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VALUE?': AN EMPIRICAL ANALYSIS OF M&A IN THE INDIAN CONTEXT

thesis submitted to the

Goa University

for the award of the degree of

DOCTOR OF PHILOSOPHY

in

COMMERCE

by -

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1-71 Alffy

Thanoor Vidya Radhakrishnan

under the guidance of

Dr. (Ms.) Guntur Anjana Raju

Reader,

Department of Commerce, Goa University Taleigao-Goa

May 2011

T-516

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DECLARATION

I, Vidya R. Thanoor, hereby declare that this thesis for Ph.D. Degree in Commerce titled 'Do Mergers Increase Shareholder Value?': An Empirical Analysis of M&A In The Indian Context' is a bonafide record of original research work done by

me under the guidance and supervision of Dr.(Ms.) Guntur Anjana Raju, Reader, Department of Commerce, Goa University and that the same has not been previously formed the basis for the award of any degree, diploma or certificate or similar title of this or any other University.

Place:

Teti.e..4.:

Date:

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Thanoor Vidya Radhakrishnan Research Scholar

Departnient of Commerce Goa University

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CERTIFICATE

This is to certify that the thesis titled "Do Mergers Increase Shareholder Value?': An Empirical Analysis of M&A In The Indian Context' is a bonafide record of the

original work done by Ms. Vidya R. Thanoor, under my guidance and supervision and the same has not been previously formed the basis for the award of any degree, diploma or certificates or similar title of this or any other University

Dr. (Ms.) Guntur Anjana Raju ti 11 Research Guide

Reader, Department of Commerce Goa University

Taleigao-Goa-403406

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ACKOWLEDGEMENT

This research work is blessed with intellectual contribution from several academicians and researchers as well as moral support from my family and friends and I take this opportunity to thank each one of them.

I am extremely indebted to my teacher and guide Dr. Guntur Anjana Raju, for her valuable guidance for my research. I am grateful to her for encouraging me into research activity and providing all the valuable contribution required for accomplishment of this study.

I am thankful to Dr. B. Ramesh, Dean and HoD, Faculty of Commerce, Goa University and FRC Chairman for shaping my research with his intellectual contributions.

I am also thankful to Dr. Y V. Reddy for his useful comments and continued guidance as subject expert for this thesis.

This research work would not have been completed without the support of two best management institutions in our country. I am extremely grateful to IIM Bangalore for providing me data services and excess to its immense resource of literature on the subject. I am also thankful to the library and computer section staff of IIM-B for their help and support. I am equally grateful to Goa Institute of Management(GIM) and especially Dr. Ghosh former director of the institute for providing me access to their rich resource of highly recognized databases.I am grateful to Prof V. S. Sukhtankar(GIM) for all the help h e provided. I also specially acknowledge the contribution of Mr. Vivek

Pissurlekar (former Librarian), Mr. Mukesh Yeshwant and Mr. Hillario from GIM for their tremendous help during data collection. I am thankful to the library staff of Goa University for their help during my reference work.

I thank Gaurish Pednekar, Nilesh Pandit and my friend Sonali Pokle for their timely help in resolving various issues concerned to software programs.

I am blessed to have a friend, motivator and an intellectual rolled into in the form of my husband Dr. Harip R. Khanapuri. This research work is unimaginable without him being there with me. I thank him for all his sacrifices and help during my study. I am

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for always motivating me and being such wonderful people around me. I owe a lot to my family for bearing everything possible to make me accomplish this task

I thank Mr. Sudhir Parsekar and appreciate the creative touch he gave to my thesis in its presentation.

Lastly, I am thankful to God for creating such a pool of resourceful and helpful people around me who made my research a memorable experience

Thanoor Vidya Radhakrishnan

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TABLE OF CONTENTS

DECLARATION II

CERTIFICATE III

ACKNOWLEDGEMENT IV - V

LIST OF TABLES IX - XI

LIST OF FIGURES XII - XIII

LIST OF ABBREVIATION XIV

Page No.

CHAPTER ONE : INTRODUCTION TO MERGERS AND 1 -16 ACQUISITIONS

1.1 Meaning of Mergers and Acquisitions 2

1.2 Types of Mergers and Acquisitions 4

1.3 Motives for Mergers and Acquisitions 8

1.4 Growth of Mergers and Acquisitions 12

1.5 Mergers and Acquisitions and Corporate 14 Performance

CHAPTER TWO : LITERATURE REVIEW AND RESEARCH 17 METHODOLOGY

- 79

2.1 Literature Review 17

2.1.1 M&A and Announcement Period Returns 18 2.1.2 M&A and Long Term Share Price Returns 32

2.1.3 Studies on Operating Performance 46

2.2 Problem of the Study 63

2.3 Importance of the study 65

2.4 Objectives of the Study 66

2.5 Research Methodology 66

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2.5.3 Data Variables and Data Sources 68

2.5.4 Methodology 70

CHAPTER THREE : ANALYSIS OF TRENDS IN MERGERS 80 -109 AND ACQUISITIONS IN INDIA

3.1 M&As in India During Pre-Liberalization Period 80 3.2 M&As in India During Post-Liberalization 82 3.3 Success Rate of M&A Deals in India 90

3.4 Value of Acquisitions 92

3.5 Sectoral Analysis of Mergers and Acquisitions 95 3.6 Causes of M&As — Analysis of Select Sectors 103

CHAPTER FOUR : EMPIRICAL ANALYSIS OF 110 -123

ANNOUNCEMENT EFFECT OF MERGERS AND ACQUISITIONS ON ACQUIRER FIRMS IN INDIA

4.1 Empirical Results on Announcement Period 110 Returns

4.2 Cumulative Abnormal Return of Acquirers in 111 Manufacturing Sector

4.3 Cumulative Abnormal Return of Acquirers in 120 Financial Services Sector

CHAPTER FIVE : IMPACT OF MERGERS AND 124-180

ACQUISITIONS ON LONG TERM OPERATING AND FINANCIAL PERFORMANCE OF ACQUIRERS

5.1 Long Term Pre-Merger and Post-Merger Operating 125 and Financial Performance of Acquirers in

Manufacturing Sector

5.1.1 Long Term Pre-Merger and Post-Merger Operating 133 and Financial Performance of Acquirers in

Chemical Sector

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5.1.2 Long Term Pre-Merger and Post-Merger Operating 140 and Financial Performance of Acquirers in Textile

Sector

5.1.3 Long Term Pre-Merger and Post-Merger Operating 148 and Financial Performance of Acquirers in Drugs

and Pharmaceuticals Sector

5.1.4 Long Term Pre-Merger and Post-Merger Operating 157 and Financial Performance of Acquirers in Food

and Beverage Sector

5.2 Evaluation of Significant Financial Variables of 164 Acquirers During Post Merger Period

5.3 Long Term Pre-Merger and Post-Merger Operating. 171 and Financial Performance of Acquirers in

Financial Services Sector

5.3.1 Operating Performance of Banking Acquirers 171 5.3.2 Operating Performance of Non-Banking Acquirers 173 5.4 Long Term Performance of Share Prices of 175

Acquirers

CHAPTER SIX : SUMMARY OF FINDINGS, CONCLUSION 181 - 196 AND SUGGESTIONS

6.1 Summary of Findings 182

6.2 Conclusion 189

6.2.1 Trends in Mergers and Acquisitions in India 189 6.2.2 Effect of M&A Announcement on Share Prices of 190

Acquirers

6.2.3 Long Term Operating and Financial Performance 192 of Acquirers

6.3 Suggestions 193

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LIST OF TABLES

Table No. Table Name Page No.

2.1 Classification of Financial Ratios Selected for the 75 Study

3.1 Mergers and Acquisitions in India (1995-96 to 2006- 83 07)

3.2 Number of Mergers Announced and Accomplished 91 3.3 Number of Acquisitions Announced and 91

Accomplished

3.4 Aggregate and Average Value of Acquisition Deals in 92 India

3.5 Highest and Lowest Value of Acquisition Deals 93 3.6 Sectoral Trends in M&A in India (1995-96 to 1999- 96

2000)

3.7 Sectoral Trends in M&As in India (2000-01 to 2006- 99 07)

4.1 Percentage Cumulative Abnormal Returns of Sample 111 Acquirer Firms in Manufacturing Sector in India

4.2 Percentage Cumulative Abnormal Returns of Sample 121 Acquirer Firms in Financial Services Sector in India

5.1 Mean Pre-Merger and Post-Merger Financial Ratios 126 of Acquirers in Manufacturing Sector

5.2 Paired Samples Correlations for Pre and Post Merger 126 Financial Ratios of Acquirers in Manufacturing Sector

5.3 Yearwise Analysis of Impact of M&A on Operating 130 and Financial Performance of Acquirers in

Manufacturing Sector

5.4 Mean Pre-Merger and Post-Merger Financial Ratios 134 of Acquirers in Chemical Sector

5.5 Paired Samples Correlations for Pre and Post Merger 134 Financial Ratios of Acquirers in Chemical Sector

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5.6 Yearwise Analysis of Impact of M&A on Operating 138 and Financial Performance of Acquirers in Chemical

Sector

5.7 Mean Pre-Merger and Post-Merger Financial Ratios 141 of Acquirers in Textile Sector

5.8 Paired Samples Correlations for Pre and Post Merger 142 Financial Ratios of Acquirers in Textile Sector

5.9 Yearwise Analysis of Impact of M&A on Operating 145 and Financial Performance of Acquirers in Textile

Sector

5.10 Mean Pre-Merger and Post-Merger Financial Ratios 149 of Acquirers in Drugs and Pharmaceuticals Sector

5.11 Paired Samples Correlations for Pre and Post Merger 149 Financial Ratios of Acquirers in Drugs and

Pharmaceuticals Sector

5.12 Yearwise Analysis of Impact of M&A on Operating 153 and Financial Performance of Acquirers in Drugs and

Pharmaceuticals Sector

5.13 Mean Pre-Merger and Post-Merger Financial Ratios 157 of Acquirers in Food and Beverage Sector

5.14 Paired Samples Correlations for Pre and Post Merger 158 Financial Ratios of Acquirers in Food and Beverage

Sector

5.15 Yearwise Analysis of Impact of M&A on Operating 161 and Financial Performance of Acquirers in Food and

Beverage Sector

5.16 Pre-Merger and Post-Merger Changes in Select 165 Financial Variables of Acquirers in Chemicals Sector

5.17 Pre-Merger and Post-Merger Changes in Select 167 Financial Variables of Acquirers in Textile Sector

5.18 Pre-Merger and Post-Merger Changes in Select 168 Financial Variables of Acquirers in Drugs and

Pharmaceuticals Sector

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Beverage Sector

5.20 Mean Pre-Merger and Post-Merger Financial Ratios 172 of Acquirers in Financial Services Sector (Banking

Acquirers)

5.21 Mean Pre-Merger and Post-Merger Financial Ratios 173 of Acquirers in Financial Services Sector (Non-

Banking Acquirers)

5.22 Percentage Long Term Buy and Hold Abnormal 176 Returns to Shareholders of Acquirers During Post

Merger Period (Aggregate Analysis)

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LIST OF FIGURES

Figure No. Figure Name Page No.

1.1 Worldwide M&A Announced — 1988 to 2006 14 1.2 Yearly Aggregate Dollar Returns of Acquiring-Firms 15

Shareholders (1980-2001)

3.1 Indian Outbound M&A Deals During 2000-01 to 88 2008-09

3.2 Cross-Border M&As of Indian Companies (1995 to 89 2006)

3.3 Sectoral Trends in M&A in India (1995-96 to 1999- 96 2000)

3.4 Sectoral Trends in M&As in India (2000-01 to 2006- 100 07)

3.5 M&A Premiums in Chemical Industry During Decade 105 of 2000: India vs. Global

4.1 Average Cumulative Abnormal Returns for Acquirers 113 in Manufacturing Sector

4.2 Average Cumulative Abnormal Returns for Acquirers 115 in Chemicals Sector

4.3 Average Cumulative Abnormal Returns for Acquirers 117 in Textile Sector

4.4 Average Cumulative Abnormal Returns for Acquirers 118 in Drugs and Pharmaceuticals Sector

4.5 Average Cumulative Abnormal Returns for Acquirers 119 in Food and Beverage Sector

4.6 Average Cumulative Abnormal Returns for Acquirers 122 in Food and Beverage Sector

5.1 BHAR Movements in Shares of Acquirers in 179 Chemicals Sector (I year, 2 Year and 3 Year Holding

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Sector (I year, 2 Year and 3 Year Holding Period)

5.3 BHAR Movements in Shares of Acquirers in Drugs 180 and Pharmaceuticals Sector (I year, 2 Year and 3

Year Holding Period)

5.4 BHAR Movements in Shares of Acquirers in Financial 180 Services Sector (I year, 2 Year and 3 Year Holding

Period)

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INTRODUCTION TO

MERGERS AND ACQUISITIONS

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CHAPTER ONE

INTRODUCTION TO MERGERS AND ACQUISITIONS

Mergers and acquisitions are increasingly becoming strategic choice for organizational growth and achievement of business goals including profit, empire building, market dominance and long term survival. The ultimate goal of this strategic choice of inorganic growth is, however, maximization of shareholder value. The phenomenon of rising M&A activity is observed world over across various continents, although, it has commenced much earlier in developed countries (as early as 1895 in US and 1920s in Europe), and is relatively recent in developing countries. In India, the real impetus for growth in M&A activity had been the ushering of economic reforms introduced in the year 1991, following the financial crisis and subsequent implementation of structural adjustment programme under the aegis of International Monetary Fund (IMF). In recent times, though the pace of M&As has increased significantly in India too and varied forms of this inorganic growth strategy are visible across various economic sectors.

The term mergers and acquisitions encompasses varied activities of stake acquisition and control of assets of different firms. Besides, there are several motives for different types of mergers and acquisitions seen in corporate world.

This chapter provides an understanding of the concept of mergers and acquisitions from industry and regulatory point of view and motives for mergers and acquisitions.

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1.1 Meaning of Mergers and Acquisitions:

The term mergers and acquisitions are often interchangeably used although together they include more than one form of transaction of acquiring ownership in other companies. Specific meaning of these different forms of transactions is discussed below.

Mergers:

Sherman and Hart (2006) define Merger as "a combination of two or more companies in which the assets and liabilities of the selling firm(s) are absorbed by the buying firm. Although the buying firm may be a considerably different organization after the merger, it retains its original identity." In other words, in a merger one of the two existing companies merges its identity into another existing company or one or more existing companies may form a new company and merge their identities into a new company by transferring their businesses and undertakings including all other assets and liabilities to the new company (hereinafter referred to as the merged company). The shareholders of the company (or companies, as the case may be) will have substantial shareholding in the merged company. They will be allotted shares in the merged company in exchange for the shares held by them in the merging company or companies, as the case may be, according to the share exchange ratio incorporated in the scheme of merger as approved by all or the prescribed majority of the shareholders of the merging company or companies and the merged company in

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Acquisitions and Takeovers

"An acquisition", according to Krishnamurti and Vishwanath (2008) "is the purchase of by one company (the acquirer) of a substantial part of the assets or the securities of another (target company). The purchase may be a division of the target company or a large part (or all) of the target company's voting shares."

Acquisitions are often made as part of a company's growth strategy whereby it is more beneficial to take over an existing firm's operations and niche compared to expanding on its own. Acquisitions are often paid in cash, the acquiring company's shares or a combination of both. Further, an acquisition may be friendly or hostile. In the former case, the companies cooperate in negotiations; in the latter case, the takeover target is unwilling to be bought or the target's board has no prior knowledge of the offer. Acquisition usually refers to a purchase of a smaller firm by a larger one. Sometimes, however, a smaller firm will acquire management control of a larger or longer established company and keep its name for the combined entity. This is known as a reverse takeover.

Amalgamation

The term "amalgamation" contemplates two or more companies deciding to pool their resources to function either in the name of one of the existing companies or to form a new company to take over the businesses and undertakings including all other assets and liabilities of both the existing companies. The shareholders of the existing companies (known as the amalgamating companies) hold substantial shares in the new company (referred to as the amalgamated company). They are allotted shares in the new company Goa University

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in lieu of the shares held by them in the amalgamating companies according to share exchange ratio incorporated in the scheme of amalgamation as approved by all or the statutory majority of the shareholders of the companies in their separate general meetings and sanctioned by the court. In other words, in amalgamation, the undertaking comprising property, assets and liabilities of one or more companies are taken over by another or are absorbed by and transferred to an existing company or a new company. The transferor company merges into or integrates with the transferee company. The transferor company losses its legal identity and is dissolved (without winding up). Both the existing companies may form a new company and amalgamate themselves with the new company. The shareholders of each amalgamating company become the shareholders in the amalgamated company. To give a simple example of amalgamation, we may say A Ltd. and B Ltd. and merge their legal identities into C Ltd. It may be said in another way that A Ltd. + B Ltd. = C Ltd. Therefore, the essence of amalgamation is to make an arrangement thereby uniting the undertakings of two or more companies so that they become vested in, or under the control of one company which may or may not be original of the two or more of such uniting companies.

1.2 Types of Mergers and Acquisitions

Mergers appear in three forms, based on the competitive relationships between the merging parties.

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(a) Horizontal Merger

Horizontal mergers occur when two companies sell similar products to the same markets. The goal of a horizontal merger is to create a new, larger organization with more market share. Because the merging companies' business operations may be very similar, there may be opportunities to join certain operations, such as manufacturing, and reduce costs. However, an interesting observation by Weston (1990) is that not all small firms merge horizontally to achieve such economies of scale. Horizontal mergers raise three basic competitive problems. The first is the elimination of competition between the merging firms, which, depending on their size, could be significant. The second is that the unification of the merging firms' operations might create substantial market power and might enable the merged entity to raise prices by reducing output unilaterally. The third problem is that, by increasing concentration in the relevant market, the transaction might strengthen the ability of the market's remaining participants to coordinate their pricing and output decisions. The fear is not that the entities will engage in secret collaboration but that the reduction in the number of industry members will enhance tacit coordination of behaviour.

(b) Vertical Merger

A vertical merger joins two companies that may not compete with each other, but exist in the same supply chain. Vertical mergers take two basic forms:

forward integration, by which a firm buys a customer, and backward integration, by which a firm acquires a supplier. Replacing market exchanges with internal transfers can offer at least two major benefits. First, the vertical merger

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internalizes all transactions between a manufacturer and its supplier or dealer, thus converting a potentially adversarial relationship into something more like a partnership. Second, internalization can give management more effective ways to monitor and improve performance.

Vertical integration by merger does not reduce the total number of economic entities operating at one level of the market, but it might change patterns of industry behavior. Whether a forward or backward integration, the newly acquired firm may decide to deal only with the acquiring firm, thereby altering competition among the acquiring firm's suppliers, customers, or competitors. Suppliers may lose a market for their goods; retail outlets may be deprived of supplies; or competitors may find that both supplies and outlets are blocked. These possibilities raise the concern that vertical integration will foreclose competitors by limiting their access to sources of supply or to customers. Vertical mergers also may be anticompetitive because their entrenched market power may impede new businesses from entering the market.

(c) Conglomerate Mergers

Conglomerate mergers occur when two organizations sell products in completely different markets. There may be little or no synergy between their product lines or areas of business. The benefit of a conglomerate merger is that the new, parent organization gains diversity in its business portfolio.

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ventures to complete mergers. Whether a conglomerate merger is pure, geographical, or a product-line extension, it involves firms that operate in separate markets. Therefore, a conglomerate transaction ordinarily has no direct effect on competition. There is no reduction or other change in the number of firms in either the acquiring or acquired firm's market.

Conglomerate mergers can supply a market or "demand" for firms, thus giving entrepreneurs liquidity at an open market price and with a key inducement to form new enterprises. The threat of takeover might force existing managers to

increase efficiency in competitive markets. Conglomerate mergers also provide opportunities for firms to reduce capital costs and overhead and to achieve other efficiencies.

Additionally Soubeniotis, Mylonakis and Fotiadis (2006) include the following new form of mergers that have emerged during the last decade and are known as "going private transactions". These mergers are facilitated with high bank lending and appear in the following forms:

Lending buyouts (LBOs):

It is the buyout of all shares or the assets of a company which is already introduced to the Stock Exchange by a group of investors through a transaction that is mainly financed via lending. Investors usually are financially supported by enterprise specializing in buyouts or by Investment Banks that arrange such transactions. Following the buyout, the bought out company operates as a

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company with few shareholders which outside the framework of the stock market.

Management buyouts (MB0s):

It is the buyout that starts with the initiative of a group of management executive who buy out part of the company's shares. The remaining money is deposited by investment banks either as share capital or loans.

Unit MBOs:

It is a special form of a company buyout where buyers, usually guided by a manager of the mother company, buy a subsidiary company. Buyers pay part of the capital while the remaining capitals are drawn by investment banks in the form of share and loan capital.

Reverse LBOs:

according to this form, the shareholder of a company which is not introduced to the stock exchange participate in the issuance of rights concerning a company already introduced to the stock exchange, and uses the drawn capitals in order to buy out the first and secure its introduction to the Stock Exchange.

1.3 Motives for Mergers and Acquisitions

Mergers and acquisitions are resorted to by the corporate entities due to

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INTRODUCTION TO MERGERS AND ACQUISITIONS 9 (a) Growth

Broadly there are two alternatives available for growth of a corporate entity as long as investment opportunities exist. The first is through the internal growth where the firm invests its own resources in creating facilities for expansion. This can be slow and ineffective if a firm is seeking to take advantage of a window of opportunity in which it has short term advantage over competitors (Gaughan, P., 2002). The faster way to achieve growth in such case would be to merger and acquire necessary resources to achieve competitive goals. In this process, the acquirer will pay premium for acquisition of other company or assets, but ideally, the strategy would not be as expensive as that of internal growth.

(b) Operating Synergy

Synergy is one of the most commonly cited reasons to go for mergers.

Synergy is simply defined as 2+2=5 phenomenon. The value of the company formed through merger will be more than the sum of the value of the individual companies just merged. Symbolically,

V (A) + V (B ) < V ( AB ) V(A) = value of A Ltd.

V (B) = value of B Ltd.

V (AB) = value of merged company.

This maximization of firm's value is based on premises that combined company can often reduce its fixed costs by avoiding duplication of operations, lowering the costs of the company relative to the same revenue stream, thus Goa University

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increasing profit margins. Operating synergy assumes that economies of scale exist in an industry and that prior to their M&A, firms are operating at levels of activity that fall short of achieving the potential for economies of scale (Weston et al., 2001). Expansion through a merger or acquisition increases the size of the company and hence may lower per-unit costs. Synergy takes the form of revenue enhancement and cost savings. By merging, the companies hope to benefit from reduced staff costs, economies of scale, acquisition of new technology to maintain or develop competitive edge and improved market reach and industry visibility.

Synergy cannot be automatically realized once two companies merge. In many cases, synergy opportunities may exist only in the minds of the corporate leaders and the deal makers. Where there is no value to be created, the CEO and investment bankers - who have much to gain from a successful M&A deal - will try to create an image of enhanced value. The market, however, eventually sees through this and penalizes the company by assigning it a discounted share price.

(c) Financial synergy

The following are the financial synergy available in the case of mergers : Better credit worthiness: This helps the company to purchase the goods on credit, obtain bank loan and raise capital in the market easily.

Reduces the cost of capital: The inverstors consider big firms as safe and

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Increases the debt capacity: After the merger the earnings and cash flows become more stable than before. This increases the capacity of the company to borrow more funds.

Increases the P/E ratio and value per share: The liquidity and marketability of the security increases after the merger. The growth rate as well as earnings of the firm will also increase due to various economies after the merged company.

All these factors help the company to enjoy higher P/E in the market.

Low floatation cost: Small companies have to spend higher percentage of the issued capital as floatation cost when compared to a big firm.

Raising of capital: After the merger due to increase in the size of the company and better credit worthiness and reputation, the company can easily raise the capital at any time.

(d) Diversification of risk

When a company produce single product then the company's profits and cash flows fluctuate widely. This increases the risk of a firm. Diversification reduces the risk of the firm. The merger of companies whose earnings are negatively correlated will bring stability in the earnings of the combined firm. So diversification reduces the risk of the firm.

(e) Empire building:

Managers have larger companies to manage and hence more power.

Manager's compensation: In the past, certain executive managemefit teams had their payout based on the total amount of profit of the company, instead of the

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profit per share, which would give the team a perverse incentive to buy companies to increase the total profit while decreasing the profit per share (which hurts the owners of the company, the shareholders); although some empirical studies show that compensation is linked to profitability rather than mere profits of the company.

1.4 Growth of Mergers and Acquisitions

Mergers and Acquisitions (M&A) have been a popular strategy of business expansion worldwide. Literature on the subject accounts for growth of M&A by way of several waves that are caused by some favourable business climate and end on account of economic or regulatory reasons. Lipton, M (2006) reports such merger waves for US that has seen multiple waves of mergers over a long period in its corporate history. The first period — 1893-1904 was the time for horizontal mergers and created the principal steel, telephone, oil, mining, railroad, and other giants of the basic manufacturing and transportation industries in the US. The Panics of 1904 and 1907, anti-trust laws, and then the First World War are pointed to as the causes of the end of the first wave. The second wave from 1919 to 1929 significantly increased vertical integrations in US but ended with the Great Depression and the 1929 Crash. The third wave of 1955 to 1969 gave birth to conglomerates with companies diversifying into new industries and areas. The wave ended with the crash of conglomerate stocks in 1969-70. While the fourth wave, 1980-89 was the period of takeovers and hostile

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INTRODUCTION TO MERGERS AND ACQUISITIONS 13

and global sweep were created on th assumption that size matters. This period also, however, ended with slowdown in important sectors such as telecommunication and media and technology and bursting of IT bubble.

Similarly, Europe also has witnessed a wave of takeovers since middle 1950s and subsequently in 1980s. In recent times, such merger wave phenomenon is observed in emerging markets with Asian economies experiencing a large growth in M&A transactions. Deals by companies in emerging markets now account for 30% of global M&A activity.'

Mergers and acquisitions deals worldwide reached an all time high in 2006, with a total value of $3.7 trillion, surpassing the 2000 high of $3.4 trillion [Dobbs, Goedhart and Suonio (2006)]. The analysis of authors indicate that US was the most targeted country for acquisition representing over 40% of global M&A activity, while UK was the most targeted European country for acquisition with $339 bn of cross-border and domestic transactions. During the year 2010, the global M&A activity increased 33% over 2009. 2 Fig.1.1 clearly depicts the growing interest of corporate firms around the world in mergers and acquisitions.

It can be observed that the number of M&As have announced during the period 1988 to 2006, have increased from 2,856 in 1988 to 23,708 in the year 2006 with maximum number of deals announced reported at 40,141 in the year 2000.

Nearly half (44%) of privately held businesses in the BRIC (Brazil, Russia, India and China) economies are planning to grow by acquisition in 2011. 3

1 Saigol, L. (2010), "Emerging Markets M&A Outstrips Europe", www.ft.com

2 Intralinks Deal Flow Indicators (2010), www.intralinks.com .

3 Grant Thornton International International Business Report, 2011.

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Fig. 1.1.: Worldwide M&A Announced — 1988 to 2006

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2 500

2,000

1500

1,000

500

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dal

3.130 9,252

2,414 'MP d.V6

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1.193 1,93

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1985 2,266

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1987 1988 1989 1990 ills 7,274 10,741 12,146

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1991 12,742

1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 17,667 12,272 14027 10.261 26,277 17,427 21,010 26,040 40,141 21,47 27,414 60,79 22,622 2027 76,708

Source: Grant Thornton (September 2006)

1.5 Mergers and Acquisitions and Corporate Performance

The subject of impact of mergers and acquisitions on corporate performance has been immensely researched. Globally, several researchers have provided evidence that acquirers actually have not realized significant gains from M&A strategy. A study conducted by Boston Consulting Group (BCG) on 302 major mergers from July 1, 1995 to August 31, 2001 showed that merger deals are not necessarily beneficial to shareholders. Moeller, Sara B., Schlingemann, F. and Stulz, R. (2005) also report a massive destruction in shareholder value for acquirers during post merger period (Fig. 1.2). A number of reasons have been cited for failure of mergers and acquisitions in improving corporate performance and accomplishing the intended objectives of the

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$ Billions

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-60 -80 -100 -120 -140 -160

buying too big targets or not giving sufficient time and attention for smaller acquisitions is one such reason (Hubbard, 1999). Besides, unfamiliarity with businesses, particularly in case of diversified mergers (Sudarsanam, 2004);

Dash, 2004), lack of previous acquisition experience (Hubbard, 1999;

Sudarsanam, 2004), poor organization fit (Jemison and Sitkin, 1986), poor strategic fit (Maitra, 1996), lack of proper communication (Schweiger, 2003) and failure of leadership role (Prayag, 2005) are some other reasons for failure of mergers and acquisitions in creating shareholder value.

Fig.1.2 : Yearly Aggregate Dollar Returns of Acquiring-Firms Shareholders (1980-2001)

Source:Moeller, Sara B., Schlingemann, F. and Stulz, R. (2005), "Wealth Destruction On A Massive Scale? A Study Of Acquiring-Firm Returns In The Recent Merger Wave." Journal of Finance, vol. 60(2).

Mergers and acquisitions are growing even in Indian economy.

Particularly, with implementation of economic reforms in 1991, a favourable

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economic and regulatory environment has encouraged businesses to resort to consolidation route to establish big size business firms, improve efficiency and develop competitiveness. However, with global evidence of value destruction by mergers and acquisitions it becomes imperative to study if shareholders in Indian companies are able to make any significant long term gains.

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LITERATURE REVIEW AND

RESEARCH METHODOLOGY

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CHAPTER TWO

. LITERATURE REVIEW AND RESEARCH METHODOLOGY

2.1 Literature Review

The significance of mergers and acquisitions as strategy decisions impacting long term profitability and shareholder wealth has led to accumulation of substantial amount of literature on mergers and acquisitions. However, since mergers and acquisitions waves have been observed quiet early in developed countries, the studies are also largely available in the context of these countries.

Thus, significant amount of accomplished empirical research work on mergers and acquisitions in countries like US, UK and other developed countries exists as of date.

There are two research approaches adopted in the literature for examining wealth creation effect of mergers and acquisitions. One approach is to use share price data to determine gains and losses to shareholders of acquirer and target firms in M&A deals. The second approach has been to use the accounting data to analyse long-run operating and financial performance of acquirers in a merger transaction. The studies falling under these two approaches can be broadly classified into Announcement period studies, Studies on long term performance of acquirers focusing on operating performance and Studies on long term share price performance. In this section we review studies for determining a general conclusion on impact of M&A on operating

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LITERATURE REVIEW AND RESEARCH METHODOLOGY 18

2.1.1 M&A and Announcement Period Returns

A large number of studies have focused on short term returns generated to shareholders surrounding the announcement period of the event. These studies essentially follow event study methodology. The application of this technique to study short term wealth creation process is based on 'efficient market hypothesis'. Upon the announcement of a merger between two or more firms, the market 'learns' new information and adjusts to a new level, incorporating this new information [Rieck , 0. (2002)]. This new information incorporated into stock prices reflect shareholders' perception about impact of merger on the future profit stream from the merged entity. The stock returns on the days around the announcement that are solely due to the occurrence of the M&A announcement are called Cumulative Abnormal Returns and have been analysed by the researchers to identify wealth gains or losses to different groups of shareholders. A general conclusion of large number of studies in this context is that the target firms are the gainers while negative returns are observed in case of acquiring firm shareholders.

Dodd (1980) finds that shareholders of target firms earn large positive abnormal returns from announcement of merger proposals. These announcement period returns range from 13% at the announcement date of the offer to 33.96%

average over the duration of the merger proposal i.e. 10 days before and 10 days after the announcement. On the other hand, shareholders of bidder firms experience negative abnormal returns of 7.22% and 5.50% over the duration of the proposals.

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Asquith, P., Bruner, R., Mullins, D. (1983) studied 343 completed mergers in US during 1975-1983 to examine the effect of mergers on the wealth of bidding firms' shareholders. They conclude that the bidding firm gains significantly during the 21 days leading to the announcement of each of their first four merger bids.

Bidders' abnormal returns are positively related to the relative size of the merger partners and the gains during the announcement period are larger for mergers which are successful. Further, the authors provide evidence that the returns to bidding firms are smaller for equity financed bids than for cash merger bids.

Besides, the study concludes that the market's average response to a merger bid is always positive for target firms and it is significantly more positive when the offer is financed with cash rather than equity. The study of Asquith, et. al (1983) thus indicates that measuring market's reaction to a merger bid for a bidder firm not only measures the estimated present value of the merger investment decision but also the market's reaction to financing decision.

Asquith, P. (1983) investigated the effect of merger bids on stock returns using the sample of successful and unsuccessful merger bids between July 1962 and December 1976, where the target firms are listed in NYSE. Using the daily common stock returns for two years before the press date until one year after the outcome date, Paul concludes that the announcement of a merger bid increases the probability of merger. Further, both successful and unsuccessful target firms exhibit positive and significant average excess returns on the press day and the

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with new information. The cumulative excess returns rises for successful target firms during this period and falls for unsuccessful target firms. Besides the author concludes that most of the gains from merger go to stockholders of the target firms with the stockholders of the successful bidding firms earning little if any return.

Malatesta (1983) examined a matched sample of targets and their bidders in 30 successful mergers and finds a significant average increase of $32.4 million (t = 2.07) in their combined equity value in the month befor and month of outcome announcement. The acquired (target) firms gained more than the acquirer forms.

The target firms earned $18.6 million (t = 5.41) of the combined increase in the equity value while acquiring firms earned $13.8 million (t = 0.91).

Firth (1990) examines mergers and takeover activity in the UK, specifically, the impact of takeovers on shareholder returns and management benefits. The research shows that mergers and takeovers resulted in benefits to the acquired firms' shareholders and to the acquiring companies' managers but that losses were suffered by the acquiring companies' shareholders.

Datta, Pinches and Narayana (1992) based on 75 observations for bidders and 79 for targets referred in 41 earlier studies on wealth creation effects of mergers, find that the bidders on an average, gain nil or statistically insignificant gains from announcement of mergers while target firms' shareholders experience over 20% increase in value. The authors further prove that both bidders and targets Goa University

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LITERATURE REVIEW AND RESEARCH METHODOLOGY 21 lose in stock-financed transactions and conclude that of all the factors, mode of payment is the most significant explanatory factor in wealth gains for both bidders and targets. A modest evidence of the positive effect of non- conglomerate mergers on bidder's wealth is also available in this study.

Davidson, W., Cheng, L. (1997) using standard event methodology tested two important hypotheses — (i) the bid premium is larger for all cash acquisitions than for acquisitions settled by an exchange of common stock, all other things being equal. (ii) Abnormal returns of the target firms in the announcement period are a function of the bid premium and not the method of payment. They show that (without controlling for other variables) the announcement period abnormal returns for target receiving cash are significantly larger than returns on target for which stock is exchanged. However when relative size of payment and other variables are controlled for, the method of payment is unrelated to target firm abnormal returns. Thus it is concluded that a cash offer is not inherently more valuable than a share exchange that offers the equivalent amount of shares.

Cash offers are the source of larger returns only because cash targets received larger payments from bidders.

, fir

Ocana, C., Pena, I., Robles, D. (1997) investigated the share price returns of target firms. Applying event study methodology to 71 targets and 32 bidders listed on Madrid Stock Market during the period 1990 to 1994 the authors

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LITERATURE REVIEW AND RESEARCH METHODOLOGY 22

(Spain) is quite similar to the pattern observed in the larger US and UK stock markets. Specifically they found that target shareholders gain significant abnormal returns, though there is some significant upturn in the two months before the bid.

Draper, P., Paudyal, K. (1999) examined the impact of takeover bid announcement on the returns, trading activities and trading costs of target and bidding firms. With sample of 581 target firms and 349 bidding firms between 1988 and 1996 and analyzing daily share prices, volume of trades, number of trades, order size and quoted bid-ask spreads the authors conclude that the shareholders of target companies benefit from the announcement of takeover bids. Within the 10 day period surrounding the announcement the cumulative excess returns available to the shareholders of target firms exceed 11%. In contrast the shareholders of a bidding firm suffer a loss of just under 1% during the same period. Benefits to the shareholders were also found to be dependent on method of payment. Prices of target (bidding) firms increase (decrease) most if the shareholders of the target firms are given an option to receive the payment in shares or in cash.

Cybo-Ottone, Murgia, M. (2000) studied the stock market valuation of mergers and acquisitions in the European banking industry. Based on a sample of very large deals observed from 1988 to 1997 they conclude that, on average, at the announcement time the size-adjusted combined performance of both the bidder and the target is statistically significant and economically relevant. The positive

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gains in shareholder value are associated to the average domestic bank to bank M&A and to banking/insurance deals. On the other hand, the economic impact of cross-border deals and of bank product expansion in investment banking, albeit much publicized, is non-existent. Although the sample chosen shows a great deal of cross-sectional variation, the general results are mainly driven by the significant positive abnormal returns associated with the announcement of domestic bank to bank deals and by product diversification of banks into insurance. On the contrary, it is found that M&A with securities firms and concluded with foreign institutions did not gain a positive market's expectation.

Floreani, A., Rigamonti, S. (2001) examined the stock market valuation of mergers in the insurance industry between 1996 and 2000 in Europe and in the US. Forming a sample of 56 deals in which the acquiring company is listed data reveal that insurance companies mergers enhance value for bidder shareholders. Over the event window (-20,+2) their abnormal return is 3.65%.

The abnormal returns for acquiring firms are larger the greater the relative size of deal value. The authors also find that mergers occurring between insurance companies located in the same European country are not valued positively by the market, while cross-border deals appear to increase shareholder's wealth.

The analysis of a sub-sample of simultaneously listed bidders and targets reveals that the combined insurance companies experience significantly positive abnormal returns over the event window (-20,+2) shareholders gain 5.27% and

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Penas, M., Unal, H. (2001) examined the impact of the merger announcements on monthly bond returns of acquiring and target-banks in a sample of 65 bank merger cases. They report that bondholders of bidder and target banks realize significant positive risk and maturity adjusted bond returns around the merger announcement month. In addition, the results show that the acquiring banks' credit spreads of the fixed-rate non-convertible bond issues decline significantly in 38 merger cases. The cross-sectional regression results provide evidence that the incremental size attained in the merger is a significant determinant of both the positive bond returns as well as the decline in credit spreads after controlling for factors such as diversification, leverage and asset quality changes. The study also report that the bond returns around the merger announcement and the post- merger decline in spreads are not monotonic with size. Mega-banks and smaller size banks do not show any significant announcement month bond returns or post-merger decline in spreads. In contrast, medium size banks experience significant bond returns and realize reduction in cost of funds.

Komoto, K. (2002) found that among acquiring companies, in the banking, cement and marine transport industries, there was a positive divergence of approximately 10% at 40 days after the announcement. Another significant characteristic was that the two industries whose stock prices increase — banking and marine transport — show a positive divergence starting at 20 days prior to the announcement. Among acquired companies, a stock price divergence was not observed in banking until the merger was announced, but then a significant positive divergence occurred in reaction to the announcement, which gradually Goa University

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4 _

continued to increase. On the other hand, in marine transport, the stock price plunged in reaction to the merger announcement, and then stabilized. The other industries showed positive and negative divergences of approximately 10% by the day of merger announcement, but the divergences subsequently disappeared by day 40. The results thus show that in reality stock prices can rise or fall significantly depending on the industry.

Billett, M., King, T., Mauer, D. (2003) examined the wealth effects of mergers and acquisitions on target and acquiring firm bondholders in the 1980s and 1990s. It is found that, below investment grade target bonds earn significantly positive announcement period returns. By contrast, acquiring firm bonds earn negative announcement period returns. Additionally, target bonds have significantly larger returns when the target's rating is below the acquirer's, when the combination is anticipated to decrease target risk or leverage, and when the target's maturity is shorter than the acquirer's.

Cummins and Weiss (2004) analyze the market value effects of mergers and acquisitions in the European insurance industry over the period 1990-2002. The results

of

the event-study analysis show that European M&As created small negative cumulative average abnormal returns for acquirers (generally less than 1%) across various windows surrounding the transaction date. Targets, however, realized substantial positive CAARs. Breaking down the transactions into cross-

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LITERATURE REVIEW AND RESEARCH METHODOLOGY 26 led to a significant loss in value for acquirers. For targets, both cross-border and within-border transactions created significant value. The value creation tended to be higher for within-border transactions than for cross-border transactions.

Overall, the results are somewhat conflicting with respect to the value of geographically diversifying versus geographically focusing mergers.

Geographically diversifying mergers seem to have superior value-related effects for acquirers, but focusing mergers tend to create more value for targets.

Kiymaz, H. (2004) investigated the impact of mergers and acquisitions on US bidders and targets involved in cross-border mergers of financial institutions.

Using the sample of 355 US targets and 391 US bidders involved in international M & A of financial institutions during the period of 1989-1999 he concluded that while US targets experience positive significant wealth gains, US bidders encounter insignificant wealth gains during merger announcements. There are also differences in wealth gains with respect to industry classification and to the regional location of foreign targets and bidders. The macroeconomic variables including foreign and US economic conditions, level of economic development of target country, exchange rate volatility along with the effectiveness of foreign government, relative size of participants and control of target largely explain the wealth gains to bidders and targets.

Rosa, R., Limmack, R., Supriadi, and Woodliff, D. (2004) studied 155 takeover bids for unlisted firms in Australia in order to investigate the response of share market to ownership structure when assessing the information content of Goa University

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LITERATURE REVIEW AND RESEARCH METHODOLOGY 27 method of payment in takeovers. Using the event study method the authors test whether the signaling implication of the method of payment in takeover of private and public companies are different by comparing the share market reaction to cash and share bids made by listed companies for respectively private and public companies. A remarkable aspect of the results of the study is that acquiring firms earned significantly positive excess returns on announcement of bids for private targets but not for public targets. In respect of method of payments the authors conclude that the positive returns to acquirer in private bids are driven by the cash-based offers. Lower competition for private targets allows acquirers to capture more of the economic rent from takeover by offering cash bids rather than shares.

Choi, J. and Russell, J. (2004) investigate if the M&A transactions of construction firms make positive contributions to the performance of the firms and if in implementing M&A transactions, firms should seek related or unrelated diversifications. The research findings, which were drawn from an analysis of 171 construction M&A transactions, indicate that the performance of construction M&A was positive at an insignificant level, as measured by equity market returns. The market performance index, CAR, is employed to assess the level of success of construction M&A transactions. Research findings obtained from the various analyses indicate that the overall success of market performance was not significantly different from zero. In other words, shareholders of construction

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indicating that shareholders of acquiring firms, on average, break even.

Whereas the relationship between the type of diversification strategy and performance indicates that while the related diversification strategy has been slightly favored by both theories and empirical research findings over unrelated diversification, no significant performance difference was observed between two diversification strategies.

Ruud, Vincent, Huib (2005) examined the wealth creation and redistribution theories of mergers and acquisitions using a Dutch sample in the period 1954 till 1997. The results shows that 52 % of the bidding companies have a positive share price reaction at the announcement of a merger or acquisition, while 82 % of the takeover targets show a positive share price performance. The Dutch data allow independent test of many issues addressed in studies of the UK and US mergers and takeovers. The research shows that returns for a bidding corporation are on average lower during a merger wave. 30% of the Dutch mergers were completed with the value of the target being overestimated or the bidding management overestimating itself. Furthermore, payment of the acquisition in cash in comparison to payment in shares provides better returns on average to both the shareholders of the bidding company and the takeover target.

Ismail, A. and Davidson, I. (2005) used event study methodology to examine the market reaction to 102 merger announcements in the European financial services industry between 1987 and 1999, and compare the results to the US

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and available European studies. They report positive returns for targets in various event windows that are examined, while the returns to acquirers varied across - the deal type and the various event windows. It is found that bank-to- bank deals are more value enhancing than cross-product deals (i.e. deals which diversify the scope of the banks operations into insurance, brokerage or securities services) and that merger deals earn higher returns than acquisition deals. The results also give some support to the view that in Europe the market reacts more positively to crossborder mergers than to national mergers, except in the (_1, 0) day event window where- it appears that marriages based on gaining market power look more profitable than those based on geographical diversification. They also found that higher weighted average returns are generated for deals settled in a combination of cash, equity and loan notes as compared to cash deals, while equity settled deals generated the lowest return.

Friesen, M. (2005) presents empirical evidence on the shareholder value effects of the announcement of the horizontal merger between Air France and KLM, which led to the creation of Europe's leading airline group, between September 2003 and May 2004. Using an event study methodology, the stock price reactions of both, the involved parties and rival carriers, around the announcement day when the intention of the French and the Dutch flag carrier to merge became public as well as on the announcements during the following exchange offer period are analyzed. KLM as the target firm experienced

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Lau, B., Proimos, A., and Wright, S. (2005) uses both accounting operating measures and share return measures to investigate the post-merger performance of 21 Australian mergers of publicly listed companies during the period 1999 to 2002. The results show that excess returns to the shareholders of the target firms are significantly greater than zero, measured over an event window of both one day and eleven days. There is weak evidence that the excess returns to the shareholders of the bidder firms are significantly less than zero, measured over an event window of one day only, with a differential effect according to the method of financing for the latter group.

Major Observations from Announcement Period Studies

Following are some of the important conclusions derived from announcement period studies:

(i) All the announcement period studies reviewed apply cumulative abnormal returns or cumulative excess returns methodology for the purpose of studying wealth creation effects of mergers and acquisitions.

(ii) Almost all the studies provide evidence that shareholders of acquirer or bidder firms do not gain any significant returns around announcement period. In fact, some studies provide evidence of negative abnormal returns for shareholders of acquirer firms. On the other hand shareholders of target firms have been found to earn statistically significant wealth gains. This is true even if proposed merger/acquisition bids have subsequently been unsuccessful.

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(iii) The observed behaviour of stock prices during takeover in a small market is found to be quite similar to the pattern observed in the larger US and UK stock markets with positive returns for target firms and negative returns for acquirer firms.

(iv) Abnormal returns have been found to be negative or insignificant for stock financed mergers and acquisitions while positive and significant for cash financed transactions.

(v) The evidence of difference in positive abnormal returns for shareholders in domestic and cross-border mergers and acquisitions deals is at best mixed. Specifically, though, for mergers and acquisitions in Europe, the markets have reacted positively for cross-border deals rather than domestic deals.

(vi) The abnormal returns to shareholders of acquiring firms are found to be sensitive to deal size. Larger the deal sizes, larger have been the abnormal returns to shareholders of acquiring firms.

(vii) Acquiring firms earn significantly positive excess returns on announcement of bids for private targets but not for public targets.

(viii) Abnormal returns to shareholders of acquirer and target firms have also been found to be sensitive to industry type.

(ix) Negative abnormal returns to acquirers have also been observed in bond market. Here again, below investment grade target bonds have found to earn significantly positive announcement period returns.

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2.1.2 M&A and Long Term Share Price Returns

Research in mergers and acquisitions is not confined to short period analysis. Several researchers have also extended the event study methodology for the purpose of studying long term implications of M&A on shareholder wealth creation. There are also a few studies available that apply a different methodology for the same research objective. The following section discusses some of the significant literature reviewed in the context of M&A and long term share price returns.

Malatesta, P. (1983) studied the net effect of the long-run sequence of events leading to merger and of merger per se on shareholder wealth. The appropriate measure of the wealth effect is shown to be the abnormal dollar return cumulated over time. Using this measure he finds that the long-run wealth effect of the event sequence culminating in merger was significantly negative for acquiring firms. For acquired firm the effect was negative but not significant. The evidence in the study also revealed that the measured abnormal rate of return to acquiring firms are sensitive to a slight variation in model specification and dependent on firm size with smaller firms earning significantly negative post- merger returns.

Schipper, K., Thompson, R. (1983) measured the impact of acquisition activity on firm value by differentiating between specific merger event and programs of acquisition activity. Applying event study methodology and computing CAR and Average Standardized Residuals (ASR) they conclude that there are positive Goa University

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abnormal returns one year before announcement of mergers. By focusing on programs of acquisitions activity, as opposed to individual mergers, the authors examined the economic impact of certain legislations on merger activity and found that such regulatory changes had a significantly adverse impact on share values of acquiring firms which is consistent with the negative performance of acquiring firms found in the post-announcement period of studies of mergers and tender offers announcements in the 1960s in US.

Gilbert, E., Lyn, E. (1990) tests for several hypotheses about the bidding firm's

stock returns during the merger announcement period and thirty six months surrounding the merger event. The hypotheses are that abnormal returns in the merger announcement month will be higher in friendly mergers than in hostile mergers, and abnormal returns during the pre-announcement period will be higher for friendly mergers than in hostile mergers and finally abnormal returns during the post-announcement period will be higher for hostile mergers than in friendly mergers. Using sample period of March 1975 to December 1978 and data on 68 mergers in US and employing CAR methodology the authors conclude that, hostile and friendly mergers are independent transactions with possible unique motivations and market impact. During the announcement month, the cumulative abnormal returns of friendly bidding firms exceed those of the hostile group indicating that there may be a difference in the acquisition costs between the two groups. The results also offer evidence that the superior stock

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the hostile bidding firms which offer support that hostile mergers are perceived to be more likely to result in leaner and more profitable organizations. However, over the entire 24 month period post-announcement, no significant difference in the performance of two groups was found.

Agrawal, A., Jeffe, J. and Mandelker, G. (1992) examined nearly an exhaustive sample of mergers between NYSE acquirers and NYSE/AMEX targets over the period 1955 to 1987 with a view to evaluate long term performance of acquirers during post merger period. Their analysis of 937 mergers and 227 tender offers after adjusting for the size effects and applying CAAR methodology, indicate that shareholders earn significantly negative returns over long term post-merger. Specifically, the authors find shareholders of acquiring firms suffering a loss of 10.26% (t = -2.37) over a five year period post completion of acquisition. Even for 3 year period the CAAR, were found to be significant -7.38% (t = -2.72) for acquiring firms. The share price performance was nothing different for conglomerate and non-conglomerate mergers with both the types earning negative (-8.6% and -25.5%) CAARs over a five year period.

The authors further conclude that the long-run post acquisition performance is worse for tender offers financed by equity rather than by cash.

Loderer and Martin (1992) control for size effects changes in the risk free rate and changes in systematic risk and find that, on average, acquiring firms do not underperform a control portfolio during the first 5 years following acquisition.

They simply earn their required rate of return, no more or less. There was some Goa University

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negative performance observed for the first 3 years, especially during the second and the third years after the acquisition.

Parkinson, C., Dobbins, R. (1993) investigated the returns to shareholders in 77 companies involved in fighting and defending a hostile bid. Using CAR methodology the authors concluded that target companies, which successfully defend a takeover bid substantially improve their economic performance in the period from 6 months to 24 months after the month of the bid. Interestingly, the study finds that significant gains obtained by shareholders in the target company around the time of the bid announcement are not lost after the failure of the bid.

In apparent defiance of the efficient market hypothesis abnormal returns continue for the two years after the bid. Bidder companies achieve small, significant positive abnormal return only in the month preceding the month of the bid. In general they conclude that shareholders in target companies are the main beneficiaries of merger although bidder companies in failed bids also demonstrate some improvement in performance subsequent to a failed bid.

Sudarsanam, S. (1995) examined the valuation effects of large block acquisitions on target companies. For a sample of 228 UK listed companies in which block acquisitions of between 5% and 30% are made during 1985-92 and for several subsamples, Sudarsanam found that partial acquisitions are indeed value enhancing.

References

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