Event Studies in M&A Research

Researchers and practitioners have shown a keen interest to explore the value creating or destroying effects of corporate mergers and acquisitions (M&As). One of the most important tools for research has been the event study methodology that helps investigate stock market responses to the announcement of M&As, and thereby measure the profitability of such activity.

Such studies draw on the theory of rational expectations and market efficiency to assume that stock prices reflect the discounted value of future profits, and adjust rapidly to reflect new public information such as unexpected transactions. Stock price reactions of the acquiring company, the target company and/or the merging entities at or around the days of the announcement of a deal can serve as a proxy for expected future profits from the transaction – but at least as investors sentiment. If on the one hand, a combination is expected to create value, the merging com¬panies’ stocks should appreciate this by an increase. If, on the other hand, the market perceives a transaction to be value destroying, stock prices should fall.

Most studies examining the stock market response over a small window of time around the the announcement of an M&A transaction (quite common is a 21 days windows, with 10 days before the announcement and 10 days afterwards plus the day of the announcement), conclude that

  • combined acquirer and target returns are positive,
  • target firm shareholders earn significantly positive excess returns, and
  • acquiring firm shareholders suffer losses or, at best, gain nothing.

However, many researchers are sceptical about the efficiency of stock markets. Investors often fail to correctly assess the full impact of corporate announcements. The announcement-period stock price reaction therefore does not fully reflect all relevant information. Hence, the accuracy of inferences based on announcement-period event windows is questioned. It is argued that the long-term post-deal negative drift in the acquirer's stock price may outweigh the positive stock price reaction for the combined entity at announcement, making the net wealth effect negative. Based on a survey of the strand of literature that considers longer event windows, Agrawal and Jaffe (2000) conclude that there is strong evidence of underperformance following M&A transactions.

The literature also provides interesting insights into the particular firm and deal characteristics and managerial motives that influence M&A success. Following are some key findings:

Product line diversification is value destroying

The degree of relatedness between the merging firms' businesses has been found to be positively correlated with stock returns (Megginson, Morgan and Nail, 2004). While conglomerate deals earn the lowest returns, divestitures or spin-offs that sharpen focus by disposing of non-core assets or operating divisions enhance stockholder value.

Cross-border diversification is value destroying, unless the target is in an emerging market

The evidence overwhelmingly suggests that acquirers of domestic targets experience larger short and long term wealth gains than acquirers of overseas targets. Cross-border deals that also diversify activity fare worse. However, returns are higher when there is little co-movement between the target's domestic product and financial markets and their counterpart's in the acquirer's home country. Accordingly, it has been noted that the stock market rewards developed market acquirers in emerging markets (Chari, Ouimet and Tesar, 2004). In fact, acquirer returns increase as emerging market spreads widen. The acquirer and target combined as well as the acquirer's shareholders enjoy even higher returns when such acquisitions involve the transfer of majority control, particularly in R&D-intensive and brand-intensive industries where proprietary assets are important.

Managerial hubris during bull markets is value destroying

Though the stock market reacts more favourably towards deals announced during bull markets, in terms of two and three year buy and hold returns, acquisitions initiated during bullish markets underperform those initiated during bearish markets (Bouwman, Fuller and Nain, 2009). Managers are more likely to suffer from hubris during market upswings, and be overly optimistic in assessing potential synergies and returns. By contrast, when the market sentiment is bearish, managers make more cautious and careful decisions so that acquisitions are more likely to be motivated primarily by realistic expectations of profitable synergies.

Management overconfidence is value destroying for `glamour' acquirers

It has been noted that while undervalued acquirers with high book-to-market ratios (`value' acquirers) enjoy positive long-run returns, overvalued acquirers with low book-to-market ratios (`glamour' acquirers) end up with negative long-run returns (Rau and Vermaelen, 1998; Sudarsanam and Mahate, 2003). This implies that the stock market extrapolates information about management's ability to make sound acquisitions from the company's financial attributes. Managers of `glamour' acquirers are often overconfident about their abilities to manage an acquisition, and their actions are not closely monitored by other stakeholders. On the other hand, managers of `value' acquirers, being closely monitored by other stakeholders, are more cautious in assessing potential targets which leads to better decisions.

Paying with cash (not excess cash) is value creating, stock financing is value destroying

Cash deals elicit a more favourable response from the stock market relative to those financed by stock. The adverse signaling effect of equity financing is consistent with the idea that managers are more likely to offer stock that is perceived to be overvalued. This negative stock market reaction to stock financing does not reverse over time. Agrawal, Jaffe and Mandelker (1992) and Loughran and Vijh (1997) observed significant negative returns to acquirers that paid with stock even five years post-takeover.

However, acquisitions financed with excess cash do not pay. Announcement period returns have been found to be negatively correlated with the acquirer's cash reserves (Harford, 1999). A cash stockpile eliminates the need for external financing. Managers are more likely to make economically irrational investment decisions when they are insulated from the external market's watchful eye.

Acquisitions of private targets successfully create value

It has been observed that when the target is a privately held company or a parent-controlled subsidiary buyer shareholders enjoyed significantly positive returns (Fuller, Netter and Stegemoller, 2002; Conn, Cosh, Guest and Hughes, 2005). The bidder gains from the discount associated with the illiquid nature of such transactions, and greater information sharing with the more concentrated ownership.

Moreover, bidders using stock transfers and other non-cash methods did not underperform, and in some cases experienced more favourable stock market reactions. The private target's managers, likely to become significant stakeholders in the new entity, have greater incentive to monitor the bidder's management which creates value for the bidder. Furthermore, deferred tax obligations in a stock offer might lead the target's ownership to accept a discounted price. This is reflected in higher returns to the bidder's shareholders.

Additionally, the lack of publicity surrounding private bids makes it easier for bidders to end negotiations, making hubris-driven decisions less likely. The stock market has been found to react more favourably to `glamour' firms bidding for private targets.

Past acquisition experience fails to create value beyond a point

Moeller, Schlingemann and Stulz (2005) found that serial acquirers with extremely high valuations suffer losses on their acquisitions when the strategy of inorganic growth is no longer sustainable.

Small acquirers successfully create value

Moeller, Schlingemann and Stulz (2004) found that announcement period returns are higher for small acquirers, whatever the payment mode or the target's ownership (public/private). Mitchell and Stafford (2000) observed significant positive returns even three years post-acquisition only for the smallest acquirers.

High managerial stake is a value driver

Returns to buyer's shareholders have been found to be positively correlated with larger equity stakes of managers in the firm (You, Caves, Henry and Smith, 1986; Healy, Palepu and Ruback, 1997). Consistent with this, it has been found that leveraged buyouts (LBOs) in which managerial interests are aligned with those of shareholders (through the discipline imposed by financial leverage) create value for buyers. Cosh, Guest and Hughes (2006) found that CEO ownership had a strong positive impact on long-term returns.

Table 1: M&A Research Results Based on Event Studies
Author Sample Size & Description Sample Period Returns to Acquiring Firm Shareholders
Megginson, Morgan and Nail (2004) 92 focus descreasing mergers 1977-1996 Announcement period abnormal returns Buy-and-hold abnormal returns
Year 1 Year 2 Year 3
-4.39% -8.61% -19.56% -18.47%
Chari, Ouimet and Tesar (2004) Sub-Sample 1988-2002 Symmetric 3-week event window around the week of the announcement
Raw returns Market-adjusted returns
346 transactions  involving a developed market acquirer and an emerging-market target 3.05% 2.43%
92 transactions  involving a developed market acquirer  gaining majority control of  an emerging-market target 5.66% 3.99%
Bouwman, Fuller and Nain (2009)   1979-2002 3-day CARs 2-year BHARs
1090 High-market acquisitions -0.04% High-market − Low-market acquisition = 1.28% -11.32% High-market − Low-market acquisition = -8.04%
1004 Low-market acquisitions -1.31% -3.28%
Rau and Varmaelen (1998) 212 mergers involving public targets and value acquirers 1980-1991 3-year bias-adjusted CAR = 9.87%
Loughran and Vijh (1997)   1970-1989 5-year post acquisition BHAR
385 stock mergers -25%
111 cash tender offers 61.7%
Conn, Cosh, Guest and Hughes (2005)   1984-1998 CARs over a symmetric 3-day event window
around the announcement day
705 acquisitions of public targets by U.K. public firms -0.82%
3615 acquisitions of private targets by U.K. public firms 0.86%
Moeller, Schlingemann and Stulz (2004) 5503 acquisitions by small U.S. firms 1980-2001 3-day CAR = 2.318% Large - Small acquirer = -2.242%


References and further studies

A. Agrawal; J.F. Jaffe; G. Mandelker 1992. The Post-Merger Performance of Acquiring Firms: A Re-examination of an Anomaly. 47 (4): 1605-1621
A. Agrawal; J.F. Jaffe 2000. The Post-Merger Performance Puzzle.
C. Bouwman; K. Fuller; A. Nain 2009. Market Valuation and Acquisition Quality: Empirical Evidence. 22 (2): 633-679
R. Chari; P.P. Oimet; L.L. Tesar 2004. Acquiring Control in Emerging Markets: Evidence from the Stock Market. 10872
R.L. Conn; A. Cosh; P.M. Guest; A. Hughes 2005. The Impact on UK Acquirers of Domestic, Cross-border, Public and Private Acquisitions. 32 (5-6): 815-870
C. Cooper; A. Gregory 2000. Advances in Mergers and Acquisitions.
A. Cosh; P.M. Guest; A. Hughes 2006. Board Share-ownership and Takeover Performance. 33 (3-4): 459-510
J.R. Graham; M.L. Lemmon; J.G. Wolf 2002. Does Corporate Diversification Destroy Value?. 57 (2): 695-720
J. Harford 1999. Corporate Cash Reserves and Acquisitions. 54 (6): 1969-1997
P.M. Healy; K.G. Palepu; R.S. Ruback 1997. Which Takeovers are Profitable: Strategic or Financial?. 38 (4): 45-57
T. Loughran; A.M. Vijh 1997. Do Long-Term Shareholders Benefit from Corporate Acquisitions?. 52 (5): 1765-1790
M.L. Mitchell; E. Stafford 2000. Managerial Decisions and Long Term Stock Price Performance. 73 (3): 287-329
S.B. Moeller; F.P. Schlingemann; R.M. Stulz 2005. Wealth Destruction on a Massive Scale? A Study of Acquiring-Firm Returns in the Recent Merger Wave. 60 (2): 757-782
S.B. Moeller; F.P. Schlingemann; R.M. Stulz 2004. Firm Size and the Gains from Acquisitions. 73 (2): 201-228
M. Stegemoller; J. Netter; K. Fuller 2002. What Do Returns to Acquiring Firms Tell Us? Evidence from Firms That Make Many Acquisitions. 57 (4): 1763-1793
V.L. You; R.E. Caves; J.S. Henry; M.M. Smith 1986. Mergers and bidders' wealth: Managerial and strategic factors.
Prof. Christopher Kummer

President of the Institute of Mergers, Acquisitions and Alliances, Professor of Finance at Hult International Business School, Visiting Professor of Strategy at Grenoble Ecole de Management, and Affiliate Faculty at Institute for Strategy & Competitiveness at Harvard Business School.