This paper serves the purpose as a radical data analysis on the reaction of the U.S. stock market against mergers and acquisitions news. Data are extracted from Thompson with minimal adjustments.

1. Vu Anh Tran - 500409016
ASB4896 – Gwion Williams
EVENT STUDIES AND ABNORMAL
RETURNS
C1 Empirical Research – 2985 words

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Table of Contents
Introduction ........................................................................................................................................... 2
Literature Review ................................................................................................................................... 3
Data ........................................................................................................................................................ 5
Data Selection .................................................................................................................................... 5
Descriptive Statistics of the Sample ................................................................................................... 6
Methodology .......................................................................................................................................... 7
Empirical Results .................................................................................................................................... 9
The Bidders ......................................................................................................................................... 9
The Targets ....................................................................................................................................... 11
Implications ...................................................................................................................................... 13
Conclusion ............................................................................................................................................ 15
Reference ............................................................................................................................................. 16

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Introduction
Mergers and Acquisitions (M&A) is a business consolidating action by combining two
separate firms into a unifying one in order to gain benefits in future operations. Obviously, it
has huge influence in both sides of the contract, from capital to structure. The targets are
typically more heavily affected than the bidders.
Because M&A events is a massive shift to both companies, appropriate adjustments are
required. The study of its short-term influence on stock valuation begins since the 1960s,
nevertheless, there has been no concrete determinants established yet. The arguments are
still going on in the matter of effect direction and many hypotheses have been proposed.
Some has become outdated already due to the shifting in market mechanism. Among them,
the wealth effect is the most prominent theory.
This paper aims to critically analyse short-term influence of M&A events on bidders and
target firms’ return. Relevant literatures are reviewed, tested and summaries in order to
give a consolidate opinion over the long argued issue. An impact comparison is conducted to
contrast the distinct influence of joint business on both side of the transaction.
The rest of this paper is arranged as following. The second part addresses related literature
research on mergers and acquisitions announcement. Next, the selected data is evaluated
to point out characteristics. Methodology is covered in the fourth section. Section five
presents empirical results and its implication. Last, the sixth section summarises and
concludes.

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Literature Review
Wealth effect in mergers and acquisitions (M&A) event is short-term effect on firm’s value
following the change in perceived wealth of both companies. It is generally believed that
after acquisitions, the share price of target firm increase while there is a decreasing trend in
acquirer’s stock value. According to that theory, the bibbers typically pay more than the
actual market value for the acquisitions. Unless in the case of hostile takeover, owners of
the target firms have no incentive to make decision resulting in losses.
There has been argument going on around the impact of M&A events on bidder’s return.
One side claims that acquirer’s value decreases after the announcement. Manne (1965)
states that the joint businesses merge capital and resources together. Small targets firms
get access to better facility for maximising profits, while the acquiring organisations lose
parts of its pristine capital. Therefore, the growing abilities of acquirers are supposed to be
at least partly affected. Another theory suggests that by cooperating more closely, both
sides gain the benefits of specialised benefits. It then consequently translates into growing
profits. In real world, there are at least two M&A scenarios, one targets expanding business
operation, another one focuses on maximising value similar to a promising project
investment. The latter case is perceived favourably than the former one as it promises quick
return. Roll (1986) supports that theory, announces that the size-focused type of joint
business reduce share value of the bidders in short term.
Jensen (1983) and Myers (1984) states the opposite findings that acquiring firms meeting
certain criteria experience significant increase in firm’s value after the M&A events. Myers
and Majluf (1984) reports that there are differences in the impact of payment method on
the business combination. As usual, cash payment is preferred due to liquidity and low
depreciating value. Offering stock payment is considered as making an unofficial
announcement signalling share price overvaluation. Investors are inclined to sell their
holdings, drive down the stock value in process. This is supported by the fact that current
financial market is increasingly becoming information sensitive and signalling plays a vital
role in shaping the mechanism. It is consistent with McCabe (1997)’s evidence of free cash
flow hypothesis. He provided that cash acquirers with low default risk and substantial

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capital have significant cash flow during the announcement date. Franks and Harris (1988)
argues against that idea by citing the effect of taxation difference between capital gain and
income. Accordingly, income is taxed at much higher rate than capital gain and reasonable
investors are interested in profit maximising. However, tax cut in 2004 causes this
arguments to lose its standing. More recent researches reflects that although generating
profits is the primary goal, behavioural finance dictates investors’ action and renders them
risk-adverse.
The return of target firms is confirmed as more difficult to accurately forecast prior to the
announcement date (Cornett, 2011). Previous wealth effect researches provided evidences
of higher cumulative abnormal return in comparison with the bidders’. However, this is due
to the asymmetry in investor’s anticipation. Information leakage has been confirmed
occurring several days prior to the announcement date and it is more significant for the
bidders. Consequently, the news for the target’s investor is fresh at the announcement
date, leading to overreaction in the market. When the expectation asymmetry is accounted
for, divergence between bidders and target firms in abnormal return becomes insignificant.
Both Jensen (1983) and Andrade (2001) finds considerable positive abnormal return to
targets firms in their research. Chang (1998) states that the result actually depend on the
methodology and data selection.

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Data
Data Selection
The empirical research compiles two separate data sets of daily closing stock price of
companies in USA prior to and during the M&A events from 1st January 2014 to 31st
December 2014. The initial dataset extracted from Thomson consists of 7,586 observations
companies taking part in acquisition. The list has a diverse business background and varied
announcement dates
After filtering companies without exact announcement date and/or available public
historical share record, there are 1,208 results left. Accordingly, 50 first firms appearing in
the list are randomly chosen from each target and acquiring firms. Besides making sure that
each firms chosen satisfies research requirements, the first-come-first-serve sampling
method significantly reduces workload and remove preference biases. Nevertheless, it
should be noted that the initial dataset exported from Thomson is partly arranged by date,
due to their searching algorithms. Therefore, seasonal anomalies, such as January effect
potentially influence the research outcomes. By actively recognising the impact, the risk of
unknown bias decline greatly.
Daily closing price of an appropriate stock index is required. The relevant choices for firms
based in USA include NASDAQ, Dow Jones Industrial Average, S&P 500, Wilshire 5000 and
Russell 2000. S&P 500 is designated to be the standard due to its wide span of industries
and sector. Though the representativeness of S&P 500 is not as strong as Wilshire 5000, its
popular is far more superior.
Historical share prices are exported from Yahoo! Finance, with the exception of few firms
are exclusively available on Thomson. Closing price is used instead of adjusted closing price
because event study focuses on the imperfection of high frequency trading. Adjusted closing
price reduces time-information difference. Other statistics including open price, volume
traded, highest and lowest points are not used in this empirical research. For some target
firms, share prices recorded on US holidays are excluded for unifying purpose.

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The data set is divided into 50 target firms and 50 acquiring firms, each observation is
matched against corresponding S&P 500 daily closing positions. The date of announcement
is set as day 0. The day before announcement date is set as -1, -2, -3... respectively. As for
the days after, they are set as +1, +2, +3… By that rule, the range of study subjects goes from
day -100 to day +5, with day 0 is the announcement date. Day -9, -8, and -7 is later removed
from the study to provide necessary gap prior to the announcement period.
The date range is further classified into two period, during the announcement period and
prior to that. As previously mentioned, the announcement date is set as day 0, hence the
announcement period will be [-5; +5]. Day -6 is included to calculate the logarithmic return.
The period before the announcement date is [-100;-10].
Descriptive Statistics of the Sample
The sample consists of 100 firms traded in US market during the period from 1st January
2014 to 31st December 2014. They are equally separated into target and acquiring firms.
Logarithm return is used instead of actual return because size effect is ruled out. The table
below presents descriptive statistics for both types.
Target firms Acquirer firms
Mean -0.00171 -0.0009
Median -0.00065 0.000151
Standard Deviation 0.037236 0.25874
Sample Variance 0.003496 0.001823

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Target firms Acquirer firms
Range 0.296886 0.188793
Minimum -0.16089 -0.1043
Maximum 0.135991 0.084491
Sum -0.17256 -0.09102
Confidence level (95%) 0.007351 0.005108
Table 1 – Descriptive statistics.
Generally, mean of both target and acquiring firms are negative but insignificant, suggesting
a mediocre performance throughout the observed period and pessimistic future. Target
firms experienced much more negative impact than the bidders. The median statistics agree
with that finding.
Sample variance, standard deviation and range are measurements of data volatility. It can
easily be observed that targets have higher statistics than the acquirers, implying that they
are indeed the more risky business group.
The minimum and maximum tell the highest and lowest return occurred during the
observed period for these statistics. In this case, it is clearly that the volatile gap of the
bidders are considerately smaller
By studying range and confidence level (95%), it is safe to assume that the stock price does
not vary much and stay largely the same.
Methodology

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Simple t-statistics testing is applied to test the hypotheses that M&A events have significant
short-term effect on both targets and acquirers. First, logarithmic return is calculated for the
ease of statistical analysis.
ln
𝑃$
𝑃$%&
= ln 𝑃$ − ln 𝑃$%&
ln
𝑃$
𝑃$%&
is the continuous compound return between day t and day t-1. It is computed for
everyday in order to reduce the influence of clustering.
ln 𝑃$ is the logarithmic return of the observed day t
ln 𝑃$%& is the logarithmic return of the previous day t-1
The purpose of logarithmic return is to define the accurate return which is free of bias.
Instead of using price, the logarithmic return distribution is normally distributed, which
make it a critical stage for advanced statistical analysis. The approximations of small value
are more accurate and daily data can be studied without obstruction of timely mistakes.
Regression analysis is executed to investigate the expected return during the announcement
period.
𝐸+,,$ = α/ + β/ 𝑅3,$
𝐸+,,$ is the anticipated return, computed by using regression analysis for the chosen firm i
subject to the M&A event in time t. A short time window [0;+1] is used to reduce the
clustering effect on the price prediction, as stated by Gande and Parsley (2005).
Alpha α/ and beta β/ is the intercept point and the slope respectively, calculated for the
period prior to the announcement [-100;-10]. Alpha serves as the base share price while
beta measure the marginal movement of stock price in day t in response to the previous
day’s price.
𝑅3,$ is the actual closing stock price of the stock index k, which is the average of all stocks
trading, in day t during the announcement period [-5;+5].
Abnormal return is the difference between the actual return of stock and the expected
return. Practically, it reflects the unmeasurable market impact of M&A announcement,
suggesting the shortcoming of the efficient market.
𝐴𝑅/,$ = 𝑅/,$ − α/ + β/ 𝑅3,$

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𝑅/,$ is the actual daily share price during the announcement period. The residual value of
𝑅/,$ and expected value α/ + β/ 𝑅3,$ makes up abnormal return for firm i in day t.
Cumulative abnormal return is the sum of all abnormal returns over a specific time window.
As previously mentioned, the time window is kept short [-5;+5] to avoid the biases off
compounding daily abnormal return.
𝐶𝐴𝑅/,$ = 𝐴𝑅/,$%& + 𝐴𝑅/,$
𝐴𝑅/,$ and 𝐴𝑅/,$%& are both measured in their real value to take into account the cumulative
effect.
Last, cumulative average abnormal return is computed by taking the average of all 50 firms
together. A common trend is illustrated from the data set into a comprehensible graph.
𝐶𝐴𝐴𝑅/,$ =
𝐶𝐴𝑅/,$
6789
/
𝑛
The second test involves testing the hypothesis 𝐻9, which confirms no relationship between
abnormal return and M&A event if the t-statistics stay in the confidence level range. If
rejected, 𝐻& implies a significant negative/positive correlation of abnormal return and the
takeover.
𝑡=>+ =
𝐶𝐴𝐴𝑅/,$
𝜎 𝐶𝐴𝑅/,$
𝑛
𝑡=>+ is the ratio of the deviation of share prices during the announcement period from its
notional value and standard error, both of which is calculated based on the data set before
the announcement.
In order to avoid missing potential effect on different direction, two tailed hypothesis test is
preferred. Critical t values are chosen at 95% and 99% confidence interval.
Empirical Results
The Bidders

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Chart 1 and Table 2 illustrates the influence of M&A event on acquiring firm’s daily stock
price. As can be seen, there is a significant upward trend during time window [-3;+3].
Graph 1 – Bidders’ abnormal return
Table 2 – Bidders’ t-statistics
The graph of cumulative abnormal return starts at about -0.008 in day -5. Starting from day -
3, it begins increasing significantly and reaches a peak at around 0.0734 in day +2. There is a
slight decline in day +3, following by a sharp decrease to 0.02 and 0.012 in day +4 and +5
respectively.
-0.040000
-0.020000
0.000000
0.020000
0.040000
0.060000
0.080000
-5 -4 -3 -2 -1 0 1 2 3 4 5
CumulativeAverageAbnormal
Return(%)
Days
CAAR

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The t-statistic test shows that there are an significant adjustments during [+1;+3]. Even
though there has been an increasing trend in the previous few days, there results are not
significant enough and does not reject the null hypothesis.
By using t-statistics test for the CAAR, it reflects a significant increase in bidders’ stock value
after the announcement date. This findings support the theories of Jensen (1983), Myers
(1984) and McCabe (1997), thus, reject both statements made by Manne (1965) and Roll
(1986). It appears that for firms of diverse backgrounds and scales, acquisition does not
weaken acquirers’ capital. By contrast, M&A event is perceived by investors as a positive
signal of business future, as it solves the problem of residual profits and project investment
at the same time.
As most of the acquisition is between US acquirers and oversea targets, the empirical results
prove Bhadat (2011) studying of internationalisation strategy through cross-border
acquisitions. In his article, evidences of positive return are found for the acquiring business
too.
The Targets
Graph 2 and Table 3 details the potential short-term relationship between M&A
announcement and stock valuation. Generally, there is a slight increase in time window [-
1;+1].

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Graph 2 – Targets’ abnormal return
Table 2 – Bidders t-statistics
The cumulative abnormal return graph presents a slight increase from -0.022 in day -3 to
0.006 in day +1. Right after that, the share price decreases quickly and hits a low at -0.035 in
day +5.
The t-statistic table shows that during the announcement period, there is no significant
impact on any particular day. Thus, the null hypothesis that reject any M&A event influence
is accepted.
With the empirical results, the wealth effect on target firms is strongly rejected as there is a
slight movement in the opposite direction. Though there is evidence supporting Jensen
-0.060000
-0.040000
-0.020000
0.000000
0.020000
0.040000
0.060000
0.080000
-5 -4 -3 -2 -1 0 1 2 3 4 5
CumulativeAverageAbnormal
Return(%)
Days
CAAR

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(1993) and Andrade (2001) arguments, its strength is not considerable enough, thus
requires further analysis. Nevertheless, the insignificant result can be explained by Cornett
(2011)’s statement, in which the difficulties in predicting return prior to the announcement
date is confirmed.
Implications
It can be concluded that share spreads are more sensitive to the M&A event for the bidders
than targets. While the empirical results show considerable positive change for acquiring
firms, no evidence has been found for the effect in target small businesses. The time
window of event influence is likely to extend from day 0 to day +3, the price reversal occurs.
One plausible explanation of this short time window is that market is reacting quicker to
news than the previous years. High frequency trading has been introduced and applied since
the last decade and it is pushing the speed reaction time of investors indirectly through
increasingly competitiveness. One important characteristics of high frequency trading is the
inability of daily historical price to reflect market movements. Thus, it is likely that the
impact on share price observed above is due to liquidity trading, rather than information
trading.
One observation is that the event period for target firms are not as long as for the acquirers.
Although the evidence of information leakage can be seen for both sides, it is delayed by 1-2
days for the targets. There are two reasons explaining the quick end of event influence. First
is the inability of daily price as detailed previously. Second, the liquidity of small firms. By
having small capital, the investors would quickly make decision to act accordingly.
The explanation of Chang (1998) regarding different empirical tests leading to different
results is only partially tested, thus no confirmation can be made regarding that.
Furthermore, it should be noted that the t-statistics test for target firms might be faulty,
because of two reasons. First, the data recorded for small firms is usually missing or
incorrect, due to the lack of heavy regulation from shareholders. Second, targets’ stocks are
thinly traded, which reduced the accuracy of advance test that relies on normal distribution.

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Conclusion
By using a dataset of daily stock price for 100 companies from 2nd
January 2014 to 31st
December 2014, the influence of mergers and acquisition event is studied to determine the
exact direction on share price during the announcement period. In this paper, the wealth
effect is focused on as it is considered as the most prominent one.
It becomes clear from the empirical results that the wealth effect does not explained
observed share price movement. Instead, the signalling theory is able to justify the increase
in acquirer’s stock valuation. Cross-border acquisition internationalisation strategy supports
the theory. As for the targets, no significant evidence is found to explain any previous
theory. However, the unpredictability of their share price during the announcement period
is revealed.
Another important finding is the leakage of information, with share price tends to move our
of the previous trend around 2-3 days prior to day 0. Also, target’s share price seems to
have a shorter impact period, because of information asymmetry and stock liquidity.
For future research, it is suggested that additional testing methodology should be added
and crosscheck the results altogether.

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Reference
Andrade, G., Mitchell, M., & Stafford, E., 2001. New Evidence and Perspectives on Mergers.
Journal of Economic Perspectives, 15 (2), pp.103-20.
Chang, S., & Suk, D., 1998. Failed takeovers, methods of payment, and bidder returns.
Financial Review, 33 (2), pp.19-34.
Cornett, M., Tanyeri, B., & Tehranian, H., 2011. The effect of merger anticipation on bidder
and target firm announcement period returns. Journal of Corporate Finance, 17 (3), pp.596-
611.
Croci, E., Petmezas, D., & Vagenas-Nanos, E., 2010. Managerial overconfidence in high and
low valuation markets and gains to acquisitions. International Review of Financial Analysis,
19 (5), pp. 363-78.
Franks, J., & Harris, R., 1989. Shareholder wealth effects of corporate takeovers: The U.K.
experience 1955-1985. Journal of Financial Economics, 23 (2), pp.225-49.
Jensen, M., & Ruback, R., 1983. The Market for Corporate Control: The Scientific Evidence.
Journal of Financial economics, 11 (1-4), pp.5-50.
Manne, H., 1965. Mergers and the Market for Corporate Control. The Journal of Political
Economy, 73 (2), pp,110-20.
McCabe, G., & Yook, K., 1997. Jensen, Myers-Majluf, Free Cash Flow and the Returns to
Bidders. The Quarterly Review of Economics and Finance, 37 (3), pp.697-707.
Myers, S., & Majluf, S., 1984. Corporate Financing and Investment Decisions when Firms
have Information that Investors do not have. Journal of Financial Economics, 13, pp.187-
221.
Roll, R., 1986. The Hubris Hypothesis of Corporate Takeovers. The Journal of Business, 59 (2),
pp.197-216.

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