Monday, October 22, 2012

Anticipation, Acquisitions and Bidder Returns

In Friday's post "Acquisition Returns and Unresponsive Toads", I talked about the empirical evidence on acquisition returns and some possible explanations for the fact that most evidence shows that bidding firm shareholders either break even or lose a small amount when deals are announced.  While that is indeed the prevailing wisdom, we have recently published new results which suggest that, when properly measured, the typical bidding firm actually earns significantly positive results.

The measurement problem we recognize is anticipation of the deal.  Markets adjust to anticipated events and anticipated or rumored mergers are no exception.  When deals start happening in an industry, prices adjust to reflect the possibility that a firm will follow with their own deals.  Think of it this way - you have a still pond (representing lack of acquisition activity in an industry).  Someone throws a rock into the pond and ripple effects are created.  (We showed this result for target firms in a paper published some time ago.  When a firm in an industry first becomes a target, the prices of other firms adjust in proportion to the probability that they will also be targets.)

In the current work, we examine bidding firms and calculate their abnormal returns - that is returns controlling for the market movements and risk.  We analyze nearly seven thousand  deals from 1985 to 2009 to determine the effects of anticipation. We define unanticipated deals as those in a particular industry where there has been a lack of bidding activity (a dormant period) for at least the previous 12 months.   Those unanticipated deals earn a 1.5% abnormal return for the bidding firm's shareholders.  In contrast deals following an initial industry bid (dormant period less than 12 months) earn significantly less - only 0.5%.  The results are shown in the graph below. (Here, CAR means cumulative abnormal return over the three day period centered on the announcement day which is day zero.)

But many factors affect bidder returns and we need to control for these factors to properly interpret our results.  For example, the factors we've analyzed include public and private targets, form of payment, horizontal or non-horizontal, friendly or hostile and even industry related factors like expansion, contraction, etc.  These analyses are interesting in their own right but for our current purposes, we will just show the differences between acquisitons following long and short dormant periods in their industry.  The chart below shows the difference in returns (long dormant periods minus short dormant periods) for 28 separate categories that have been shown to impact bidder returns.  In all but two categories, the bids that are more of a surprise (i.e., longer dormant period) earn larger returns.  The two categories where the difference is negative are driven by the definition of the category - hostile deals and deals with multiple bidders are soon followed by competing bids with higher price.  The results here, and in the paper provide considerable evidence that acquisitions are anticipated based on previous industry activity and that once you control for this, acquiring firms earn significantly positive abnormal returns.

The paper contains a proper multiple variable framework(regression analysis), and many other results.  It is coauthored with Jay Cai of Drexel and Moon Song of San Diego State.  It can be downloaded here.

All the best,


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