So far, we've identified the different types of M&A activity and corporate restructuring events that firms regularly participate in around the world. We established an economic framework for evaluating the value proposition of these types of transactions. And we then critically assessed the common justifications for these transactions as routinely cited by the management of acquiring or restructuring companies. But now it's time to actually check whether, on average, the claims made by management that these corporate transactions are actually creating value for shareholders. We'll do this by reference to some of the most widely cited and well respected empirical studies in the area. To set the scene, let's firstly consider the pattern of acquisition activity that we've observe across time. As you can see from this graph, there is definite evidence of M&A transactions clustering in time. And we refer to peaks in such activity as being associated with merger waves. Now there are at least a couple of explanations for this phenomenon. Firstly, there might be regular trade or technological triggers for M&A activities, such as a relaxation in competition laws. Or alternatively, a technological innovation that triggers acquisition activity as acquirers identify target firms that, following the innovation, are underutilizng their assets. Another explanation for merger waves, is related to the value of equity markets more generally and suggests that you might expect to see a sudden rush in M&A activity when the share price of acquiring firms is relatively high. And the acquiring firm then seeks to take advantage of this by using their shares as consideration in new merger deals. This explanation is a little bit more nuanced in that it implies that perhaps the management of the acquiring firm is behaving opportunistically in taking advantage of what may be a temporarily overpriced share. We'll come back to this point a little bit later on. So what about target firms? Well, let us consider the following graph that plots the share price movement for food producer, HJ Hines of baked beans infamy, around the time of the announcement of its acquisition by Berkshire Hathaway and 3M Capital. As you can see, there was very little anticipation of the event in the market and then immediately upon announcement, the share price leapt up very close to the offer price. Clearly, mergers and acquisitions seems to be good news to target share holders. But how good and what factors influence that share price jump? So the three questions we're going to consider here are, firstly, why do bidding managers enter into M&A transactions and what benefits are they chasing? Secondly, what are the wealth affects of M&A activity for bidder and target firms and is there a link between these wealth affects and the method of payment offered by the bidder to target shareholders? Finally, what are the motivations and wealth affects of alternative types of corporate restructuring events? We turn to the survey work of Tarin Mukherjee, Halil Kiymaz, and Kent Baker to try to divide the motivation from M&A activity. These authors surveyed the management of the acquiring firms that were involved in the top 100 deals done in the US each year between 1990 and 2001. They found that the number one reason for merger activity was, not unexpectedly, to take advantage of synergies between the two entities. Of some concern was the fact that the second most popular justification for merger activity was diversification. That's right, one of our two so-called dubious reasons for M&A activity. When prodded further to identify the sources of the synergies claimed in the first question, managers identified operating economies, that is improved productivity and cost cutting, as being the primary source of synergistic benefits. Interestingly, very few managers cited financial economies as delivering the synergies and not surprisingly at all, fewer still admitted that the synergies resulted from reduced competition in the marketplace. The authors then probed more deeply into the earlier results, indicating that diversification was commonly viewed as a benefit of merger activity. They separated out those that believed that diversification was a justifiable reason for M&A activity from those that believed the opposite and asked each group for reasons for their views. Those that believed that diversification was a good reason to merge argued that it allowed the firm to dampen down volatility and earnings. While those that believe that diversification is never a valid reason suggested that this was because firstly, shareholders could diversify on their own behalf and then secondly, it could result in the parent company losing focus from its core operations. So what about the wealth effects of M&A activity? Andrade, Mitchell and Stafford conducted one of the widest ranging studies into M&A activity by documenting the impact on share prices of over 4.000 mergers that took place between 1973 and 1998. Amongst other things, their study looked specifically at two time intervals. Firstly, the three days surrounding the announcement of the merger. That is the day before, the day of, and the day after the announcement. Secondly, they documented the long-term effect of mergers by recording the shared price returns in the acquiring company in the three year period after the acquisition. Well what did they find? Firstly with respect to announcement period returns, very clearly, target shareholders enjoyed very large positive gains of about 16% on average. What about the acquiring company? Well it was a negligible, indeed, statistically insignificant return in that same three day interval. When we break down the results further by separating out cash finance deals from deals where stock is offered in the combined entity, we see that the results are rather interesting. When an acquirer announces a merger and announces we'll be using shares in the combined entity as the consideration the returns to the target are much lower and the returns to the acquirer are now statistically and significantly negative. A reasonable interpretation of this result is that the market often perceives an all-stock offer as a negative signal about the current share price of the acquiring firm. That is, the market often interprets such an acquisition as being motivated by management wishing to opportunistically take advantage of an inflated share price. And the market adjusts its valuation of the acquiring company accordingly. So what about the long term returns to the acquiring firms? For the full sample of observations, the results are fairly unequivocal. Acquirers under perform in the three years after the merger. Interestingly, when we separate out those deals, finance with shares and the combined entity, from all-cash deals, we find that it is the stock finance deals which drive this result. That is consistent with the short term announcement results, acquirers that fund an acquisition with stock significantly underperform the market by, on average, 9% in the three years subsequent to the acquisition. In contrast, the three-year return for acquirers who do not use any stock consideration at all, were not significantly different to market benchmarks. So now let's turn from M&A activity to corporate restructuring and consider some further evidence from the survey conducted by Mukherjee, Kiymaz and Baker. They report that the two main reasons for corporate restructuring were to increase corporate focus and to offload a poorly performing division. Espen Eckbo and Karin Thorburn conducted a meta-analysis, where the synthesized the results from a great many studies conducted in different markets across different time periods, from around the world, and they concluded that divestitures, equity carve outs, and spin offs all created value for the shareholders of the parent company. So, in summary, merger and acquisition activities are often motivated by sound decision-making by acquiring management teams. We've found that most of the gains from acquisitions are captured by target shareholders. And that there seems to be a strong pattern of negative returns for acquiring shareholders that may persist for as long as three years following a transaction, and that this is particularly the case in stock finance deals. On the other hand, corporate restructuring events, which are often motivated by a desire to refocus the company on core activities, these transactions do tend to create value for the firm concerned. In this module, we decomposed the mechanics of an acquisition and then developed an objective economic framework capable of determining the circumstances under which M&A activity should proceed from an acquiring shareholder's point of view. We then critically accessed common justifications for merger activity before turning our attention to corporate restructuring, which involved firms unlocking the diversification discount by divestitures, spin offs, and equity carve outs. We concluded this module by considering a range of empirical evidence, that documented both the motivations and the wealth effects of M&A and corporate restructuring transactions. In the next module, we're going to turn our attention to the last of the big questions facing chief financial officers. How do we best manage risk for our shareholders? In this module, we'll get into the derivative markets. We'll consider forwards, futures, and options. We'll touch upon caps, colors and floors and finish with a broader discussion of how does managing risk create any value at all. See you then.
