The Effects of Mergers

1. The Effects of Mergers Burcin Yurtoglu University of Vienna Department of Economics

2. Three sets of consequences of mergers • They can affect the performance of the merging firms such as • Profits, growth rates, markets shares, productivity, ... • They can affect industry and aggregate concentration levels. • They can affect social welfare • As a result of (1) and (2)

3. Profitability • Major Studies • Ravenscraft and Scherer (1987) analyze 6000 mergers between 1950 and 1977. • Meeks (1977) 1000 mergers after WW II in the UK. • Gugler, Mueller, Yurtoglu, and Zulehner (2003) analyze 2753 mergers from around the world.

4. Ravenscraft and Scherer (1987) • They regressed the profits of individual lines of business in the years 1975-77 on industry dummies and a variable that measured the fraction of the line of business that had been acquired since 1950. • They also controlled for other aspects of mergers • Hostile vs friendly • Market share • Accounting convention: pooling vs purchase accounting • The profit rates of the acquired lines of business were 2.82 % below those of non-acquired units

5. A typical regression equation Profit rate 75-77 = [257 Industry dummies] + 0.68 POOL - 2.82* PURCH + 0.84 NEW + 1.46 EQUALS + 30.15* SHR - 3.65 HOSTILE - 3.77 WHITE -2.23 OTHER Adj. R2 = 0.182 N = 2,732

6. GMYZ (2003): Prediction of Sales

7. GMYZ (2003): Prediction of Profits

8. GMYZ (2003): Main results

9. Analysis of variance in year t+5 by country categories

10. Analysis of variance in year t+5 in the manufacturing sector by merger categories

11. Market Power or Efficiency

13. Effects on Market Shares • Mueller (1985, 1986) examined the effects of mergers for a sample of 209 acquired firms from the 1,000 largest companies of 1950 in the USA. • The methodology compared the market shares of firms acquired between 1950 and 1972 with those of non-acquired firms of similar size in the same industries • Typical regression equation: mi 72 = 0.011* + 0.885* mi 50-0.705* Dmi50 N =313 R2 = 0.940 D : a dummy variable for acquired firms.

14. Mergers Effects on Productivity • Lichtenberg and Siegel (1987) • between 1972 and 1981 productivity fell in plants before an ownership change and rose afterward  spin-offs of plants obtained in previous mergers • Baldwin (1981) • similar results for Canada • McGuckin and Nguyen (1995) • Plant productivity increases following mergers in the USA

15. Mergers Effects on Firm-level Employment • If a merger results in an optimal employment level different from the total employment of the merging firms, then a profit maximising firm will adjust its labour force via an active policy of hiring or firing. • Dynamic models of labour demand place great emphasis on the costs of this adjustment process. • In general, the a priori predictions on the effects of mergers on labour demand are ambiguous: • A merger may lead to a reduction in output, e.g. because the merger increased market power or the technologies of the acquiring and acquired company exhibit increasing returns to scale, and a consecutive reduction in employment. • A merger may, on the other hand, lead to an increase in output, e.g. because the merger significantly increased the efficiency of the combined firm or led to product improvements and demand shifts. • Thus, the employment of the combined entity may rise or fall relative to the sum of the pre-merger employment levels

17. Gugler and Yurtoglu (2004) • If mergers are used as a general device to restore a firm’s optimal employment level, we would expect differential effects depending on labour market institutions. • High labour adjustment costs make hiring a worker a somewhat irreversible decision. • Therefore, it appears likely that in countries with very rigid labour markets some firms carry excess labour with them. • Fewer such firms are expected to exist in countries whose labour markets allow quick adjustment of the workforce. • Mergers and acquisitions are an effective means to achieve a desired restructuring, since the managerial team is likely to be new and therefore less likely to be committed to upholding past contracts with stakeholders (Shleifer and Summers, 1988). • Since Europe has more rigid labour markets than the USA, mergers may be used as a device to reduce excess labour. Thus, we expect that the demand for labour is reduced by more after a merger or acquisition in Europe than in the USA.

22. Mergers Effect on Share Prices Event Study Methodology: • announcement  new information  changes in share price reflect the market’s expectations of the effects of mergers Problems: • when does the share price change occur? • How does one separate it from other events? • select a control group and assume that the acquiring firm’s share price would have performed over the chosen period exactly as the control group • relative to the control group (start earlier)

24. Capital Asset Pricing Model

25. The Market Model

26. Alternatives

27. Findings: The first wave 1972 - 83 • Strong belief in the short horizon (announcement) effects, i.e., strong belief in the efficiency of capital markets. • Consequently, several studies ignored post-merger performance of acquiring companies. • Studies that ignored post-merger performance • tended to find small and often insignificant changes in acquirers’ share prices around the announcements. • The acquirers’ shareholders were judged not to have lost as a result of the mergers, • the acquired shareholders were clear winners, • and thus the studies that ignored the post-merger performance of acquiring companies concluded that M&As increased total shareholder wealth.

28. Studies that did report post-merger returns: • Firth (1980) and Malatesta (1983): the acquiring companies’ shareholders had suffered significant losses. • Firth: all losses occurred in the announcement month • Malatesta: they occurred over the year following the mergers. • They also add up the absolute wealth changes for both groups of shareholders and find found that the aggregate losses to the acquiring companies’ shareholders exceeded the gains in wealth of the targets. • The remaining studies that reported post-merger losses for acquiring companies dismissed them as “surprising” or “puzzling,” or simply ignored them.

29. Findings: The second wave post -1983 • Debates on • the proper benchmark, and • the length of the window • The Proper Benchmark: Estimates using CAPM imply

30. The natural choice for a benchmark period is some interval before the merger announcements. • However, several studies estimate post-merger abnormal returns using a post-merger period. • This choice results in much lower estimates of post-merger losses. • Example: Magenheim and Mueller (1988)

31. Long-Horizon Studies: Agrawal, Jaffe and Mandelker (1992): • Returns over five post-merger years • 1955-87: -10% significant • negative significant ARs for the 1950s, 1960s and 1980s • insignificantly positive ARs for 1970s • Estimates by Loderer and Martin (1992) and Higson and Elliott (1998) are also sensitive to the time period in which M&As occurred. • Rau and Vermaelen (1998): • 2823 acquisitions over 1980-1991 period: • mergers: -4% significant • tender offers: significant and positive • acquirers with high market values relative to their book values: -17.3% over the 3 –year post-merger period. • Conclusion: • The evidence compiled so far is consistent with the idea that stock market run-ups lead to unsuccessful mergers.

33. Additional Findings • Managerial discretion and the gains to acquirers • Hubbard and Palia (1995): Managers with small stakes tend to overpay • Diversification: • Diversification mergers produce losses to acquirer shareholders at the announcement date. • Diversification is negatively related to returns, Tobin’s q, and market value of a company. Discount for diversification is quite large (13%-15%). • Spin-offs that increased focus produce positive ARs and improvements in operating performance.