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Do Stock Mergers Create Value for Acquirers?

By Harvard Law School Program on Corporate Governance

(Editor?s Note: This post is from Pavel Savor at the Wharton School at the University of Pennsylvania and Qi Lu is at the Kellogg School of Management at Northwestern University.)

In our forthcoming Journal of Finance article entitled Do Stock Mergers Create Value for Acquirers?, we investigate and find support for the hypothesis that overvalued firms create value for long-term shareholders by using their equity as currency, which is consistent with a market-timing theory of acquisitions.

One of the primary empirical predictions of the market-timing theory of acquisitions is that the acquirer?s long-term shareholders benefit from the bid, even though it might entail no real synergies. The only requirement is that the chosen target be less overvalued than the acquirer. A famous example of such a deal is America Online?s (AOL) stock-financed acquisition of Time Warner, which was one of the defining moments of the Internet bubble. Despite the high premium paid by AOL (48% using the announcement day closing price) and the drop in its stock price upon announcement (17.5% measured over a three-day window), the deal is now almost universally regarded as beneficial to AOL.s long-term shareholders, not for the synergies it delivered, but simply because AOL.s equity was overpriced at the time.

We approach our principal question of whether stock acquirers would have performed better in the absence of the merger by creating a sample of both successful and unsuccessful mergers, and by using the unsuccessful acquirers as a proxy for how the successful ones would have performed had they not managed to close their transactions. Since we do not want the bid termination to be related to the acquirer?s valuation, we research every failed transaction in our sample and create a subsample of those that did not succeed for exogenous reasons. (In this context, exogenous means unrelated to the valuation of the acquirer.) The subsample includes bids that failed because of regulatory disapproval (mostly antitrust action), subsequent competing offers, or unexpected target developments. We also restrict this subsample to non-hostile bids, since hostile bids are more likely to fail and targets might be more inclined to resist offers by overvalued. We find that unsuccessful stock bidders significantly underperform successful ones. Failure to consummate is costlier for richly priced firms, and the unrealized acquirer-target combination would have earned higher returns. None of these results hold for cash bids.

The full paper is available for download here.

Full post as published by The Harvard Law School Corporate Governance Blog on November 21, 2008 (boomark / email).