Market perception of synergies in related acquisitions.
Krishnan, Hema A. ; Krishnan, Ranjani ; Lefanowicz, Craig E. 等
INTRODUCTION
Unlike the mergers and acquisitions (M&A) era of the 1970s and
1980s where the predominant motives for acquisitions were hubris, empire
building, market power, and agency (Jensen, 1991; Roll, 1986; Trautwein,
1990), an increasing number of acquisitions in the 1990s, and in this
decade, have been purportedly undertaken for synergistic reasons (Hitt,
Harrison, & Ireland, 2001). Synergy has been defined in various ways
such as, utilization of the resources that creates value for the
combined entity (Chatterjee, 1986), as "valuation of a combination
of business units which exceeds the sum of valuations for stand alone
units" (Davis & Thomas, 1993: 1334), and as "increases in
competitiveness and resulting cash flows beyond what the two companies
are expected to accomplish independently" (Sirower, 1997). The
synergy motive for acquisitions states that by combining the resources
of the two firms, economies of scale and scope are created, which in
turn, creates value for the combined entity (Slusky & Caves, 1991).
Both market and accounting measures have been used to measure the
performance of firms engaged in synergistic acquisitions. Researchers
using market measures have focused on the wealth gains to shareholders.
The basic findings of these studies can be summarized as follows: (1)
shareholders of target firms earn significant positive abnormal common
stock returns immediately following the acquisition (Jensen, 1986;
Jensen & Ruback, 1983), (2) irrespective of the extent of
relatedness between the two firms, acquiring firms earn negative
abnormal common stock returns in approximately 65% of the acquisitions
(Berkovitch & Narayana, 1993; Datta, Pinches & Narayanan, 1992;
Loughran & Vijh, 1997; Lubatkin, 1987), and (3) bidding firms often
overestimate the value of the target firms by underestimating the cost
of exploiting relatedness with targets (Salter & Weinhold, 1979;
Seth, 1990).
Accounting measures to study the operating performance of the
combined entity following the acquisition have also been extensively
used. The basic findings of these studies can be summarized as follows:
(1) acquisitions, on average, do not create value (Ravenscraft &
Scherer, 1987), (2) the presence of synergies is not sufficient:
effective integration of the two firms is essential to realize the
synergies (Haspeslagh & Jemison, 1991; St. John & Harrison,
1999), and (3) synergy is an elusive concept, difficult to define and
measure and therefore firms often overestimate the perceived synergies
between the two partners (Collis & Montgomery, 1995; Markides &
Williamson, 1996; Martin & Eisenhardt, 2001).
In this paper, we propose a novel method to identify and measure
synergy using the efficient capital market theory. Past researchers of
corporate strategy have attempted to measure synergy using several
proxies such as relatedness in product/markets (Rumelt, 1974),
relatedness in the underlying process and assets of the business units
(Markides & Williamson, 1994), presence of similarities (or
differences) in the resource base of the two partners (Capron, 1999;
Harrison, Hitt, Hoskisson & Ireland, 1991; Salter & Weinhold,
1979), opportunity to share or combine resources among businesses
(Brush, 1996; Farjoun, 1998; Haspeslagh & Jemison, 1991), or, as an
outcome (abnormal returns) associated with acquisitions (Seth, 1990).
Our method to measure synergy is novel because we examine whether market
participants are able to identify post-acquisition operating synergies
arising out of unique combinations at the time of the acquisition
announcement. For this, we examine the abnormal returns of the bidding
firm and its major rival and relate equity gains or losses during
acquisition announcements to subsequent post-acquisition operating
performance. For example, when the merger between Chemical Banking and
Chase Manhattan was announced, the market reaction was a 11% increase in
the share price of Chase and a 9.6% increase in the share price of
Chemical (Pulliam, 1995). The increase in price was attributable to
merger-related synergies perceived by investors (Hitt, Harrison &
Ireland 2001). There has been very little research in the area of
synergy measures despite three decades of inquiry into the M&A
phenomenon. Healy, Palepu, and Ruback (1992) used the abnormal returns
of the combined firm and related them to post-acquisition operating
performance, and Chatterjee (1986, 1992) studied the abnormal stock
returns of the merging firms, and the firm that is the major rival to
the target firm.
Our study makes a contribution to the literature by examining the
abnormal returns of the bidding firm and its major rival firm, and
relating them to post-acquisition operating performance. Because Healy
et al. (1992) examine the abnormal returns of the combined firm, their
results do not allow us to disentangle the individual contributions of
the bidding and target firms. Chatterjee's studies (1986, 1992) do
not examine the relationship between abnormal returns and
post-acquisition operating performance and thus do not provide a test of
operating synergy. Our research design allows us to isolate any synergy
valuation effects associated with the market perception of
post-acquisition operating performance to the valuation of the bidder
and its major rival.
We examine 50 large U.S. acquisitions that occurred during 1992 and
1996 between firms where the businesses of the combining firms were
related. Our results indicate that the abnormal returns of the bidding
firm are positively associated with post-acquisition operating
performance as measured by return on sales (ROS). Second, and more
critically, our results show that the abnormal returns of the major
rival firm are negatively associated with post-acquisition operating
performance of the combined bidder and target firm. Taken together, the
results suggest that the market is able to identify acquisition-related
synergies at the time of the acquisition announcement.
THEORETICAL DEVELOPMENT
Motives for Mergers and Acquisitions
While an extensive body of literature in finance, economics and
strategy has examined the motives and consequences of mergers and
acquisitions, some of the basic questions still remain unanswered
(Agarwal, Jaffe & Mandelkar, 1992). For example, there is no
consensus on whether the stock market fully comprehends the consequences
of an acquisition immediately on announcement (Jensen & Ruback,
1983). Second, there has been limited success in relating equity gains
during acquisition announcement to subsequent operating performance.
However, in recent times, it may be easier to predict the
subsequent performance of acquisitions by studying their equity gains or
losses during the acquisition announcement. This is because many
institutional investors have taken on a greater role as a watch-dog of
firms' value destroying activities and firms are less likely to
pursue deals for size alone (Investors Business Daily, 1995; Useem,
1993; Zuckerman, 2000). In deals completed in the 1970s and 1980s, the
target usually received all the abnormal returns and the bidding firms
witnessed negative returns even when the capital market perceived
synergistic gains from the acquisition. However, in the deals completed
in the 1990s, the acquiring firm was not penalized if the acquisition
was perceived to be synergistic (Sirower, 1997). Hence, if we assume
that the capital markets are semi-strong efficient, then security prices
will reflect all publicly available information (Chatterjee, 1992; Fama,
1976).
Measurement of synergies using stock prices
The efficient capital market theory offers a useful theoretical
lens to understand synergies because if indeed, security prices reflect
all publicly available information, there are advantages to measuring
performance by studying stock price movements around the time of an
acquisition announcement. The efficient capital market theory assumes
that stock prices are fully specified and not limited to a specific
aspect of performance such as sales growth or profits, is readily
available for all publicly traded firms and cannot be manipulated by
managers (Fama, 1976). Woolridge and Snow (1990) make a strong case for
the efficacy of semi-strong version of an efficient capital market and
their position is strongly supported by finance (Chang, Chen, Hsing
& Huang, 2007; Dow & Gorton, 1997) and strategy researchers
(Seth, 1990; Sirower, 1997). They argue that the capital market is
capable of judging the existence of positive potential synergy in any
major long-term investments such as joint ventures, research and
development, or acquisitions that firms may announce to the public.
Thus, initial reactions of the stock market to an acquisition
announcement are representative of the market's perceptions of
long-term performance (Sirower, 1997).
In this context, we argue that valuable information may well be
obtained from the market's perception of the acquisition. Within
the backdrop of efficient markets, the resource-based view offers a
useful approach to understand synergistic acquisitions. According to the
resource-based view, resources contribute to the advantage of one firm
over another in a particular industry. In the context of acquisitions,
the following types of synergies have been defined: operational
synergies arising out of similarities and complementarities in the value
chain that result in economics of scale and scope (Chatterjee, 1986),
collusive synergies arising out of increased market power (Caves &
Porter, 1977), financial synergies arising from diversification
(Lubatkin, 1987) and managerial synergies that arise from applying
complementary competencies and by creating a more efficient transacting
environment (Coase, 1937; Martin & Eisenhardt, 2001). However, in
the context of related acquisitions, particularly those relationships
that are complementary, operational and managerial synergies play a
critical role in creating value for the organization (Brush, 1996; Hitt,
Harrison & Ireland, 2001; St. John & Harrison, 1999).
Operational and managerial synergies are derived from the resources
of the combined entity. Combining the operating assets or resources of
the two firms such as marketing, manufacturing, logistics, or
procurement may result in economies of scale and scope (Brush, 1996;
Rumelt, 1974). In an efficient capital market, the market may perceive
that the combined firm possesses a unique combination of resources not
easily replicable by its major competitors (Barney, 1988; Chatterjee,
1986). If this is indeed true, buyers may be willing to purchase the
combined firms' outputs at prices significantly above their costs
and are not likely to switch to competitors who offer similar or
substitute products (Coombs & Ketchen, 1999).
Barney (1988) argues that not all potential bidders have complete
information about their targets. Thus, a bidder with private synergy
based on perceived uniqueness is likely to have an advantage over other
potential bidders (Chatterjee, 1992). Private synergy refers to synergy
between the acquiring and target firm that is due to unique resource
complementarity not found among other potential bidders for a specific
target. Barney (1988) argues that complementary acquisitions have the
potential to create greater value because the synergistic relationship
between the two firms is unique, difficult to imitate, and durable. An
imperfectly competitive market can exist when a target is worth more to
one bidder than it is to others. Once acquired, the performance of the
combined firm will be greater than expected and generate abnormal
returns for its shareholders. If other bidders cannot duplicate the
uniqueness of the newly combined firm then the shareholders of the
combined firm will earn abnormal returns and that firm can gain a
competitive advantage (Barney, 1991). Hitt, Harrison, and Ireland's
(2001) case studies reveal that successful acquisitions are ones in
which complementary resources exist between the acquiring and target
firms.
A complementary relationship between the partners offers
opportunities for asset improvement and asset creation (Haspeslagh &
Jemison, 1991; Markides & Williamson, 1994). Over a period of time,
the changing knowledge of the organization's workforce enables the
consolidated organization to combine the resources so that new
capabilities are developed. These capabilities may then be applied to
help improve the strategic value of the existing assets which may
eventually result in new product offerings for existing and new markets
(Teece, 1980). Markides & Williamson (1994) argue that value is
created when the organization is able to utilize its competencies (pools
of knowledge, experience, and systems that exist elsewhere in the
corporation) in existing businesses to create new assets in a new
business faster, or at a lower cost. The stock market is indeed capable
of sensing such uniqueness as revealed in empirical and anecdotal
studies. Woolridge and Snow (1990) found that the stock market reacts
positively to announcements concerning new product offerings in old and
new product markets. As mentioned earlier, the announcement of a merger
between Chemical Banking and Chase Manhattan was followed by a 11%
increase in the share price of Chase and a 9.6% increase in the share
price of Chemical (Pulliam, 1995). Hitt, Harrison, and Ireland (2001)
argue that Wall Street perceived a complementary, synergy yielding
relationship, between the two partners.
Seth (1990) argues that any abnormal returns that accrues to the
combined firm after the acquisition announcement is due to synergies
that the market is able to perceive. She measured synergy by comparing
the value of the combined firm after all gains were incorporated into
the stock price with the combined value of the bidder and target had
there been no acquisition. Healy, Palepu, and Ruback (1992) found that
combined firms have increases in post-merger operating performance
compared to the industry and that there is a positive association
between combined abnormal returns for the target and the bidder at the
time of the merger announcement and the post-merger operating
performance. Sirower (1997) found that stock market losses or gains on
announcement of acquisitions are indicative of long term stock
performance. Extending this argument, if the market assigns a greater
value to mergers that exhibit the potential for operating synergies,
then it will bid up the price of both the acquiring firm and the target.
That is, the shareholders of bidding firms would gain from the
acquisition. If these "perceived" synergies are indeed
materialized in the form of better operating performance after the
acquisition, then there should be an association between the stock price
of the acquiring firm at the time of the acquisition announcement and
the post-acquisition operating performance of the combined firm. Hence
we predict that greater perceived synergies between the acquirer and
acquired firm would be associated with higher post-acquisition
performance.
Hypothesis 1: There is a positive association between the abnormal
returns of the bidding firm and the post-acquisition operating
performance of the combined firm.
Impact of acquisition on rival firm
If the market perceives a synergy from the acquisition then it
should also affect the market's valuation of rival firms. It is
generally believed that rival firms benefit from an acquisition in at
least two major ways. First, an acquisition increases collusion or
concentration, which in turn increases the market power of the entire
industry including that of the rival firms. Indeed, Kim and Singal
(1993) examined 14 large airline mergers and found that rival firms also
benefited from market power after the merger and therefore, increased
prices of their services. Second, if a merger signals a need for
restructuring for the entire industry then rivals would also benefit
from the merger (Chatterjee, 1992). For the rivals to benefit from the
acquisition, the predominant process for creating value should be
restructuring because it is likely to be industry-wide instead of being
limited to the combined entity (Chatterjee, 1992). Hence, if upon an
announcement, the stock prices of the major rivals to the bidding firm
decrease, it suggests that synergy rather than restructuring may be the
motive behind the proposed acquisition.
Chatterjee (1986) argues that the wealth gain attributable to a
merger should be related, assuming that the impact of collusion has been
controlled for, to either an operational or a financial synergy. If the
acquisition is perceived to create cost efficiencies for the combined
organization, the rivals of the acquiring firm may face a lower final
price of the product and also a higher cost of raw materials (due to
monopsony power) and therefore, are likely to experience a reduction in
their market value. This is based on the assumption that the rivals are
not in position to adopt the same cost-efficient production process
(Chatterjee, 1986; Eckbo, 1983). Further, synergistic acquisitions are
likely to provide the combined entity with increased bargaining power
over customers and suppliers. They may be in a position to sell
complementary products to a common buyer, bundle products, use common
logistics or distribution and thus reduce the search costs for buyers
(Nelson, 1970). Additionally, increased scale of purchasing may improve
their negotiating position with suppliers (Adelman, 1949). The combined
firm's improved bargaining power may come at the expense of its
rival firms in the competitive cost and price environments of the 1990s.
Finally, assuming an efficient capital market, the market may
perceive that the combined entity may limit the competitors'
ability to contest their input markets, processes, or output markets,
and may encroach into markets where the competitors may not be able to
quickly respond (Sirower, 1997). Drawing on the above arguments we
predict that a synergistic acquisition will hurt a rival firm because
the uniqueness perceived in the combination is likely to translate into
improved long-term operating performance which is not replicable by the
rivals of the bidder (Barney, 1991). Additionally, in the absence of
collusion, the improvement in performance is likely to come at the
expense of their rivals.
To our knowledge, there is no study that has examined whether the
stock performance of the bidding firm's rival firm is affected by
the potential for post-acquisition synergies. However, to the extent
that the bidding firm obtains these synergies, it strengthens the
post-acquisition position of the combined firm. Hence, if synergies
indeed exist, the abnormal stock performance of the rival firm
surrounding the acquisition announcement should be negatively associated
with post-acquisition operating performance of the combined firm. Hence
we predict that greater perceived synergies between the acquirer and
acquired firms would be associated with lower stock price performance of
rival firms during the time of the acquisition announcement.
Hypothesis 2: There is a negative association between the abnormal
returns of the major rival firm and the post-acquisition operating
performance of the combined firm.
METHODOLOGY
Sample and Data
A list of all the U.S. mergers and acquisitions completed during
the years 1992-1996 was obtained from the Almanac editions of Mergers
and Acquisitions. We selected this time period for two reasons. First,
the U.S. economy was facing robust growth during this period after
emerging from the recession during the late 80s and early 90s. Second,
after 1996, internet based firms became a significant economic force,
and the market was perceived to be overvalued.
To be included in the final sample, both the bidder and the target
firm had to be sufficiently large, and have generated revenues of at
least $200 million at the time of the acquisition. We restricted our
sample to large related acquisitions because such acquisitions entail a
higher degree of operational integration compared to unrelated
acquisitions and therefore, have greater potential to create synergies
not easily duplicated by competitors (Chatterjee, 1992; Oliver, 1997;
Seth, 1990). From the same we excluded the following: all acquirers who
were acquired within two years after the acquisition, acquisitions by
privately held groups, firms which made other major acquisitions during
the two years following the acquisition, acquisitions which did not
result in single ownership, and foreign acquirers. This was to ensure
that the stock price change was not influenced by other confounding
events. Also, firms that witnessed significant events (such as
top-management changes, or changes to the product mix) in the 240 day
window prior to the announcement were deleted. The above criteria were
adopted to (a) reduce the noise in the data pertaining to the acquiring
company and obtain a "clean" sample (Seth, 1990) and, (b)
ensure that the acquisition has a considerable impact on the operations
of the combined entity (Kroll, Wright, Toombs & Leavell, 1997).
Related acquisitions were identified in two ways. First, the
two-digit SIC code of the bidder and the target for the major lines of
business had to be the same. Second, the acquisition had to be
undertaken for reasons of "synergies" as stated by the firm in
any of the leading newspapers featuring the announcement. We chose a
broad measure for relatedness because managers seek to increase the
likelihood for operational synergies by acquiring firms that may have
multiple businesses (Brush, 1996). These criteria resulted in a sample
of 50 related acquisitions and included both horizontal and
non-horizontal acquisitions. Including non-horizontal acquisitions, as
long as they were broadly related at the 2-digit SIC level, was
important because first, the product/factor price effect is assumed to
have an impact on the rival if it had a stake in that industry and
second, complementary relationships are usually witnessed when firms
operate within the same 2-digit SIC level, and are likely to generate
unique synergies (Chatterjee, 1986; Haspeslagh & Jemison, 1991; St.
John & Harrison, 1999).
Rival firms were identified using the Hoovers Database, which
identifies the biggest rival firms for each bidding firm. We also
examined the COMPUSTAT database for firms that operated in the same
major 4-digit SIC levels as the bidding firms during the year of the
acquisition. This procedure yielded at least two domestic
publicly-traded rivals for every bidding firm which were then
scrutinized to ensure that the major lines of business were common for
each bidding firm, target firm, and rival firm.
Independent Variables
Perceived Synergies
CAR of acquiring firm surrounding the announcement.
Recall that perceived synergy is measured by analyzing the stock
market's response to the acquisition announcement. Following an
announcement, the target's price usually increases whereas the
bidder's stock declines slightly or stays relatively flat (Hayward
& Hambrick, 1997). If the bidder's price drops very sharply it
reflects investor uncertainty associated with acquisition costs and
concerns regarding the viability of the combined entity. Additionally,
it may also indicate that the market doubts whether the relationship
between the bidder and target is indeed synergistic. If the
bidder's price does not decrease significantly, or increases
marginally, investors may perceive synergies from the combination
(Chatterjee, 1992).
CAR of the rival firm surrounding the announcement.
The stock price of the bidder firm's rival may also be
influenced as a result of the announcement. If the stock price of the
rival decreases, then it implies that investors perceive synergies in
the original combination and believe that the acquisition could have an
adverse impact on the subsequent performance of the rival firms. If
there is little change in the stock prices of the rival firms, investors
may not perceive major synergies from the combination.
Consistent with prior research, we measured perceived synergies as
the cumulative abnormal returns (CAR) for the bidding firm surrounding
the acquisition announcement. Security returns were obtained from the
CRSP database. The following event windows were used in our main
analysis: (1) -1 to 1 days with 0 denoting the date of the acquisition
announcement (3-day window), and (2) -2 to 2 days with 0 denoting the
date of the acquisition announcement (5-day window). We also used an
11-day window (-5 to 5 days) in supplemental analysis and found no
significant results, corroborating the findings in previous research
that increasing the event window creates greater noise in the data
(Brown & Warner, 1985; McWilliams & Siegel, 1997). For the rival
firms, the CAR for the 3-day window around the announcement was used.
We calculate abnormal common stock returns for each firm using
standard event study methodology with a market model based upon a
value-weighted market index estimated over a 240-day estimation period
with the estimation period ending 45 days preceding the acquisition
announcement.
Using the market model, we defined abnormal returns (AR) of a firm
i on any given day d as follows:
[AR.sub.id] = [R.sub.id] - [a.sub.i] - [b.sub.i] [R.sub.md] (1)
Where a is the risk-free rate of return and b is the sensitivity of
the return to the market portfolio. a and b are estimated from the
following OLS regression:
[R.sub.id] = [a.sub.i] + [b.sub.i] [R.sub.md] + [e.sub.id] (2)
In equation (2), [R.sub.id] is the daily return of the individual
firm and [R.sub.md] is the daily return of the market portfolio. The CAR
for a 3-day window is computed as:
CAR = [S.sup.n.sub.i=-1] [AR.sub.id] (3)
Where day 0 is the date of the acquisition announcement and n
equals the 3 days surrounding the announcement.
In sensitivity tests, we also calculated abnormal common stock
returns for each firm using a net-of-market methodology as
[MAR.sub.id] = [R.sub.id] = [R.sub.md] (4)
Where [R.sub.id] is the return of firm i on day d and [R.sub.md] is
the return of the market portfolio on day d.
The simple excess returns over the market is essentially the same
as the market model in equation (1) where a=0 and b=1 for all
securities. This measure is free from the parameter biases from the
estimation period in the market model (Sirower, 1997). The results (not
reported) using this alternative methodology were not qualitatively
different from the results presented in Table 3 in terms of the
direction and significance of the coefficient estimates.
Dependent Variable (Post acquisition performance of combined
entity)
Accounting measures
We used the combined firm's return on sales (ROS) in the year
following the acquisition as our measure of post-acquisition operating
performance. ROS, obtained from the COMPUSTAT database, is measured as
operating income (before acquisition adjustments) divided by net sales.
We used ROS rather than an equity based performance measure such as firm
value or Return on Equity (ROE), or an asset based performance measure
such as Return on Assets (ROA) for several reasons. First, ROS is less
sensitive to unexpected economy and industry factors compared to firm
value. Second, a performance measure using assets as a base will be
affected by the alternative accounting methods allowed under generally
accepted accounting principles as well as the two acquisition accounting
methods available during our sample period, purchase and pooling of
interests (Ayers, Lefanowicz, & Robinson, 2000). Third, ROS reflects
the operational performance of a firm and is therefore, a better
indicator of any synergies that may arise from the acquisition (St. John
& Harrison, 1999). Finally, our sample is comprised of U.S. firms
that operate in a business environment that is short term in
orientation, and hence a one-year ROS appears to be an appropriate
measure that is likely to capture the synergies.
Control Variables
Post-acquisition year ROS of the industry
This variable was included as a control for the post-acquisition
year performance of the industry. This allows us to control for
unmeasurable factors that may affect all the firms in the industry.
Prior performance of the acquiring firm
Prior performance can influence the strategic actions of top
managers. Firms may undertake acquisitions as a means to improve their
performance or to reduce slack (Porter, 1987; Hambrick & Cannella,
1993). Prior performance was measured as the return on sales (ROS) of
the acquiring firm in the year prior to the acquisition.
Pre-acquisition year ROS of the industry
This was used to control for the pre-acquisition performance of the
industry, thereby providing industry adjusted pre-acquisition bidder
performance.
Competing bid
This variable controls for acquisitions where there was a competing
bid from another firm. This measure was included because the presence of
a competing bid may push up the price of the target and affect the
post-acquisition behavior of the merging firm.
Payment type
Prior research indicates that payment type is an important
determinant of post-acquisition operating performance (Morck, Schleifer,
& Vishny, 1990; Sirower, 1997). To control for the type of payment,
we divided our sample into three categories; stock acquisitions, cash
acquisitions, and cash-stock combination acquisitions. We use the
variable Equity-Based Payment, which is a dummy variable that takes the
value of 1 if the acquisition was financed using stock, or else it has a
value of zero. Similarly, Cash-Based Payment is a dummy variable that
takes the value of 1 if the acquisition was financed with cash, else it
is zero. The combination-financed acquisition was the omitted dummy.
Nature of Acquisition
Friendly acquisitions are more likely to result in superior
post-acquisition performance compared to hostile acquisitions because in
the former, integration problems are easier to overcome. Following the
method suggested by Jensen and Ruback (1983) and subsequently employed
by Loughran and Vijh (1997), an acquisition was classified as friendly
if the target managers were favorable, the board of directors and
shareholders voted to approve the acquisition, and the general tone of
the acquisition was friendly. An acquisition was coded as hostile if the
tone was unfriendly and there was no shareholder approval. Acquisition
climate was assessed from statements made in the Wall Street Journal and
other business journals (Hambrick & Cannella, 1993). This variable
was coded as 1 for hostile acquisitions and 0 otherwise.
Empirical Model
The following empirical model was used to test our hypotheses.
Post acquisition ROS of combined firm in the year following the
acquisition = a + [b.sub.1.sup.*](CAR of acquiring firm surrounding the
announcement) + [b.sub.2.sup.*] (CAR of the rival firm surrounding the
announcement) + [b.sub.3.sup.*] Post-acquisition year ROS of the
industry)+ [b.sub.4.sup.*] (Prior performance of the acquiring firm) +
[b.sub.5.sup.*] (Pre-acquisition year ROS of the industry) +
[b.sub.6.sup.*] (Competing bid) + [b.sub.7] (Equity-Based Payment
Dummy)+ [b.sub.8.sup.*] (Cash-Based Payment Dummy)+ [b.sub.9.sup.*]
(Nature of acquisition-friendly or hostile)
RESULTS
Table 1 provides the mean values for the variables used in the
study. It can be observed that the ROS of the combined entity is lower
in the post-acquisition year compared to the pre-acquisition year. The
average CAR for the acquiring firm is approximately -2% around the time
of the announcement, consistent with previous studies (Sirower, 1997).
However, there is considerable cross sectional variation in the returns
as evidenced by the large standard deviation. Similarly, the CAR for the
rival firms is also negative. In approximately 26% of the acquisitions,
a competing bid was present and 20% of the acquisitions were hostile.
Regarding method of payment, 46% of the acquisitions were financed using
only equity, 28% were financed using cash, and 26% were financed using a
combination of cash and stock.
Table 2 provides the Pearson correlation coefficients for the
variables used in the analysis. The pre-acquisition ROS performance of
the industry is highly correlated with the pre-acquisition performance
of the firm (r=0.60, p<0.001), and the post-acquisition performance
of the industry (r=0.85, p<0.001). Hence, separate regressions were
run including and excluding one of the correlated variables. Competing
bids and hostility are also related and therefore, we perform similar
analysis using only one of them.
Table 3 contains the results of the regression analysis. Column 1
provides the results for the 3-day window and column 2 provides the
results for the 5-day window. For both windows, the CAR of the acquiring
firm has a large positive and significant coefficient. These results are
consistent with Hypothesis 1 and suggest that higher perceived synergy
(CAR) values are associated with greater post-acquisition ROS. Thus, the
market is able to perceive synergistic acquisitions at the time of the
acquisition announcement, and acquisitions that are more likely to
result in operating synergies are assigned a greater value by the
market. Similarly, for both windows, the CAR for the rival firm has a
significantly negative coefficient. Thus, higher post-acquisition ROS is
associated with lower CAR for the rival firms, suggesting that the
market assigns a lower value to rival firms which are most likely to be
affected by the synergistic acquisition. These results are consistent
with hypothesis 2. We also substituted industry-adjusted pre-acquisition
year ROS instead of including the pre-acquisition ROS of the acquiring
firm and the industry separately. The results are substantively the
same. The industry-adjusted ROS of the pre-acquisition firm had a
positive and significant coefficient.
For the control variables, higher post-acquisition return on sales
for the industry is associated with higher ROS for the merging firms.
Pre-acquisition ROS for the acquiring firms is positively associated
with post-acquisition ROS suggesting that prior performance has a
significant influence on post-acquisition performance.
The adjusted [R.sup.2] of the model using the 3-day window is 0.74.
This is relatively high compared to previous studies. To examine this
further, we partitioned the adjusted [R.sup.2] by first entering only
the control variables and then entering the rival CAR and compared the
incremental explanatory power of the synergy measures. The adjusted
[R.sup.2] for the model containing only the control variables was 0.69
for the 3-day window. The incremental adjusted [R.sup.2] of the rival
CAR was 0.02 and the incremental adjusted [R.sup.2] of the bidder CAR
was 0.03. These are comparable to previous studies which examine the
association between CAR and other outcome variables. Similar incremental
adjusted [R.sup.2]s were observed for the 5-day window model. Finally,
we applied Cook's test to examine the role of outliers. Our
analysis revealed outliers to present no problem.
Our study is restricted to examining post acquisition operating
performance (ROS) for one year because of the inherent limitations
associated with longer time periods. Over longer time periods, there
could be significant changes in the external environment, related or
unrelated to the acquisition, which may violate the clean data criterion
(Ramaswamy, 1997). Further, the U.S. business environment had been very
active in acquisitions and acquisitions during the period of our study
with many of the firms in our sample engaging in further acquisitions.
Thus, adding further years is likely to add noise to the data.
DISCUSSION
This study examines whether the market expectations of synergies
following an acquisition are associated with post-acquisition financial
performance. Using a sample of 50 related acquisitions, results indicate
that there is a strong positive association between abnormal security
returns for the bidding firm surrounding an acquisition announcement and
the post-acquisition operating performance as measured for by return on
sales for the combined firm. Results also show a strong negative
association between post-acquisition ROS and abnormal returns for the
firm that is a major rival to the acquiring firm. Taken together, these
results indicate that the market is able to accurately perceive
synergies from an acquisition.
There are several reasons as to why the market reacts negatively to
most announcements of acquisitions. First, managers perceive synergies
because they may find it difficult to separate the real opportunities
from the illusions (Goold & Campbell, 1998). The market, assuming it
is efficient, may not perceive any synergies in the combination. Second,
even if there are potential synergies in the combination, the stock
market may not have confidence in the firm's ability to
successfully integrate the acquisition and to implement operational
strategies to extract these synergies after the acquisition. This lack
of confidence may have its roots in the previous experience of the
bidding firm in integrating acquisitions, composition of the current top
management team, high premium for the target, size of the acquisition
and possible cultural incompatibility between the two firms (Hitt,
Harrison, & Ireland, 2001). When the market reacts positively to an
acquisition announcement, that is, there are abnormal gains to the
acquiring firms relative to the market, the market may believe that the
combined entity is capable of integrating the value chains of the two
firms (Lee & Lim, 2006), and effectively meshing the cultures of the
merging partners, or, as Hitt, Harrison, and Ireland (2001) argue, it
may sense a resource complementarity between the two partners.
Synergy is not an easy concept to define or operationalize and it
has been argued that synergy cannot be seen and that only its effects
can be studied in organizations. Our major contribution to this area of
research is to revisit the notion of synergy by examining the reactions
of the stock market to the announcement of major acquisitions and
relating the abnormal gains (or losses) of the bidding firms to
subsequent post-acquisition operating performance. Acquisitions
represent strategic decisions that have major long-term performance
implications and therefore, their effects have to be examined on the
wealth of the acquiring firm's shareholders (Sirower, 1997).
Additionally, by examining the impact of an announcement on the abnormal
returns of the major rival to the bidding firm and linking it to
post-acquisition operating performance of the combined organization, a
more complete test of synergy is provided.
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Table 1: Means for Variables used in the Analyses *
Variable Mean
(Standard Deviation
in Parenthesis)
N=50
Post-Acquisition Return on 6.36 (5.03)
sales (ROS) of the
combined entity
(Net Operating margin
(before acquisition
adjustments) divided by
net sales.)
Cumulative Abnormal Return of the -0.0205 (0.0571)
Acquiring Firm
3 day period surrounding -0.0207 (0.0607)
the announcement
5 day period surrounding -0.0234 (0.0686)
the announcement
11 day period surrounding
the announcement
Cumulative Abnormal Return of the -0.0032 (0.0302)
Rival Firm
3 day period surrounding 6.26 (3.90)
the announcement
Post-Acquisition Year ROS of the 6.59 (5.93)
Industry
Prior performance of the 6.28 (3.95)
acquiring firm
Pre-Acquisition ROS of the 0.26 (0.44)
Industry
Competing bid present (1=yes) 23
Payment Type 14
All Equity (number of 13
acquisitions)
All Cash
Mixed 0.20 (0.40)
Nature of Acquisition (1=hostile)
* Means for the 50 related acquisitions
Table 2: Pearson Correlation Coefficients
1 2 3
1 Post-acquisition ROS -- 0.18 0.09
2 CAR bidder - 3 day window --
3 CAR bidder - 5 day window --
4 CAR rival - 3 day window
5 Post-acquisition year ROS of
the industry
6 Pre-acquisition year ROS of
the industry
7 Prior performance of the
acquiring firm
8 Competing Bid
9 Equity-Based Payment
10 Cash-Based Payment
11. Nature of Acquisition
(1=hostile)
4 5 6
1 Post-acquisition ROS -0.25 * 0.77 *** 0.65 ***
2 CAR bidder - 3 day window 0.19 0.06 0.09
3 CAR bidder - 5 day window 0.20 0.00 0.03
4 CAR rival - 3 day window -- -0.22 -0.25 *
5 Post-acquisition year ROS of -- 0.85 ***
the industry
6 Pre-acquisition year ROS of
the industry
7 Prior performance of the
acquiring firm
8 Competing Bid
9 Equity-Based Payment
10 Cash-Based Payment
11. Nature of Acquisition
(1=hostile)
7 8 9
1 Post-acquisition ROS 0.63 *** -0.15 -0.00
2 CAR bidder - 3 day window 0.09 -0.07 -0.26
3 CAR bidder - 5 day window 0.04 -0.09 -0.32 **
4 CAR rival - 3 day window -0.09 0.16 0.03
5 Post-acquisition year ROS of 0.44 *** -0.24 * -0.07
the industry
6 Pre-acquisition year ROS of 0.60*** -0.18 0.01
the industry
7 Prior performance of the -0.07 -0.01
acquiring firm
8 Competing Bid -- 0.00
9 Equity-Based Payment --
10 Cash-Based Payment
11. Nature of Acquisition
(1=hostile)
10 11
1 Post-acquisition ROS -0.09 -0.11
2 CAR bidder - 3 day window 0.10 -0.22
3 CAR bidder - 5 day window 0.19 -0.22
4 CAR rival - 3 day window 0.01 0.17
5 Post-acquisition year ROS of 0.07 -0.07
the industry
6 Pre-acquisition year ROS of -0.02 -0.13
the industry
7 Prior performance of the -0.36 *** -0.30 **
acquiring firm
8 Competing Bid 0.14 0.62 ***
9 Equity-Based Payment -0.56 *** -0.16
10 Cash-Based Payment -- 0.24
11. Nature of Acquisition
(1=hostile) --
* p < .05, ** p < .01, *** p < .001
Table 3: Results from the Regression Analysis - Predictors of
Post-Acquisition Return on Sales
(Standard Errors in Parentheses)
Post acquisition ROS of combined firm in the year following the
acquisition = a + [b.sub.1] *(CAR of acquiring firm surrounding the
announcement) + [b.sub.2] * (CAR of the rival firm surrounding the
announcement) + [b.sub.3] * (Postacquisition year ROS of the
industry) + [b.sub.4] *(Prior performance of the acquiring firm)+
[b.sub.5] * (Pre-acquisition year ROS of the industry) + YMBOL98f"Symbol"\[s12.sub.6] * (Competing bid) + [b.sub.7] *
(Equity-Based Payment Dummy)+ [b.sub.8] * (Cash-Based Payment Dummy)+
[b.sub.9] *(Nature of acquisition - friendly or not)
Dependent Variable = ROS of the
Combined Firm in the Year
Following the Acquisition
(1)
3-day Window
Cumulative Abnormal Return (CAR) 20.04 ** (7.56)
of the Acquiring Firm
Surrounding the Announcement t=2.65
Cumulative Abnormal Return (CAR) -25.06 ** (13.92)
of the Rival Firm
Surrounding the Announcement t=-1.80
Post-acquisition Year Return-On- 0.98 *** (0.11)
Sales of the Industry t=9.24
Prior performance of the acquiring firm 0.43 *** (0.09)
t=4.72
Pre-acquisition Year Return-On-Sales 0.05 (0.04)
of the Industry t=1.29
Competing Bid (1=yes) -0.49 (1.18)
t=-0.41
Equity-Based Payment (1=yes, 0=no) 0.59 (0.97)
t=0.61
Cash-Based Payment (1=yes, 0=no) -0.28 (1.12)
Nature of Acquisition (1=Hostile) 2.05 (1.38)
t=1.49
Intercept -0.79
Adjusted [R.sup.2] 0.74 ***
N 50
(2)
5-day Window
Cumulative Abnormal Return (CAR) 16.29 ** (7.41)
of the Acquiring Firm
Surrounding the Announcement t=2.20
Cumulative Abnormal Return (CAR) -23.65 * (13.24)
of the Rival Firm
Surrounding the Announcement t=-1.79
Post-acquisition Year Return-On- 1.00 *** (0.11)
Sales of the Industry t=9.23
Prior performance of the acquiring firm 0.43 *** (0.09)
t=4.56
Pre-acquisition Year Return-On-Sales 0.06 (0.04)
of the Industry t=-1.33
Competing Bid (1=yes) -0.30(1.20)
t=-0.25
Equity-Based Payment (1=yes, 0=no) 0.50 (1.00)
t=0.51
Cash-Based Payment (1=yes, 0=no) -0.41 (1.15)
Nature of Acquisition (1=Hostile) 1.81 (1.41)
t=1.29
Intercept -0.91
Adjusted [R.sup.2] 0.73 ***
N 50
p < .05, ** p < .01, *** p < .001
