Is Distortional Merger Activity More Likely to Happen During Waves

1
Is Distortional Merger Activity More Likely to
Happen During Waves?

• Jarrad Harford

2
Background and Motivation

• Empirical fact that mergers come in waves
• Brealey and Myers
• Industry Shocks Mitchell and Mulherin (1996)
• Despite massive attention to mergers, little
  attention has been paid to the waves themselves
• Clustering of activity suggests that mergers in
  waves may be different from those outside waves

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Why Study Waves?

• We know little about
• The characteristics of participants in merger
  waves
• What generates the clustering of activity
• Whether waves create value overall
• Potential to help sort out different explanations
  of merger activity
• Better understand where the sources of gains in
  mergers come from

4
Why should mergers in waves be different?

• Efficient Response
• By its nature, a shock causes a group of firms
  that had not previously been sensible acquisition
  parties to make acquisitions
• Mergers in waves are more likely than average to
  be motivated by economic efficiencies

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Why should mergers in waves be different?

• Distortion
• Manager Irrationality
• Hubris (extension of Roll 1986)
• Agency/Free Cash Flow
• Jensens idea of industry overcapacity leading to
  diversifying acquisitions.
• Herding Investment Models
• Recent attention to manager irrationality offers
  an alternative explanation for clustering of
  activity
• Scharfstein and Stein (1990), Heaton (1998),
  Milbourn, Boot and Thakor (1999), Shleifer and
  Vishny (2001)

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Predictions

• Overall Wealth Creation
• Efficient Response Waves create wealth overall
• Distortion Waves destroy wealth
• Bidder Characteristics
• DistortionHigh pre-bid stock returns (hubris)
• High free cash flow and low growth opps
  (free cash flow)

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Predictions

• Bidder returns
• Distortion Returns will be worse in waves
• Negative relation between pre-bid return
  and announcement return (hubris)
• Wave bidders will exhibit negative long-run
  returns
• Both announcement and long-run returns will
  be worse for bids occurring later in the wave
  (herding)

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Predictions

• Post-bid corrective action
• Distortion Divestiture waves will follow merger
  waves
• Kaplan and Weisbach (1992), Paul (2002)
• Wave bidders will be more likely to be
  targeted themselves (Mitchell and Lehn 1990)

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Sample

• Start with all merger transactions (gt50mil) on
  SDC from 1981 to 2000
• Measure highest 24-month concentration in 1980s
  and 1990s for each industry (Fama-French 48
  industries)
• For each industry, compare that concentration to
  the empirical distribution of concentrations from
  1000 simulations specific to that industry
• If the actual concentration was greater than the
  95th percentile concentration in the
  distribution, categorize that period as a wave

10
Sample

• 35 waves from 28 industries (7 of which have 2
  waves, one in the 1980s and one in the 1990s)
• Average 24-month non-wave period has 7.8 bids
• Average 24-month wave period has 34.3 bids

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Overall Wealth Creation in a Wave

• Change in market value of every bidder, target
  and industry member firm over the wave period
• Scale by total market capitalization of those
  firms 20 days prior to the first bid in the wave
• Do the same with every non-overlapping 24-month
  non-wave period

12
Overall Wealth Creation in a Wave

• 21 of 35 waves are marked by wealth creation
• Overall, waves create 16 more value than
  investing in the market portfolio at the
  beginning of the wave
• The average non-wave period has an insignificant
  wealth differential
• Distortional activity does not dominate efficient
  activity in waves

13
Bidder and Target Characteristics

• Financial and Performance Variables
• Sales Growth ? M/B Assets
• ROA ? Book D/E
• FCF ? Cash
• MVAssets ? Pre-bid Returns
• Industry-adjusted
• Year before announcement or year before wave
• Avoids industry comparison problem during first
  year of wave

14
Bidder and Target Characteristics

• Bidders do not have higher pre-bid performance
  inside waves and they have lower ROA
• Inconsistent with hubris
• Bidders in waves have higher M/B and lower cash
• Inconsistent with FCF inside waves and suggests
  this motivation is more likely outside of waves

15
Bidder stock price reactions

• Adjust for partial anticipation using Malatesta
  and Thompson (1985)
• Time-series estimation
• just before start of wave to one-year after for
  wave events
• days 252 to 252 for non-wave events

16
Bidder stock price reactions

• Summary of results of M/T regressions
• Intercepts are positive and significant
• In M/T framework, implies negative expected bid
  value
• Event returns are negative and significant

17
Bidder stock price reactions

• Cross sectional regressions for Event coefficient
• Control for method of payment, whether wave
  followed deregulatory event, and relatedness of
  acquisition
• Focus on
• pre-bid return (hubris)
• Wave dummy and interactions (distortion vs.
  efficiency)
• Early vs. later bids (herding)

18
Bidder stock price reactions

• Some evidence of hubris outside waves
• All else equal, wave bid returns are higher, and
  are higher the earlier in the wave the bid occurs
• Evidence consistent with herding later in a wave
• Some evidence that bids in waves following
  deregulatory events are better

19
Long-run post-bid returns

• Prior evidence of poor long-run performance after
  mergers (Loughran and Vijh 1997, Rau and
  Vermaelen 1998)
• Use Mitchell and Stafford (2000) approach
• Calendar time
• Form portfolio each month and measure one-month
  return
• Regress vector of monthly returns on F/F 3-factor
  model and examine intercept

20
Long-run return results

• Overall, bids in waves do not show worse
  performance than those outside waves
• Underperformance is concentrated in bids made
  later in waves using stock as the method of
  payment
• Some support for herding later in the wave

21
Post-bid Corrective Actions

• Look at divestitures and targeting of the bidder
• Kaplan and Weisbach (1992), Paul (2002)
• Mitchell and Lehn (1990)
• Looking for divestiture waves that follow merger
  waves
• Are wave bidders more likely to later be targeted
  themselves?

22
Post-bid Corrective Actions

• There is no evidence of divestiture clustering
  following merger waves
• Bidders from outside waves are actually the ones
  more likely to later become targets themselves

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Summary and Conclusions

• Mergers in waves are different
• Many factors contribute to wavesthe hypotheses
  put forth here are not mutually exclusive
• Efficiency receives the most consistent support
• Overall, non-wave mergers exhibit characteristics
  more consistent with distortional activity than
  do mergers during waves.
• However, there is some evidence of herding
• Helps interpret prior evidence on mergers and
  design new tests

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Summary and Conclusions

• The most consistent picture of an industry merger
  wave emerging from this and prior work is that
  some shock (regulatory, technological or
  economic) engenders a legitimate and efficient
  reorganization of industry assets that is best
  accomplished through mergers.