10 pages/≈2750 words
Business & Marketing
Factors that Influence Share Price Underperformance Following Mergers and Acquisitions (Dissertation Review Sample)
Literature Review: Factors that Influence Share Price Underperformance Following Mergers and Acquisitions
Mergers and acquisitions are common corporate practices in many economies around the world. They have a big impact on industry performance in terms of the way they accelerate or downplay competition as well as trigger market speculation. The biggest challenge for mergers and acquisitions, however, is realizing the objectives for which they were intended, that is, improving shareholder profitability and operating performance of both the acquiring and target firms. Understanding the post-merger and acquisition performance of businesses as well as the factors that influence performance patterns is of significant interest to company CEOs looking for potential merger opportunities, business consultants who advice firms involved in mergers and acquisitions, as well as regulatory authorities concerned with the short term and long term economic impacts of corporate mergers and acquisitions. For corporate firms, mergers and acquisitions present expansion and growth opportunities in terms of gaining access into new markets and acquiring additional assets. Companies entering into new territories look for partnerships with firms already established in the target market, thus making it easier to hit the ground running. This is a common occurrence for companies seeking to expand internationally. At a theoretical level, mergers and acquisitions lead to gains in economies of scale due to the combination of capital assets and market share. The motivation for investors and business managers is the expectation for enhanced market share through the gain in economies of scale and expansion of capital assets. However, this is not always the case as some mergers can lead to share underperformance in the long term. Evidence from past studies point to a situation where mergers result in disappointment. This may result from unrealistic expectations of the mergers or failing to achieve the expected economies of scale. The focus of this paper is to review the existing literature on the post-merger and acquisition performance of firms to account for the decline in share value in this period.
The existing literature on the performance impact of mergers and acquisitions is inconclusive due to the researchers’ use of different variables and focus on specific industry niches, thereby making it difficult to draw accurate general conclusions that can apply to all industries. At the same time, previous studies were carried out within unique economic conditions, thus questioning the applicability of the findings across different time-spans. This paper seeks to address this gap by reviewing literature from different time periods to assess their consistency in explaining post-merger and acquisition performance patterns of firms. Past studies employ multiple variables in measuring and accounting for the performance of firms after acquisition or merging with others. These measures include:
Method of payment used to compensate the acquired firm, i.e. whether by cash or using stock,
Book to market ratio of the acquired firm,
Type of merger/acquisition, i.e. whether in a related or unrelated industry,
Domestic versus international mergers/acquisitions
Relative size of acquiring and target firms
Existing economic conditions
These factors, singularly or in combination, affect the performance of firms following mergers and acquisitions, and mangers should take them into consideration when making decisions about possible mergers and acquisitions.
Gallet (1996) investigated the correlation between market power and mergers in the steel industry in the U.S. The study examined the annual market patterns within the industry in a 38-year period, from 1950 to 1988. The findings indicated that in the period between 1968 and 1978, the mergers did not lead to any significant changes in market power, either negatively or positively. In contrast, the mergers that took place between 1978 and 1983 had a boosting effect on the market power of the steel industry. The study also reports that there were no differences between the two merger periods in terms of payment methods or relative sizes of the firms involved. These findings indicate that the existing economic conditions during the merger period could have a negative or positive impact on post-merger performance. Consequently, share underperformance could be a result of business-unfriendly economic conditions such as inflation in the period following the merger. Other factors may include overvaluation of the target firm’s shares or failure to adjust into the dynamics of the new market, such as in cross-border acquisitions and mergers.
Rau & Vermaelen (1998) examined the tendency of mergers to underperform compared to tender offers. The researchers assessed performance in light of firm size and book-market value to explain the post-acquisition underperformance of mergers and over performance of tender offers within the same industry. In addition, the researchers examined the effect of payment modes (cash versus stock offer) on the firms’ post-acquisition market power and performance. Using a sample of 348 tender offers and 3169 mergers, the study found out that acquirers in mergers underperformed by a 4% margin over a period of three years, while tender offers resulted in a 9% growth within the same period. These results were arrived at after adjustments for book-to-market ratio and firm size. The findings point to inaccuracies in the belief that post-acquisition performance is attributed to failure to adjust for book-to-market ratio. Instead, the researchers concluded that underperformance resulted from the extrapolation of the current performance of the acquirer and target firms to post-acquisition performance, as well as extrapolating the acquiring company’s past performance with low book-to-market ration. Extrapolation in the first context refers to assuming that the acquiring firm’s market performance will have a positive impact on the share performance of the target firm in the case of mergers and acquisitions involving different businesses from different industries. In the second context, the bidding company overextends its book-value (the estimated share value) to actual market value with respect to operation performance, profitability and competitive edge over market competitors. Under these circumstances, underperformance can result from changing economic conditions which results to high book-to-market ratio, or a burst of the economic bubble caused by market speculation during and immediately after the merger or acquisition. At the same time, the glamour acquirer firms can overestimate their ability to adjust to new markets or manage the resulting merger.
Tse and Soufani (2001) used a sample of 124 mergers between 1990 and 1996 to examine the impact of existing economic conditions on the share value of both acquirer and target firms. The study divided the sample into two categories characterized by the level of industry performance during the specific time period. One category was identified as the Low Merger Activity Era (LMAE) covering the period between 1990 and 1993, and the High Merger Activity Era (HMAE) covering the period between 1994 and 1996. The HMAE sample of mergers took place in a booming period, explaining the positive share performance following the mergers. The LMAE category mergers were transacted in a period of low economic industry performance, leading to post-acquisition and merger underperformance. These results support the findings of Gallet (1996) who attributed the direction of post-merger and acquisition performance to prevailing conditions in the economy. Unfavorable economic conditions lead to negative post-acquisition performance whereas favorable market conditions lead to positive post-acquisition performance.
Choi and Russel (2004) studied the factors that influence post-merger performance in the U.S. real estate, and whether mergers have a positive impact to a firm’s market performance. They considered payment method, the size of the transaction and timing of the acquisition. The study used a sample of mergers from 1980 to 2002, and the findings indicated that the mergers did not have a significant positive impact on the firms’ post-merger performance. Method of payment or merger timing were also found to have little impact, whereas related diversification (merging with or acquiring similar businesses) had a significant positive effect compared to unrelated diversification (venturing into new lines of business). The positive impact of related diversification suggests that acquirers are able to extend their performance to the target firm by using the strength of their brand and market share. On the other hand, unrelated diversification leads to post-merger/acquisition underperformance due to venturing into new markets where the acquirer firm may not have the needed market networks and market share to compete with rivals. This is the case when the acquiring firm comes in with its own management personnel, who will take time to learn about and understand the market. This pattern is related to poor post-merger/acquisition adjustment whereby the acquirer firm fails to adjust its market approach and management style to market practices in the target firm’s industry.
Andre et al (2004) examined the factors that promote value creation or value destruction in the Canadian market following mergers and acquisitions. Using a sample of 267 merger events from 1980 to 2000, the study sought to find out the performance impact of payment method, domestic versus cross-border transactions, and book-to-market ratio on a firm’s post-merger share performance. The research findings indicated that acquirers tended to underperfor...
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