Do Takeovers Create Value? New Methods and Evidence

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Do Takeovers Create Value? New Methods and
Evidence
Sanjai Bhagat, University of Colorado, Ming
Dong, York University David Hirshleifer, Ohio
State University, Robert Noah, Cambridge Finance
Partners
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The Question

• Do takeovers improve target and bidder firm
  value?
• Other stakeholders not considered
• Employees
• Customers/Suppliers
• Bondholders

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• Two important challenges to estimating
• value effects of takeovers
• I Truncation Dilemma (of Window Length)
• Short return window Since not all bids succeed,
  return is only a fraction of the value effects of
  successful takeovers.
• Long return window Can capture full value
  effects. But, return includes greater noise, and
  raises questions of benchmark specification.

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• Two important challenges to estimating
• value effects of takeovers
• II Revelation Bias
• Bidders return at the time of bid gives a wrong
  estimate of the markets valuation of the
  bidders gain from takeover, because
• Some bidders deliberately time bid announcement
  with unrelated negative announcements. Wall
  Streets version of Wag the Dog (WSJ 12/18/98).
• The form of the offer and the very fact of an
  offer may convey information about the bidders
  stand-alone value.

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It's Wall Street's version of Wag the Dog.

• Over the past week, both Mattel and Coca-Cola
  have announced acquisitions on the same day they
  also issued warnings about disappointing
  earnings. ... No one is suggesting that either
  company unveiled its acquisition solely to divert
  attention from its problems... But it is also
  clear that the acquisitions, like the Iraq
  bombings, helped shift attention away from other
  less favorable developments.''
• WSJ, Heard on the Street', 12/18/98, p. C1

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Revelation Examples

• Returns to bidding firm shareholders.
• Fact of an Offer
• Good news
• Bidder expects high cash flow.
• Bad news
• Poor internal investment opportunities.
• Bidder management with empire-building
  propensities.
• Cash vs. Exchange Offer
• Stock Offer Bad news, lemons problem with equity
  issuance
• Cash offer Good news that not issuing equity.

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• Solution to Dilemma of Window Length problem
• Probability Scaling Method
• Like traditional methods, uses short return
  window.
• Method adjusts return from short window upward to
  reflect the probability of success of bid.

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• Solution to Dilemma of Window Length and
  Revelation Bias problems
• Intervention Method
• Focuses on the returns to the bidder when
  something happens (while the bid is outstanding)
  that changes the probability of success of the
  bidder.

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What might change the probability of success of a
bidder?

• Litigation by target firm.
• Arrival of other bidders.
• Objection by a government regulatory agency (FTC,
  Dept. of Justice).
• Defensive measures by target (poison pill,
  lock-up provision).

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Arrival of a second bidder

• Decreases probability of success of the first
  bidder.
• If takeover is in the interest of the first
  bidder, the first bidders stock price declines
  at the arrival of the second bidder.
• If takeover is not in the interest of the first
  bidder, the first bidders stock price rises at
  the arrival of the second bidder.
• Note Decline/rise in the first bidders stock
  price is not related to the stand-alone value of
  the first bidder, but only reflects value from
  the takeover.

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Findings

• Value improvements (as of combined value) from
  tender offers in the competing bid subsample
• Intervention Method Mean of 13.1 (median of
  12.4).
• Probability Scaling Method 14.7 (9.7).
• Conventional combined abnormal returns 9.0
  (7.6).
• Full sample of tender offers
• Bradley-Desai-Kim (1988) Conventional combined
  abnormal returns 5.3 (3.7).
• Probability Scaling Method 7.3 (4.6).

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Findings

• Traditional methods lead to incorrect inferences
  about economic forces in the takeover market.
• We find that friendly offers, equity offers, and
  diversifying offers are
• associated with lower combined bidder-target
  stock returns.
• A conventional interpretation would be that the
  gains from combination
• are smaller for firms involved with these types
  of transactions.
• However, our new methods indicate that these
  effects reflect
• differences in revelation about stand-alone value
  of the bidder,
• not differences in the gains from combination.
• For example, cash offers on average are
  associated with higher bidder, target and
  combined abnormal returns than equity or
  mixed-payment offers.
• In contrast, based on the intervention method,
  cash offers do not create higher value
  improvements than mixed or equity offers.
• Hence, apparent superiority of cash offers in
  creating shareholder value is an illusory
  consequence of a more negative revelation effect
  for the bidder for equity or mixed offers than
  for cash offers.

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Findings

• Conventional combined returns, PSM value
  improvements, and bidder returns tend to be lower
  in diversifying acquisitions.
• IM estimates of value improvements are similar in
  diversifying and same-industry acquisitions.
• The relative superiority of same-industry
  acquisitions with PSM
• (which does not filter out revelation effects)
  compared to IM (which does) indicates that
  same-industry acquisitions are associated with
  more favorable revelation about the bidder than
  cross-industry acquisitions.
• This finding suggests that investors perceive
  diversifying acquisitions as indicating poor
  investment opportunities within the bidder's own
  industry.

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Findings

• Bidder announcement period returns and total
  value
• improvements are negatively related to bidder
  Tobin's Q.
• This result is quite different from the evidence
  from earlier samples
• of Lang, Stulz, and Walkling (1989) and Servaes
  (1991),
• Do bidders overpay?
• Conventional combined abnormal returns Yes.
• Intervention and Probability Scaling Methods No.
  

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Specifics of the Intervention Method

• 4 dates
• t 0 Time prior to first bid.
• t 1 Arrival of first bid.
• t 2 Time prior to arrival of competing bid.
• t 3 Arrival of competing bid.

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y Market value of bidder not related with
takeover. ?t Bidder's profit from takeover
conditional on ?t. Pt Bidder's price at
t. Hence, P1 y ?1 , P3 y ?3 . (8)
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V0T Non-takeover target value. ?
Fraction of target held by first bidder prior to
first bid. VC Combined post-takeover
value. V0B Non-takeover bidder
value. VI Value improvement from
takeover. Then, VI VC V0B V0T(1- ?)
(1)
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V1 , V3 Post-takeover gains. B1 , B3 Price
ultimately paid by a successful first
bidder. Hence, ?1 Pr(Sq1) aV1 (1-a)V1
V0T - B1, ?3 Pr(Sq3) aV3 (1-a)V3 V0T
- B3. (9)
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Assume, V3 V1 V . See footnotes 18,
19, sec. 4.5 Also, R3 P3 / P1 - 1. (VI/VC)
R3(P1/V0) / Pr(Sq3) - Pr(Sq1) (1 -
a) l(B1/V0) (1 - l)(B3/V0) - 1(VOT/ VC),
(11) where, l Pr(Sq1) / Pr(Sq1) -
Pr(Sq3). LHS of (11) is the Intervention
Method Improvement Method, IRIM. Strong Agency /
Hubris Hypothesis IRIM 0. IRIMgt 0. Implies
joint value improvement.
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The Probability Scaling Method of Estimating
Value Changes IRPSM Value Improvement
Combined Initial Bidder and Target Return
/ (Probability a First Bidder arrives
and wins) (Probability a First Bidder
arrives but a Later Bidder wins) (6)
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• DATA
• MERC and SDC datasets.
• Table 1 1018 tender offers during 1962-2001.
• Figure 2 Percentage of
• Successful takeovers,
• Multiple (two) bidder takeovers,
• Hostile takeovers,
• All cash offers.
• Figures 3, 4 Mean percentage and dollar
  shareholder returns to
• Bidders,
• Targets,
• Combined entity,
• over various sub-periods during 1962-2001.

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• Table 3, Model B Entry of second bidder
  significantly lowers probability of success of
  first bidder.

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ESTIMATES OF VALUE IMPROVEMENTS (VI/VC)
R3(P1/V0) / Pr(Sq3) - Pr(Sq1) (1 - a)
l(B1/V0) (1 - l)(B3/V0) - 1(VOT/ VC),
(11) where, l Pr(Sq1) / Pr(Sq1) -
Pr(Sq3). LHS of (11) is the Intervention
Method Improvement Method, IRIM. R3 Bidder
abnormal return at entry of second bidder
-.43. P1/V0 Size of bidder relative to
initial combined value .656 (median .690).
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Pr(S?1) Unconditional probability of success
of first bidder 690/1018
.6778. Pr(S?3) Probability of success of
first bidder given arrival of competing
bid 38/147 .2585. ? Fraction of
target's equity owned by first
bidder .024 (median .000). B1/V0
Average price at which first bidder wins in
full sample 1.407 (1.384). B3/V0
Average price at which first bidder wins
given arrival of competing bid 1.514 (1.421).
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Table 4 IRIM Implicit market estimates of the
value improvement as a result of the takeover.
CIBR Combined Initial Bid Return target
CAR (target market value/target and bidder
market values) bidder CAR (bidder market
value/target and bidder market values). CAR is
the market-model cumulative abnormal return for
the target or bidder over the period five days
before the first bid through five days after.
IRPSM (CIBR)/(Probability the first bidder
succeeds unconditionally Probability a later
bidder succeeds). All improvement ratios are
expressed as a percent of target and bidder
market values.
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• Table 5, Panel B Table 6, Panel B
• IRPSM - IRIM (Estimated Revelation Bias)

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SENSITIVITY ANALYSIS 1. Sensitivity of mean of
estimated IRIM to simultaneous variation in each
of the estimated parameters Pr(S?1), Pr(S?3),
B1/V0 , B3/V0 in the direction of lower IRIM
Mean IRIM remains positive with simultaneous 12
shift in all four estimated parameters. 2.
Parameter estimates from Bhagat-Shleifer-Vishny
(1990) IRIM 9.0 (9.9). Parameter estimates
from Betton-Eckbo (2000) IRIM 17.5
(15.3).
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• SENSITIVITY ANALYSIS
• 3. Model Specification Table 10
• If the arrival of a competing bid causes an
  upward revision in the expected post-takeover
  value of the target to the first bidder gt K gt
  1.
• If the first bidder fails to acquire the target,
  the first bidder will successfully acquire
  another similar target at a similar premiumgt g
  gt 0.
• An unsuccessful first bidder can sometimes profit
  by selling its holdings to a successful competing
  biddergt Pr(S2q3) gt 0.