. (2005): Wealth Destruction on a Massive Scale? A Study of Acquiring Firm returns in the Recent Merger Wave 9 Rhoades, Stephen A. (1994) ”A Summary of Merger Performance Studies in Banking, 1980–93, and an Assessment of the ‘‘Operating Performance’’ and ‘‘Event Study’’ Methodologies” Page 6 of 25
  7. 7. Advanced Corporate Finance 3. May 2010 Exam. No. 402387 3. Hypothesis The theory and literature reviewed in section 2 point towards that the shareholders of the acquiring firm doesn’t experience abnormal return but this will be further tested in this paper. According to the theory of the efficient market hypothesis any effect from the event will be immediately adopted in the prices and will therefore be detectable in the event window set. According to Moeller et. Al. (2005) and Andrade et. Al. (2001) acquisitions are in general wealth destructive from the acquiring shareholders point of view. These earlier findings will therefore be tested whether there is a significant difference in abnormal return for shareholders of the acquiring firm and whether there is a significant difference in the abnormal return for shareholders of the acquiring UK firms in regards to domestic UK target firms or cross border EU target firms. This leads to the formulation of the following hypotheses to be tested: 1. Acquisitions do not create short term abnormal returns for the shareholders of the acquiring firm around the period of the announcement of the acquisition. 2. There is a significant difference between the abnormal return created by UK firm acquiring domestic UK firms and UK firm acquiring cross border firms within the EU. 4. Methodology To test the hypothesis stated in the section above the method of an event study will be used and conducted to determine any abnormal return in the event window around the acquisition. An event study is an econometric method to measure the impact on a company from a certain event and is one of the most used empirical methods in finance and accounting. The event study methodology was introduced by Fama et. al. in 1969 in the paper “The adjustment of stock prices to new information” of measuring changes in security prices from an event or announcement as done in this paper 10 . An event study is an econometric method to measure the impact on a company from a certain event and is one of the most used empirical methods in finance and accounting. Accordingly to the efficient market hypothesis the effects of an event will immediately be reflected in the security prices and the event study methodology has its strength in measuring these implications11 . 4.1 The event window The event window determines the number of days over which we measure the possible abnormal return caused by the event. The theory of the efficient market hypothesis, mentioned in the literature review, proposes that any shift in stock prices caused by the event will happen immediately due to 10 Sudarsanam, Creating value from mergers and acquisitions (2003) 11 Pilloff and Santomero, The Values Effects of Bank Mergers and Acqusitions (1997) Page 7 of 25
  8. 8. Advanced Corporate Finance 3. May 2010 Exam. No. 402387 rational behaviour which talks in favour of a short event window since a long window could risk diluting the possibility if finding any significant evidence. However if the event window is too short we risk not catching the effect of the event if the information comes out after the closing of the market and therefore doesn’t reaches the public until the next day or if the information is leaked the day before the announcement and therefore causes the effect the day before the actual announcement/event day. To make sure that these possibilities are accounted for, the event window is set to three days containing the announcement day and the day prior to it and after it. 4.2 The estimation period The estimation period is used to estimate the expected return of the stocks. The period therefore needs to be long enough to create a representative measure of returns but too long and estimation period can risk biasing the estimation with information from other events or changes in the firms general conditions. It is normally set at around a year of trading prior to the event window12 . In this paper it is set to 200 trading days when the weekends are excluded and the three days of the event window are kept separate from the estimation period. This is done to make sure that the normal returns don’t get influenced by event related returns: The timeline of the event study is illustrated in figure 1. Figure 1 - Timeline 4.3 Abnormal return In order to test for an effect of the announcement on the stock prices we need to find the abnormal return in the event period. The abnormal return can be expressed as the actual return, subtracted the expected return if the event had not occurred. ARit = Rit - E(Rit|Xt)13 Where ARit is the abnormal return, Rit the actual return, and E(Rit|Xt)14 the expected return for company i. When estimating the actual return, there are several ways of doing so. In this paper the market model will be used due to its inclusion of the mean adjusted model and market adjusted model and 12 Bartholdy et. al. Conducting Event studies on a small stock exchange (2005) p.5 13 Bartholdy et. al. Conducting Event studies on a small stock exchange (2005) p.5 14 Can also be denoted Rˆit accordingly to Broan and Warner (1985) Page 8 of 25 -1 0 1 1-200 Estimation period Event window
  9. 9. Advanced Corporate Finance 3. May 2010 Exam. No. 402387 incorporation of the constant mean return model. The market model is the most widely used model because it takes explicit account of the risk associated with the market and means returns15 . The market model is a statistical model that relates the return of any given security to the return of the market portfolio16 . The market model for any stock i is: it i i mt itR Rα β ε= + + Rit is the actual return of a given stock i at time t and Rmt is the market price index connected with the stock i at time t. An OLS regression is performed to determine the model parameters estimates of αi and βi the intercept and slope respectively, for each stocks at every day in the estimation period. On the basis of this the abnormal return can then by measured for each stocks at every day in the estimation period and event window. In order to make an overall conclusion of abnormal return in the event window the concept of cumulative abnormal return (CAR) over the event window must be used17 CAR is the sum of the abnormal returns for the three days in the event window. The market model parameters are obtained in the estimation period and used in the event period to estimate the expected return, R^it. The expected return is calculated in the following way: R ^ it=α ^ i+β ^ iRmt The abnormal return ARit is now possible to calculate in the event window by subtracting the actual return Rit, with the expected return, Rˆit, as shown in the equation ARit = Rit - E(Rit|Xt). In order to make an overall conclusion of abnormal return in the event window the concept of cumulative abnormal return (CAR) over the event window must be used18 CAR is the sum of the abnormal returns for the three days in the event window, (-1;1), the cumulative abnormal return (CAR) model is used. CAR=Ai,−1+Ai,0+Ai,1 15 Brown and Warner, Measuring security price performance (1985) 16 Mackinley, Event Studies in Economics and Finance (1997) p.18 17 Bartholdy et. al. Conducting Event studies on a small stock exchange (2005) p.9 18 MacKinlay; Event Studies in Economics and Finance (1997) p.21 Page 9 of 25
  10. 10. Advanced Corporate Finance 3. May 2010 Exam. No. 402387 4.4 Statistical test To test the hypotheses stated in section 3, a battery of both parametric and non-parametric tests are used and in the end a cross sectional regression is performed to test for differences in the explanation on abnormal return from UK firms acquiring domestic UK firms or cross border firms within the EU. The parametric test requires normal distributed returns and the non-parametric test requires non-normal returns meaning that it does not have the assumption of normal distributed returns19 . Accordingly to Bartholdy et. al. (2007) the non-parametric tests generally outperform the parametric test. 4.4.1 Parametric tests Parametric tests are performed on the assumption of normal distributed returns and the test statistics for abnormal returns on the event days is based on a standard t test of the difference between two means20 . The Central Limit Theorem guarantees that the distribution of the mean abnormal return measure converges to normality as the number of firms in the sample increases if the measures of abnormal returns in the cross section of firms are independent and identically distributed drawings from finite variance distributions21 . It is therefore assumed that the conventional t-statistic will be well specified with a sufficiently large sample. First the parametric test T1 – Cross sectional dependence is used to test the stated hypotheses. In this test the standard deviation is estimated over a portfolio using the time series of portfolio returns. The test T3 – Standardized excess return instead uses a scaling of the abnormal returns by their individual standard deviation and then adds them together. This test will therefore also be used to test the hypothesis to see if it differs in result. In an event study performed by Bartholdy et.al. the standardized excess return test is concluded to perform the best. TCAR is estimated for both the T1 and the T3 test to see whether there is a significant abnormal return over all days in the event window. 4.4.2 Non-parametric test When there are problems with normality in the returns, which might occur due to small samples and few trades, the non-parametric tests can be used since they do not have the assumption of normal distributed returns and will therefore create more reliable results than the parametric test if this assumption is not satisfied. Also by including the nonparametric tests it provides a check of the robustness of conclusions based on the parametric tests22 and the two common non-parametric tests for event studies; T4 Corrados Rank test and T5 Sign test are therefore conducted as well. The Rank 19 Bartholdy, et. al. Conducting Event studies on a small stock exchange (2007) 20 Bartholdy et.al. Conducting Event studies on a small stock exchange (2007) p.9 21 J. D. Lyon et. al., Improved Methods for Tests of Long Run Abnormal Stock Returns (1999) p.178 22 MacKinlay; Event Studies in Economics and Finance (1997) p.32 Page 10 of 25
  11. 11. Advanced Corporate Finance 3. May 2010 Exam. No. 402387 test proved to be power full on the thickly traded stocks. The Sign test tells us about the direction of the abnormal return since it ascribes a + or – for each return regardless of the size of it. 4.4.3 Cross sectional regression A cross sectional regression can be used to explain the wealth effect from the announcement by determining which factors play a part in explaining the effect. In order to test the hypothesis of a significant difference between the abnormal return created by UK firm acquisitions domestic UK firms and cross border firms within the EU. A cross sectional regression is conducted in Excel where CAR for the portfolio of stocks is set as the dependent variable and regressed with a Dummy of domestic vs. cross border as the explaining variable. The Dummy is activated with a 0 if the stock is cross border and otherwise 1 if it is a domestic. 5. Data The following section provides an evaluation of the data collection process and a description of the selection criteria’s for the chosen firms. 5.1 Data collection A Number of firms have been found through a screening process in the database Zephyr that holds data on M&A in Europe since around 2000 and covers more than 600.000 M&A. Since Zephyr does not contain financial data on the firms the data will afterwards have to be extracted from the database Datastream. 5.1.1 Selection criteria The study focus on UK firms acquiring domestic UK firms and cross border firms within the EU and in the period from 2006 until today (2010). The first criterions provided 61.902 and 5.468 acquisitions of domestic and cross border firms, respectively. In order to narrow down the samples sample size other selection criteria’s were set up as well. 5.1.2 Deal status, type and final stake The second criterion set is that only M&A that have been completed and where the company have acquired a final stake of 100 % of the other company is included. These criteria’s are just too narrow down the number of M&A to 9.073 domestic and 720 cross border acquisitions. 5.1.3 Banking, Insurance and Financial Services Companies The third criterion set is that only acquisition with the Banking, Insurance and Financial Service sector is included. These criteria’s are just too narrow down the number of acquisitions to 2.285 domestic and 175 cross border acquisitions. Page 11 of 25
  12. 12. Advanced Corporate Finance 3. May 2010 Exam. No. 402387 5.1.4 Deal value To further narrow down the samples in regards to the domestic acquisitions only the top 300 ranked deals in value terms are selected. This should also have a positive effect on the risk of thin trading. This leaves 300 domestic deals and still 175 cross border deals. 5.1.5 Datastream To make the companies easier to find in datastream the ISIN numbers were extracted from Zephyr and the announcement dates and rumour dates were extracted as well. The reason for extracting the data with respect to the announcement date and not the completion date is due to the underlying assumption of efficient markets that assumes that the information is reflected in the stock prices immediately after the announcement. Firms that have different rumour and announcement dates are excluded from the data because the potential shift in prices as an effect of the announcement, in accordance to the efficient market hypothesis already will have happened at the rumour date since the hypothesis states that any information will be absorbed in the prices immediately after it reaches the public. So a rumour date before the announcement date would create bias in the estimation of abnormal return since the potential shift then will lie in the estimation period instead of on the event day and this will dilute any possible significant effect from the event. After correcting for missing information, delisting and firms with more than one acquisition in the time period and differences in rumour and announcement dates the two samples totals 123 domestic deals and 70 cross border deals. Accordingly to Bartholdy et. al. (2007), with sample sizes close to and above 50 events the performance of the test statistics is good, since it provides enough size and power. 5.2 Thin trading Thin, medium and thick trading are measures of how frequently a specific stock is traded. Thin trading is defined as stocks that are traded on less than 40% of all trading days or on average less than two days per week. Medium traded stocks are traded between 40% and 80% of the trading days and thick traded stocks are traded on more than 80% of the trading days23 . Thinly traded stocks can create problems in respect to making reliable analysis on daily data and if the problem is extensive it can be recommended to use weekly or monthly data. Using daily data with thin trading can create biases in the regression used to estimate the expected return and I therefore test for thin trading in my data using the volume as an indicator of when the stock has been traded and when not. 23 Bartholdy et.al. Conducting Event studies on a small stock exchange (2007) p.7 Page 12 of 25
  13. 13. Advanced Corporate Finance 3. May 2010 Exam. No. 402387 The data set has been corrected for non-trading days and therefore on average consists of 200 trading days. All 48 thinly traded companies have been excluded, respectively 31 acquisition of a domestic firms and 17 acquisitions of cross border firms. The dataset now consists of 92 domestic acquisitions and 53 cross border acquisitions24 . 5.3 Data descriptive As mentioned in the data collection section the analysis contain stock return data for 145 UK companies over 203 days including both the estimation period and the event window which provides 29.435 observations that are used in the empirical testing. The stock and market returns over the estimation period for the portfolio of stocks are shown in the figure below. Figure 2 - Spread Over the 200 trading days in the estimation period included in the analysis the average market return and stock return are 6,81% and 10,16%, respectively, which equals a spread in the estimation period of 3,35%. The spread is equally explained by the return in the UK firms acquiring domestic UK firms and cross firms within the EU with an average return of 9,51% and 11,30%, respectively. The lowest average spread between the market return and an individual stock return is -140,15% and the highest spread being 81,15%. To test for significance in the event period, a statistical analysis, which is earlier described, will be conducted in the following section. 24 Figure 8 and 9 in the appendix Page 13 of 25
  14. 14. Advanced Corporate Finance 3. May 2010 Exam. No. 402387 6. Empirical evidence In this section the hypotheses will be tested and the empirical analysis of the battery of tests presented. The tests are performed following the methodology stated in section 4 and the results will be interpreted and compared to the earlier empirical evidence described in section 2. The results from the empirical analysis for the entire portfolio, the portfolio of domestic acquisition and the portfolio of cross border acquisition are presented in table 1, 2 and 3 respectively. We test the following hypotheses of abnormal return H0: Ait = 0 No significant abnormal return H1: Ait ≠ 0 Significant abnormal return Where the alternative hypothesis; H1 covers both the scenario of positive abnormal return and negative abnormal return. Because the event study method assumes normally distributed security returns the rank test (T4) and the sign test (T5) are also included25 . 6.1 Test result Figure 3 – Acquisitions portfolio Looking at the results of the entire portfolio in table 1 it can be concluded on the basis of the T1, T3 and the T5 Sign test that the average abnormal return to the acquiring shareholders over the entire event period is significantly different from zero at a 5% significance level equal to 1,96. Especially on the announcement day (day 0), the results are very strong and indicating a significant abnormal return in all tests. The T4 Rank test where the t-statistic are negative pointing towards negative abnormal return - This point towards problems with the efficient market hypothesis stating that the information will be incorporated in the prices at the same day as the information reaches the public or it tells us that information has reached some traders the day before the announcement and in other cases the information might first have reached the shareholders after the closing of the markets. T5 Sign test being positive indicating a positive abnormal return. Figure 4 - Domestic 25 Kiymaz & Baker, Short-term Performance, Industry and Effects, and Motives (2008) Page 14 of 25
  15. 15. Advanced Corporate Finance 3. May 2010 Exam. No. 402387 The results from the tests conducted only on the portfolio of UK acquiring domestic UK firms point towards higher abnormal returns than for UK acquiring cross border firms within the EU and for the entire portfolio all together. The fact that the non‐parametric tests show different results than the parametric tests could suggest that the assumption of normality might be violated. Only on the event day are all the tests significantly different from zero but it is not enough to conclude that the abnormal return in the event window is significant. Figure 5 – Cross border In the analysis of the portfolio of UK firms acquiring cross border firms within the EU the average abnormal return over the event window is 1,0488% and the result is not significant for any of the statistic tests and the H0 hypothesis of zero abnormal return can therefore not be rejected at a 5% significance level and it can thus not be concluded that the acquiring shareholders experience wealth creating return in regards to the acquiring announcement. The reason that nothing is tested significant could however be due to abnormal returns too small for the test to detect as Batholdy et.al suggests that the abnormal return needs to be above 2% for each day in the event window to reject the null hypothesis, which might be why there is no significant evidence found here26 . 6.1.1 Cross sectional regression A cross sectional regression has been conducted to test for if it can be significantly proven that there is a difference in the abnormal return between the acquisition of domestic and cross border firms27 . The results generated show that the beta value of the dummy (domestic) is 0.0064 which could point towards greater abnormal return to the shareholders of domestic firms. The R2 is 0,000 which means that the variable do not explain any of the variations in the CAR variable. The ANOVA model shows a Sig. value of 0,939, which equals a H0 choice and therefore a rejection of H1 meaning that the difference is not significant at a 5 % significance level. Therefore it is not possible to conclude anything from the model. 26 Batholdy et.al. Conducting Event studies on a small stock exchange (2007) p.15 27 Please see Figure 10 in the appendix Page 15 of 25
  16. 16. Advanced Corporate Finance 3. May 2010 Exam. No. 402387 6.2 Comparison to existing empirical studies The findings of the empirical tests of this section are here compared to the empirical findings stated under section 2.2 by earlier conducted studies on the subject. As opposed to a lot of the earlier empirical findings this paper shows significant abnormal returns for the shareholders of the acquiring firm of around 1.1499% when looking at the overall portfolio. This goes against the findings of Jensen and Ruback who found that the shareholders of acquiring firms experience returns close to zero. It however fits better to the findings of Roades who found significant positive results to acquiring shareholders in three of his studies and Moeller et.al. who found average abnormal returns to the acquiring firms of 1.1% which is close to the findings of this paper for the overall portfolio. When looking only at the portfolio of UK firms acquiring cross border firms within the EU nothing significant can be said about the returns to the acquiring shareholders which is more in line with the earlier empirical evidence. This can maybe be explained by the motive theories listed earlier in the paper if for example the market interprets the bidding price as being too high, perhaps as a result of managers’ over‐optimism or agency reasons, a negative return would be expectable. According to behavioural theory takeovers are often motivated by the self-interest of the management of the acquiring firm. Furthermore the behavioural theories argues that the return to the acquiring shareholders normally is around zero and insignificant, indicating that the acquiring managers do not create value for their shareholders when they engage in takeover activities. The empirical findings from this study has proven that the management are acting rational and maximizing shareholder wealth and thereby supportive of the neoclassical theory. 7. Conclusion The paper deals with the subject of M&A’s and more specifically on whether UK firms acquisitions of domestic UK firms or cross border firms within the EU in the period from 2006 until today (2010) have been wealth creating or wealth reducing events for the acquiring shareholders and if there was a difference in the abnormal return in acquisitions of domestic or cross border firms. The theory listed states that M&A’s can be seen either as sound strategic decisions made by rational managers or as a result of behavioral mistakes by managers as agency problems or hubris. Using the event study methodology with data extracted from datastream the hypotheses was tested using both parametric and non‐parametric tests as well as a cross sectional regression to detect differences in return across the two portfolios. The empirical evidence shows a significant average abnormal return over the window of 1,1499% for the entire portfolio of 145 firms. The fact that there are found evidence of overall returns could explain motives for why companies keep engaging in M&A Page 16 of 25
  17. 17. Advanced Corporate Finance 3. May 2010 Exam. No. 402387 activities despite unsure empirical evidence for the return of acquiring shareholders, but the findings of abnormal returns in this paper can be uncertain due to a violations of assumptions. As outlined in the hypothesis one would expect abnormal positive returns if the market interpreted the M&A decision as a result of synergies to be exploited thereby implying a higher combined value than the sum of the two participating companies. The empirical evidence in this paper supports this motive of acquisitions and the neoclassical theories. The management can be concluded to have been operating rational and have made rational choices in favour of the shareholders due to the acquisitions having increased shareholder wealth. Conducting event studies often experienced problems with its finding in regards to the significant estimates in the returns to the acquiring shareholders. This paper has been able to find significant estimates in the entire portfolio and domestic acquisitions especially on the announcement day (day 0), making it possible to conclude on the results with a 95 % probability. Page 17 of 25
  18. 18. Advanced Corporate Finance 3. May 2010 Exam. No. 402387 8. References Books Copeland, Thomas. E, Weston, Fred. J & Shastri, Kuldeep (2005): Financial theory and Corporate policy, 4. Edition, Pearson Addison Wesley Sudarsanam, S., Creating Value From Mergers and Acquisitions, (2003), FT Prentice Hall Articles Andrade, Gregor, Mitchell, Mark & Stafford, Erik. (2001): New Evidence and Perspectives on Mergers; Journal of Economic Perspectives, vol. 15, no.2. pp. 103-120 Barberis, Nicholas and Thaler, Richard (2003): Handbook of the Economics of Finance, Chapter 18, 1. edition, volume 1, number 2 Bartholdy, Jan, Olsen, Dennis & Peare, Paula. (2007): Conducting event studies on a small stock exchange; European Journal of Finance, vol. 13, No. 3, pp. 227-252, April. Berkovitch, Elazar & Narayanan, M P (1993): Motives for takeovers: An empirical: Journal of Financial and Quantitative Analysis, vol. 28, no. 3. pp. 347-362 Brown, Stephen, and Warner, Jerold. (1980): Measuring security price performance; Journal of Financial Economics 8, pp. 205–258. Brown, Stephen, and Warner, Jerold. (1985): Using daily stock returns: The case of event studies; Journal of Financial Economics 14, pp. 3–32. Chakrabarti, Rajesh, Gupta-Mukherjee, Swasti & Jayaraman, Narayanan. (2009): Mars-Venus marriages: Cross boarder M&A; Journal of International Business Studies, vol. 40 Fama, Eugene, F., Fisher, Lawrence, Jensen, Michael, C. & Roll, Richard (1969): The adjustment of stock prices on new information; International Economic Review, vol. 10, No. 1 Fama, Eugene, F. (1980): Agency Problems and the Theory of the Firm; Journal of Political Economy, apr80, vol. 88, Issue 2, pp. 288-307 Fama, Eugene, F. and French, Kenneth, R. (2004): The Capital Asset Pricing Model: Theory and Evidence; Journal of Economic Perspectives, vol. 18, No 3 pp. 25-46 Fuller, Kathleen, Netter, Jeffrey & Stegemoller, Mike. (2002): What do returns to acquiring firms tell us? Evidence from firms that make many acquisitions; Journal of Finance, vol. LVII, No. 4, August. pp.1763-1793 Harford, Jarrad (2005): What drives merger waves?; Journal of Financial Economics, 77. pp. 529- 560 Jarrell, G. A. & Brickley, J. A. & Netter, Jeffrey M. (1988): The Market for Corporate Control: The Empirical Evidence Since 1980; Journal of Economic Perspectives, vol. 2, no. 1. pp. 49-68 Jarrell, Gregg, A. and Poulsen, Annette, B. (1989): The Return To Acquiring Firms In Tender Offers: Evidence From Three Decades; Financial Management, Autumn, 1989 Jensen and Meckling (1976): Theory of the Firm: Managerial Behavior, Agency Costs and ownership structure; Journal of Financial Economies, vol. 3, pp. 305-360 Jensen, M. C. and Ruback R.S., (1983): The market for corporate control: The evidence; Journal of Page 18 of 25
  19. 19. Advanced Corporate Finance 3. May 2010 Exam. No. 402387 Financial Economics, vol. 11, pp. 5-50. Kiymaz, Halil and Baker, Kent. (2008): Short-Term Performance, Industry Effects, and Motives: Evidence from Large M&As; Quarterly Journal of Finance and Accounting, vol. 47, No. 2 Lin, Wuh, James, Madura, Jeff & Picou, Armand. (1994): The Wealth Effects of International Acquisitions and the Impact of The EEC Integration; Global Finance Journal, vol. 5, No. 1 Lyon J. D., Barber, B. M. & Tsai, C. (1999); Improved Methods for Tests of Long-Run Abnormal Stock Returns; The Journal of Finance, vol.54, No.1, pp.165-201 MacKinlay A.C., (1997): Event Studies in Economics and Finance; Journal of Economic Literature, vol.35, No.1, pp. 13-39. Maynes, E. and Rumsey, J. (1993): Conducting event studies with thinly traded stocks; Journal of Banking and Finance, vol. 17, No. 1, pp. 145-157 Moeller, Sara B, Schlingemann, Frederik P. & Stulz, René M. (2005): Wealth Destruction on a Massive Scale? A Study of Acquiring Firm returns in the Recent Merger Wave; Journal of Finance, vol. IX, No. 2, April. pp.757-782 Pilloff, Steven J. and Santomero, Anthony M. (1997): The Value Effects of Bank Mergers and Acquisitions. Working Papers -- Financial Institutions Center at The Wharton School, p1, 30p. Rhoades, Stephen A. (1994): A Summary of Merger Performance Studies in Banking, 1980–93, and an Assessment of the ‘‘Operating Performance’’ and ‘‘Event Study’’ Methodologies; Federal Reserve Bulletin, vol. 80, Issue 7, pp. 589-590 Roll, R., (1986): The Hubris Hypothesis of Corporate Takeovers; The Journal of Business, vol. 59, No. 2, Part 1, pp. 197-216 Tuch, Christian and O’Sullivan, Noel. (2007): The impact of acquisitions on firm performance: A review of the evidence; International Journal of Management Reviews, vol. 9, issue 2, pp. 141-170 Page 19 of 25
  20. 20. Advanced Corporate Finance 3. May 2010 Exam. No. 402387 Appendix Figure 6 – Selected companies domestic - 300 deals (UK firms acquiring domestic UK firms) Page 20 of 25
  21. 21. Advanced Corporate Finance 3. May 2010 Exam. No. 402387 Page 21 of 25
  22. 22. Advanced Corporate Finance 3. May 2010 Exam. No. 402387 Figure 7 - Selected companies cross border -175 deals (UK firms acquiring cross border firms within the EU) Page 22 of 25
  23. 23. Advanced Corporate Finance 3. May 2010 Exam. No. 402387 Page 23 of 25
  24. 24. Advanced Corporate Finance 3. May 2010 Exam. No. 402387 Figure 8 – Volume of stocks on UK firms acquiring domestic UK firms Figure 9 - Volume of stocks on UK firms acquiring cross border firms within the EU Page 24 of 25
  25. 25. Advanced Corporate Finance 3. May 2010 Exam. No. 402387 Figure 10 – Cross sectional regression analysis Page 25 of 25

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