2) ASSESSING MERGERS AND ACQUISITIONS

Question 1

3 tests of M&A profitability based on market efficiency

Answer 1

1) Weak form (Pafter > Pbefore)
2) Semi-strong form (RofM&A>Rbenchmark)
3) Strong form
(RofM&A>RnoM&A)

Question 2

Why is weak form test of M&A profitability unreliable

Answer 2

susceptible to confounding events

Question 3

Effectiveness of semi-strong form test of M&A profitability

Answer 3

not perfect but better than weak form (benchmark selection an important consideration)

Question 4

Effectivness of Strong form test of M&A profitability

Answer 4

Perfect test but unobservable!

Question 5

4 research approaches to M&A outcomes

Answer 5

1) market based (event study)
2) accounting based
3) manager surveys
4) case studies

Question 6

Application of market based (event study) approach to M&A outcomes

Answer 6

• assesses market impact of particular event
• in semi-strong market we look at shareholder wealth – if there’s a form of efficiency, the investors are looking forward & that they’re impounding their views into the current prices.

Question 7

strengths of market based (event study) approach to M&A outcomes

Answer 7

• Direct measure of shareholder wealth

* Forward looking

Question 8

Weaknesses of market based (event study) approach to M&A outcomes

Answer 8

Weaknesses
• Relies on assumptions of market efficiency, unrestricted markets
• Benchmark choice can influence results confounding results

Question 9

Returns to target firm shareholders

Answer 9

always winners, and get +ve outcomes from transactions (as they’ll only sell firm it’s above the market value of it – otherwise no incentive to sell!)

Question 10

Returns to acquirer firm shareholders

Answer 10

Mixed results - at announcement no clear and consistent research evidence,
longer term studies indicate more -ve outcomes (but note exposed to more confounding events so need to interpret such results carefully)

Question 11

long-term performance for targets and bidders

Answer 11

• target shareholders win

- bidders –> short term no big dif. in long term starts to destroy wealth

Question 12

what needs to be considered about the fact targets appear to be winners and not acquirers?

Answer 12

net economic gain!!

• size of acquirer usually way larger,
• A large % gain to target may be wiped out if acquirer experiences even a small % loss

Question 13

Event studies

Answer 13

measure security price reaction of some economic disturbances (aka abnormal returns)

Question 14

what does measuring abnormal returns do?

Answer 14

measures extent to which realised security returns vary from the expected return

Question 15

basic formula for measuring abnormal returns (AR)

Answer 15

AR = Ri,t - E(Ri,t | Xt)

company i, event date t
Ri,t = actual return over event period
E(Ri,t | Xt) = is the expected return where Xt denotes the clean period

Question 16

Structure of an event study

Answer 16

1. define event period
2. measure expected performance (using benchmarks)

(• Need to determine clean period, benchmark return and abnormal return_

Question 17

types of benchmarks to use for step 2 for event study (measuring expected performance)

Answer 17

1. Mean adjusted return
2. Market adjusted return - most desirable but less used
3. Market-model return - most commonly used but least desirable

Question 18

Outcomes from academic research - event study findings - TARGET FIRMS

Answer 18

• Returns to target (target of acquisition/merger) shareholders usually significant & materially positive - studies show significant regardless of time period

Question 19

Outcomes from academic research - event study findings - BIDDER FIRMS

Answer 19

• Not very great findings compared to target firm shareholders.
• Some research shows bidders earn positive results on announcement date, however other findings indicate evidence of negative/insignificant average returns for acquiring firms even on announcement date losses or 0 change has been shown

Question 20

Event studies measure

Answer 20

abnormal return to estimate the effect of M&A while controlling for other influences on the share price.

Question 21

The event study approach involves identification of

Answer 21

the event and event window, a clean period, and a benchmark return.

Question 22

for event studies, the abnormal return is calculated as the

Answer 22

difference between the observed event return and the benchmark expected return.

Question 23

in event studies what does the abnormal return do?

Answer 23

isolates the effect of the event while the benchmark reflects the return that would be expected in the absence of the event.

Question 24

The primary limitation in event studies is

Answer 24

estimation of the benchmark

analyst must choose between alternative benchmark measures (mean-adjusted, market-adjusted, market models etc), and the choice of clean period data used as an input to this estimation.

Question 25

rationale for shareholder maximization as a success criterion for M&A

Answer 25

The focus on shareholder wealth derives from finance theory, since the share price provides a relatively objective yardstick by which to measure merger success.

If it can be shown that the post-acquisition share price of the merged firm has increased relative to the pre-acquisition values of the merging firms,demonstrate that at least from the shareholders’ perspective, mergers have been value enhancing.

Question 26

post-acquisition firm is different from the pre-acquisition merging entities, hence to compare the post-acquisition performance of the merged firm with the pre-acquisition performance of the separate merging firms, requires

Answer 26

a measure of the shareholder value had the merger not occurred

Question 27

issues in setting up an appropriate benchmark for assessing shareholder value performance of mergers –> taking weighted average of the shareholder return of the premerger firms (1)

Answer 27

• The separate performance of the merging firms in the pre-merger period may not have continued in the post-merger period –> - Extrapolation of past performance would overstate future performance benchmark

Question 28

issues in setting up an appropriate benchmark for assessing shareholder value performance of mergers –> taking weighted average of the shareholder return of the premerger firms (2)

Answer 28

• merged firm may perform better than the separate combining entities even if individually they would have maintained their pre-merger performance, since objective of merger is to create new sources of competitive advantage. Extrapolation of past performance in this case would understate future performance.

Question 29

• An alternative approach to extrapolating past performance is

Answer 29

use of external benchmarks like a control sample of non-merging firms

Question 30

Using external benchmarks such as a control sample of non-merging firms - what’s presumed?

Answer 30

• firms sharing common characteristics are likely to have similar performance. BUT choice of characteristics on which to pick a control sample is imprecise.
• Additionally firms may share some common characteristics and still be widely different in their strategic posture, resources, capabilities and ability to create and maintain competitive advantage.

Question 31

Market model CAPM returns used to

Answer 31

generate the expected benchmark return that would have occurred in the absence of the merger.

Question 32

CAPM model states that

Answer 32

systematic risk (or beta) is the sole determinant of the expected return from any company.

Question 33

what’s wrong with the CAPM return model’s assertion that systematic risk (or beta) is the sole determinant of the expected return from any company?

Answer 33

assertion is not borne out by the empirical evidence, which have found that factors like size, book-to-market value of equity, dividend yield etc all have significant impact on the expected returns from any security.

Question 34

Use of the CAPM to generate expected returns for the merged firm is

Answer 34

sensitive to the specifications of the model.

Question 35

Why is CAPM to generate expected returns for the merged firm sensitive to the specifications of the model.?

Answer 35

As there is no comprehensive theoretical model that encapsulates all these factors that have been shown to empirically affect the calculation of expected returns

Question 36

research on short-term price reaction to M&A announcements finds significant positive abnormal returns to target firms on average - why? reasons 1-2.
In any given takeover announcement, these factors may apply:

Answer 36

1) The acquisition offers a positive synergy value which can be split between the target’s and bidder’s shareholders;
2) The bidder is offering target shareholders a premium to the target’s current price in order to secure a successful deal;

Question 37

research on short-term price reaction to M&A announcements finds significant positive abnormal returns to target firms on average - why? reasons 3-5.
In any given takeover announcement, these factors may apply:

Answer 37

3) The bidding firm is offering a price above the target’s fair value in order to beat competing bidders (leading to winner’s curse)
4) The target firm is underperforming, which made it a potential target in the first place, and the bid closes some of the valuation difference;
5) The bid has put the target in play and the market is anticipating higher bids.

Question 38

If only the announcement date abnormal returns indicates a negative return for the target and positive return for the acquirer how should we interpret these results (from the event study)?

Answer 38

CAREFULLY (this could be an explanation)

• target appears to have moved heaps in price on day before announcement.
• cumulative abnormal return analysis indicates large positive return through event window
• The bidder was in a trading halt on the announcement date. When trading resumed, the share price fell by a large amount, and results in a negative return through the event window.
• The clean period may be affected by confounding features relating to this deal, as it captures earlier rumours relating to a potential takeover.

Question 39

things to assess if market is efficiently pricing a deal at announcement period

Answer 39

a. The prices for both companies seem to be moving in response to deal information in the days following the announcement (indicating some drift and that not all information is captured at the announcement

Question 40

in terms of whether market is efficiently pricing a deal at announcement period, what does it mean if target share price trades at a discount to the implied offer value?

Answer 40

May reflect expectations that the acquirer’s stock is overvalued (and will fall in price) and/or that there is some deal risk.