An empirical study of the value creation in Mergers and Acquisitions in relation to the strategic rationale

Transcription

1 Department of Business Studies MSc. in Finance Authors: Rikke Eriksen (Exam ID: ) Louise M. Møller (Exam ID: ) Advisor: Jan Bartholdy An empirical study of the value creation in Mergers and Acquisitions in relation to the strategic rationale Focusing on acquiring companies located in the UK or Scandinavia September 2008 Aarhus School of Business, University of Aarhus

2 Abstract This thesis evaluates the effects of mergers and acquisitions upon the acquiring company based on the underlying strategic rationale for the deal. The analysis is based on both daily stock prices (analysis up to 1 year after the event) as well as on operating measures (analysis up to 3 years after the event) in relation to UK and Scandinavian based acquiring companies. An event study approach is taken to evaluate the abnormal performance following a merger or an acquisition. Both a parametric t-test as well as different non-parametric tests are conducted and the empirical results indicate that the highest amount of power and reliability is attached to the non-parametric tests. The main empirical results from the thesis in relation to the performance of the acquiring firms are that in most cases it is not possible to detect any abnormal performance. This indicates that it is not possible to find support in favour of a positive reaction or effect of a merger. However, in cases when an abnormal performance is detected it is mostly negative indicating that the acquiring company looses value. In the shortest period of time around the event day the stock prices show some evidence in favour of a positive reaction in the stock prices in response to the deal. In relation to the investigation of differences between the different strategies it appears that it is not possible to conclude that all of the strategies differ. However, some indication of one strategy outperforming the remaining strategies as well as one strategy being outperformed by the others was detected from the analyses of differences.

3 An empirical study of the value creation in M&A in relation to the strategic rationale Table of contents 1. Introduction Research question Definitions and clarifications Delimitation Evaluation of sources Research method Measuring performance based on stock prices Measuring performance based on operating measures Preparation and selection of data Results from previous empirical studies on value creation in M&A Event studies Measuring abnormal performance based on stock prices Estimation period, event day and event window Creating a benchmark for the normal performance Choice of tests Parametric or Non-parametric The parametric t-test Non-parametric tests Measuring abnormal operating performance Definition and determination of the selected operating figures Return on assets based on EBIT and EBITDA Return on sales based on EBIT and EBITDA Cash flow return on assets Tobin s Q Event day, event window and estimation period Creating a benchmark - performance based Specification of statistical tests Parametric and non-parametric tests Parametric t-test for abnormal operating performance Wilcoxon Signed Rank test for abnormal operating performance Test for differences between the strategies Overview and discussion of the research approach and the selected tests Overview of the research approach Discussion of choice of research approach... 33

4 An empirical study of the value creation in M&A in relation to the strategic rationale 9. Descriptive statistics Description of the strategies Descriptive statistics Daily stock prices Descriptive statistics Accounting figures Hypotheses and expectation in relation to the empirical results Empirical evidence abnormal stock price performance Empirical results parametric t-test Robustness and power of the parametric t-test Empirical results the non-parametric tests Empirical results of the Rank test Empirical results of the Sign test Empirical results of the Generalized Sign test Examining differences between strategies Summery of the empirical results in relation to stock prices Empirical evidence abnormal operating performance Presentation of empirical results Return on assets EBIT Return on assets EBITDA Return on sales - EBIT Return on sales EBITDA Cash Flow Return on assets Tobin s Q Examination of differences between strategies based on operating performance Summary of the empirical results in relation to operating performance Evaluation of the data, the research approach, and the empirical results Conclusion A final perspective on value creation in M&A Bibliography... 96

5 An empirical study of the value creation in M&A in relation to the strategic rationale 1. Introduction Due to increased competition and increased globalization the economic environment has changed in recent years and in light of this, the challenges a company faces have become larger and more demanding. One result of this has been an increase in the number of acquisitions both within and across borders. For companies to stay at pace with competitors growth through acquisitions has become increasingly important and has at least partly replaced organic growth. The number of mergers and acquisitions as well as the value of these transactions has risen significantly through time. However, the increase in the M&A activity is not linear, in fact it moves up and down over time with an overall rising tendency. This phenomenon is referred to as merger waves 1 in fact research documents periods with obvious increases in activity. These merger waves influence the business environment and in conducting analysis of M&A activity possible merger waves within the period in question should be kept in mind. In research literature attention has been paid to M&A transactions and several studies have been conducted in order to understand and determine the trends and the characteristics in this field. The overall motive for the acquirer is value creation and in the light of increasing M&A activity it is relevant to examine whether or not value is created. One branch of research has focused on whether or not value is created for the acquiring firm in relation to mergers and acquisitions. No overall consensus exists that unanimously documents whether or not value is created for the acquiring firm. Moeller et al. (2005) have concluded that value is actually destroyed when engaging in acquisitions. The reason for this conclusion is imputed to the fact that the largest M&As are the ones experiencing massive losses. A part from the large loss deals the remaining companies actually experience gains from M&A. The conclusions from this paper are based on US companies and have not yet been fully explored on European companies. Companies engaging in mergers and acquisitions can be motivated by several different objectives, some of the most obvious as presented by Sudarsanam (2003) are synergies, increased growth, cost savings and increased efficiency. Apart from these more 1 Several research studies have focused upon M&A activity and have identified periods of increased activity, which is referred to as merger waves (see Mulherin and Boone (2000) and Andrade et al. (2001)) 1

6 An empirical study of the value creation in M&A in relation to the strategic rationale apparent motives might also include decreased transaction costs, increased knowledge or so forth. Besides the motive for a company to engage in mergers or acquisitions the type of industry in which the company operates also affect the type of merger. The motive for the acquisition in the case of a mature industry could be far different from the motive dominating an immature industry. In paying attention to the motive that drives the acquisition and the industry in which the acquirer operates emphasize the importance of the strategic rationale for a merger or an acquisition. It is widely recognized that it is decisive for a company to set up a strategy in order to meet the challenges it faces due to a fierce competition and a quickly changing environment. The strategy a company chooses to follow should be in line with an overall goal of value creation. A decision to expand through acquisitions has to correspond to the underlying strategy of the company. In line with this, the strategy or the motivation behind an acquisition is according to Bower (2001) an important factor in determining whether or not an acquisition becomes a success - meaning whether or not value is created. In his study he distinguishes between five overall strategies, which are examined based on US companies. The five strategies are referred to as: the Overcapacity M&A, the Geographic Roll-up M&A, the Product or Market Extension M&A, the M&A as R&D, and the Industry Convergence M&A Research question The findings from the two mentioned articles are the main motivators for this thesis and the ambition of the thesis is thus to combine the two observations and apply them to European companies in an analysis of value creation. In order to conduct this analysis the following research question is posed: Is it possible to detect abnormal performance in relation to a Merger or an Acquisition? - And does abnormal performance differ between the different strategies/motives behind the deal? In order to ensure the debt of the thesis the overall research question is analyzed in connection to the following sub questions: Is value created in general based on the entire sample of firms? When looking at each strategy separately is value created within the strategies? 2

7 An empirical study of the value creation in M&A in relation to the strategic rationale Is it possible to document a significant difference between the strategies? Throughout the thesis the analyses are conducted in relation to both stock prices and operating figures, which enables a focus upon short-term as well as long-term value creation. The purpose of this thesis is to detect value creation in mergers and acquisitions based on the strategy motivating the transaction. Seeing that the thesis is mainly inspired by the two observations mentioned above, it aims to document if value is created in mergers and acquisitions in cases where the acquiring company is located in the UK or Scandinavia Definitions and clarifications The vocabulary and the research approach in this thesis are in line with existing research in the field. Therefore no separate definitions are presented here except for a clarification of what is meant by mergers and acquisitions. The sample included in the thesis consists of both mergers and acquisitions, but no distinction between the two types of deals is made in the analyses of value creation. A specific merger or acquisition is referred to as a deal Delimitation To conduct the analysis some delimitation has been made partly due to the scope of the thesis, but also in relation to the available sources of information. The companies included in the analysis were chosen based on some overall criteria in which the starting point was a sample of 959 companies. In preparing this data and conducting the analysis the sample was reduced somewhat. A specific deal was excluded in cases where no information is available to document the strategy behind the deal. This is a necessary exclusion due to the fact that the entire analysis is based on the strategy behind the deal and thus it is a necessity to distinguish the motive for each deal. To determine the underlying strategy some further delimitation have been made. In cases where a subsidiary was acquired the deal was excluded. This was done in order to maintain focus upon acquisitions of another company. In addition, some deals included in the original sample of 959 companies were located outside the UK and Scandinavia and these deals were also excluded in order to stay in line with the overall characteristic 3

8 An empirical study of the value creation in M&A in relation to the strategic rationale of the data sampling focusing exclusively on acquiring companies situated in either the UK or Scandinavia. Furthermore, the original sample included some deals that were announced in 1999 or completed in These deals were also excluded from the sample. In order to perform the analyses stock prices or operating figures needed to be available. To conduct the analysis based on stock prices at least 75 observations prior to the announcement day were needed for a deal to be included. Furthermore, the sample only consists of companies that in the relevant period were listed on a stock exchange in the UK or Scandinavia, therefore, companies that was only listed elsewhere was excluded. In the case of operating figures, deals were excluded if changes in the accounting year were made during the period of analysis or if accounting figures in the year prior to the event were unavailable. For a specific deal to be included all operating figures needed not be available. Finally the benchmark was constructed based only upon those deals included in the analysis of operating performance. This final delimitation is in particular due to the scope and time available for the paper seeing that the data collection was a very large and demanding task Evaluation of sources The sources used in this thesis are primarily research papers, which are considered appropriate for this type of thesis. In setting up the event study inspiration was sought in previous literature, and it was attempted to choose methods that were well documented and evaluated in previous work. In doing so the research approach is valid without having to perform a simulation study of the approach. Seeing that the approach is chosen in accordance with recommendations from previous literature the different alternative approaches and models are not discussed in debt. The reason for not including this type of discussion is primarily the limited scope of the thesis as well as the consideration that basing the event study on the work of primarily Brown and Warner (1985), Barber and Lyon (1996), MacKinlay (2001), and Bartholdy et al. (2007) ensures a valid and reliable approach. Furthermore, the thesis will focus more on the analysis and the actual results that can be drawn. Since the approach is well specified and valid a comparison with other empirical work is possible. 4

9 An empirical study of the value creation in M&A in relation to the strategic rationale 2. Research method As mentioned above, the starting point of this thesis is the two observations first, value is destroyed in mergers and acquisitions based on a US sample of firms, and second, the underlying strategy is a determinant for the success of a deal. These two observations have served as inspiration in designing the research question for this thesis. In order to examine if any value is created the event study methodology is chosen as the research approach. The event study methodology is applied to the analysis of both stock prices and operating figures and both parametric and non-parametric tests are included. In the following an elaboration of the research method is presented Measuring performance based on stock prices In the analysis of performance based on stock prices, daily stock quotes are applied. The analysis of stock prices is performed on five different time intervals (the 11 day event window, 1 month, 3 months, 6 months and 1 year). The method chosen and the analysis conducted are inspired by those methods applied in other research papers in particular MacKinlay (1997) and Bartholdy et al. (2007), which in large also corresponds to Brown and Warner (1985). Both parametric and non-parametric tests are conducted in order to examine if value is created. To perform an event study the first thing to do is to determine the event day, the event window and the estimation period. In this thesis the event day is set to the day that the announcement of the deal is published. The reason why the announcement day is chosen as the event day instead of the completion day is the fact that stock prices are expected to adjust immediately to new information - in this case news of an upcoming merger or acquisition. The event window is the event day and five days before and after the event day, thus 11 days in total or ± 5 days of the event. In determining the normal performance of the companies an estimation period needs to be chosen. In this case the estimation period consists of 250 days prior to the first day in the event window. The estimation period is in line with the recommendations from Bartholdy et al. (2007). Due to the fact that not all stocks trade multiple times a day or even daily, an adjustment for 5

10 An empirical study of the value creation in M&A in relation to the strategic rationale thin trading is recommended. This is done by applying trade-to-trade returns to the entire sample as recommended by Bartholdy et al. (2007). To conduct the event study the abnormal return at each day in the estimation period and the event window is calculated. The abnormal performance or in this case the abnormal return (AR) is the difference between the actual return and the normal return. The normal return is estimated by means of the market model. This model assumes that all stocks perform equally to a market index adjusted by the risk associated with the stock. In estimating the normal return the actual return of the company is regressed on the market index and the parameters α and β are estimated. The main market index in the country of the acquirer is chosen as the market index, these are FTSE 100, OMXS30, OMXC20, OMXH25, OSEBX and OMXI15 for the UK, Sweden, Denmark, Finland, Norway, and Iceland respectively. Since the aim of the thesis is to detect value creation based on a sample of firms over a period of time an aggregation of the daily abnormal returns is necessary. For this purpose the cumulative abnormal return (CAR) is calculated both over time and across securities. In relation to testing for abnormal performance by means of stock prices the following statistical tests are performed: Parametric t-test Non-parametric tests: o Rank test o Sign test o Generalized Sign test In the parametric t-test the null hypothesis of no abnormal performance is tested by means of whether or not the average CAR is significantly different from zero. This parametric t-test is conducted for the entire sample as a whole and also for each of the strategies. A parametric test is subject to some assumptions that might influence the robustness of the results. The assumptions are presented in section The main advantage of non-parametric tests is the fact that no assumptions are attached and the results are robust regardless of possible problems in relation to the parametric test. According to Cowan (1992) another important motive for including non-parametric tests is the fact that when thin trading is present in the sample, violation of the 6

11 An empirical study of the value creation in M&A in relation to the strategic rationale assumptions that characterize the parametric test is more likely and thus non-parametric tests are justified. The Rank test conducted in this thesis is based upon Corrado (1989). In the Rank test all abnormal returns for each security in the estimation period and in the period of analysis are ranked with the lowest rank corresponding to the lowest abnormal return and the highest rank the highest abnormal return. 2 The expected rank of the event day is the median rank plus 0.5. In order to test for abnormal performance, under the null hypothesis it is tested if the expected rank is equal to the rank at the event day. The Sign test is conducted in line with Corrado and Zivney (1992). The Sign test is based upon the assumption that the probability of observing a negative or a positive abnormal return is the same - that is 0.5. In performing the test the sign for each daily abnormal return is traced which is done by first obtaining the median abnormal return for each security and afterwards for each day in the sample the sign is obtained by subtracting the median abnormal return from the actual abnormal return. If obtaining a positive sign the observation is given the value 1, a negative sign is given the value -1 and finally in cases where the actual abnormal return is equal to the median abnormal return the observation is given the value 0. Under the null hypothesis the probability of observing a positive cumulative abnormal return is the same as observing a negative abnormal return. The Generalized Sign test is based on Cowan (1992). The main difference from the Sign test included in this thesis is that in the Generalized Sign test, the probability of observing a negative or a positive abnormal return is estimated based on the actual returns observed in the estimation period. Thus in conducting the Generalized Sign test, the probability of observing a positive abnormal return around the event day is compared to the probability of a positive abnormal return in a period unaffected by the event (the estimation period). Under the null hypothesis of no abnormal performance the number of securities with positive abnormal returns in the event window is equal to the number that is expected in the absence of an event. After having performed the parametric and non-parametric tests for abnormal performance a F-test is performed to determine if any differences between the strategies 2 In case of the event period being analyzed the estimation period and the event window consist of 261 abnormal returns. These are ranked from 1 to

12 An empirical study of the value creation in M&A in relation to the strategic rationale can be traced. The F-test indicates if a difference is detected, however, it does not determine where the difference is observed. Therefore, three pair wise difference tests are also concluded, that is the Fisher s Least Significant Difference (LSD) method, the Bonferroni adjustments to LSD method, and the Tukey Multiple Comparison Method. All tests for abnormal stock price performance are conducted for each strategy as well as for the total sample. A significance level of 5% is applied; however, tests that yield significant results with a 10% significance level are also commented Measuring performance based on operating measures The analysis of operating performance is conducted in line with the method specified in Barber and Lyon (1996). In the analysis of performance based on accounting figures six operating measures Return on assets (ROA) based on both EBIT and EBITDA, return on sales (ROS) based on both EBIT and EBITDA, cash flow return on assets and Tobin s Q - are tested in order to detect any abnormal performance in the sample. To test for abnormal operating performance the following tests are applied: Parametric t-test Non-parametric test o Wilcoxon Signed Rank test To observe any abnormal performance a measure for the normal performance is constructed - in this case a benchmark for each security is created as the measure for normal performance. The benchmark is constructed on the basis of the ROA in the year prior to the event. For each deal within each year the ROA is observed and a benchmark group is established based on all securities with a ROA of ±10% of the ROA in question. The median observation from the benchmark group is observed and applied as the benchmark. The benchmark group is kept constant throughout the analysis and a benchmark for each security, for each operating figure and in each year is observed as the median observation in the benchmark group. If no observations fall inside the ±10% of the ROA a benchmark is obtained as the median between the observation itself and the security with an ROA the closest to observation in question. After constructing the benchmark any abnormal performance is detected in the following way. The performance of each company is measured as the difference between accounting figures in two years and in the same way, the performance of the 8

13 An empirical study of the value creation in M&A in relation to the strategic rationale benchmark is the difference between the benchmark corresponding to the accounting figures in question in the same two years. Finally the abnormal performance is the difference between these two differences. The tests for abnormal operating performance are performed in the event year and the three years following the event. Abnormal performance is in all cases the difference between the performance in the year prior to the event and the year in question. The event year is determined as the accounting year in which the transaction is completed. The parametric t-test that is performed to detect abnormal operating performance is in line with the parametric test described above regarding stock prices. The main difference is the construction of the normal performance, which in this case is based on a benchmark as described above. The null hypothesis in this t-test is zero abnormal performance, which corresponds to the average cumulative abnormal performance being equal to zero. In analysing abnormal performance based on operating figures a potential problem with extreme observations (outliers) may influence the test. According to Barber and Lyon (1996) this potential problem can be overcome by applying winsorized data in which extreme observations that fall outside the 1 st and 99 th percentiles are replaced by the 1 st and 99 th percentile respectively. The non-parametric test of performance Wilcoxon Signed Rank test - is constructed in line with the method applied in Wilcoxon (1945) and Lowry ( ). First, the sign of the abnormal performance for each security is determined. Second, the observations are ranked regardless of their sign as the absolute values of the abnormal performance. The signs are giving back to the ranks in order to test if the sum of the positive ranks is the same as the sum of the negative ranks. In this case the null hypothesis is that the sum of both positive and negative ranks is zero in which case no abnormal performance is detected. The null hypothesis is tested by means of the standard normal distribution. The tests specified above are conducted upon the entire sample of companies as a whole as well as upon each strategy. A significance level of 5% is applied; however, tests that yield significant result with a 10% significance level are also commented. 9

14 An empirical study of the value creation in M&A in relation to the strategic rationale 2.3. Preparation and selection of data When performing an event study, the selection and preparation of the data is extremely important, therefore, the next section is an elaboration on the collection of the sample on which the analysis is performed. The database Zephyr was used to select the overall sample. It is a database that contains information about deals in relation to company transactions. By means of the information provided by Zephyr a crude sample based on the following criteria was selected: 1) The acquiring company was based in either the UK or Scandinavia (Denmark, Finland, Iceland, Norway, and Sweden) a criteria set up in order for the thesis to possibly serve as a counterpart to analysis performed on US data. 2) For a deal to be included the announcement date and the completion date should be in an interval from the beginning of 2000 to the end of 2004 this criteria was set up to ensure the most recent data in which a three year post event period was available. 3) A deal value larger than EUR 75mio. (Only deals with an available actual deal value are included). The smallest deals were excluded by this criterion which was set up as a response to a presumption that with respect to the smallest deals it would be difficult to obtain adequate documentation for the chosen strategy. 4) Only Mergers and Acquisitions were included in the sample. 5) The current deal status should be completed. The crude selection above yielded a sample of 1194 deals. The deals in which the acquiring company after completion had an ownership share of the target of less than 97,5% or an ownership share of more than 20% of the target prior to the deal were excluded from the sample which was reduced to 959 deals. The next step in preparing for the event study analysis was to sort the 959 deals based on the strategic rationale. The sample is divided into the following six strategies: The Overcapacity M&A (Overcapacity) The Geographic Roll-up M&A (Geographic) The Market Extension M&A (Market) The Product Extension M&A (Product) 10

15 An empirical study of the value creation in M&A in relation to the strategic rationale The M&A as R&D (R&D) The Industry Convergence M&A (Convergence) The motivation for this division is Bower (2001), however, he only operates with five different strategies where The Product Extension M&A and The Market Extension M&A are one strategy Product or Market Extension M&A (Product + Market). The rationale for dividing this strategy is a presumption that the result from Product is potentially different than that of Market. In order to keep this research in line with previous research the tests are also conducted for the combined strategy. The characteristics for each strategy are in line with those described in Bower (2001) and the overall criteria will be presented later on in section 9.1. In determining the underlying strategy behind each transaction the rationale or the motivation for the transaction were determined based on different sources of information web-pages, articles, annual reports, press releases etc. If documentation for the strategy of a specific deal was not available the transaction was excluded from the sample. For each deal with a documented strategy the stock prices and the accounting figures was collected from Datastream and Amadeus / Orbis In order for a transaction to be included either stock prices or accounting figures had to be available, thus in cases when neither was available the particular deal was excluded from the sample. Seeing that only stock prices or accounting figures are a requirement the final sample for each of the two analyses are not the same. In case of the analyses performed based on stock prices the final sample consists of 410 deals and the sample for the analyses of operating performance consists of 389 deals. The documentation for the chosen strategy is submitted in appendix A. From Datastream a time series of daily stock prices is collected for each deal containing quotes in the interval ranging from 250 days before and until one year after the announcement day. The time series is adjusted in order to exclude holidays from the sample in thereby only actual possible trading days are included. Due to thin trading a stock need to be traded at least 30 days of the 250 days in the estimation period in order to be included. The choice of a minimum of 30 days is made to ensure the power of the estimation model. To perform the analyses the data for the estimation period needs to be available; however, in some cases the acquiring companies stock is not available in the 11

16 An empirical study of the value creation in M&A in relation to the strategic rationale entire period of analysis. The deal is included anyway and the analyses are performed only on the period available. From Amadeus / Orbis accounting figures for each deal is collected from a year before the transaction and until three years after the transaction, and in addition Total Assets are collected two years before the event due to the construction of the performance measures. The accounting figures need not be available in all three years after the transaction in order to be included. All tests that are conducted in this thesis are carried out in Excel or SAS. The preparation of the data is performed in Excel and the actual tests are conducted in SAS. The reason for applying SAS in this thesis is the programs ability to process extensive data. The analyses are performed by means of the IML procedure a matrix procedure that facilitates work with complex data, where a procedure is repeated numerous times. Throughout the thesis references to the relevant spreadsheets and codes is present in the beginning of each section. The remainder of this thesis is structured as follows. Section 3 is a description of the main conclusion from previous studies in relation to value creation and M&A activity. In section 4 to 8 the event study method is presented for both stock prices and operating figures, and furthermore, the choice of research approach is discussion and evaluated. A description of the data that is included in the analysis is presented in section 9. Section 10 presents the main hypotheses in relation to the analysis performed in this thesis. The empirical results in relation to detecting abnormal stock price performance are present in section 11, while section 12 presents the empirical results corresponding to the abnormal operating performance. Finally, before the concluding remarks, section 13 consists of an evaluation of the research approach and an attempt to detect possible pitfalls in relation to the empirical work in this thesis. 12

17 An empirical study of the value creation in M&A in relation to the strategic rationale 3. Results from previous empirical studies on value creation in M&A The aim for the companies when engaging in a merger or an acquisition is primarily value creation and according to Jensen and Ruback (1983), managers also compete to gain control over as many company resources as possible and thereby create a better market position for their company. Harford (2005) concludes that economic, regulatory and technological factors have an impact on the creation of a merger wave, which is defined as a cluster within the M&A activity. One of the factors, which had a significant impact within the European market, was the introduction of the Single Market in 1992 as well as the single currency in These actions were followed by deregulations and privatization, which increased the competition between European companies and lead to a prolonged bull effect within the stock market. All these aspects affect the willingness of European companies to engage in mergers and acquisitions. Two merger waves have been detected, concerning the European market - a small one during and another one during 1995 to (Sudarsanam, 2003) When examining the impact that a merger or an acquisition has on a company the general result, according to MacKinlay (1997), is that the shareholders of the target company gain large positive abnormal returns whereas the shareholders of the acquiring company gain close to zero abnormal return. This result if found by use of either the daily stock prices or the accounting figures. Jensen and Ruback (1983) used the stock data and divided the shareholders into two groups and concluded that the shareholders of the target company gained abnormal performance and as well did the shareholders of the acquiring company when analyzing the impact in the short-run one month around the announcement. Loderer and Martin (1990) supported this conclusion. They examined the abnormal returns within an interval of 6 days around the announcement day and did also conclude that the overall result was a minor positive abnormal return. Loughran and Vijh (1997) examined the long-term abnormal return and concluded a loss in value seen from the perspective of the acquiring company. Both Agrawal et al. (1992) and Loderer and Martin (1992) also documented negative abnormal performance in relation to the acquiring company concerning the long-term abnormal performance. 13

18 An empirical study of the value creation in M&A in relation to the strategic rationale The studies mentioned are all conducted based on US companies and within the period of 1962 to However, Franks & Harris (1989) and Goergen and Renneboog (2004) documented that also in the UK, positive abnormal returns are present in the short-run. The expectation of negative abnormal returns in the long-run in the UK market was supported by Franks & Harris (1989) and Baker and Limmack (2002). The analyses conducted by means of analyzing the abnormal operating performance are divided into two groups those using the earning based measures and those using cash flow based figures. Ravenscraft and Scherer (1987) used both approaches and concluded that when measuring the performance by use of accounting profitability a decline in wealth was detected, whereas when basing the analysis on cash flow no decline was found which was supported by Ghosh (2001). Meeks (1977) also documented a decline in the UK company value when measuring the performance by means of accounting profitability figures. Manson et al. (1994) use the cash flow performance measure and document an improved performance within the UK companies after a merger or an acquisition. Investments in R&D are considered to be a management or an investment decision and not a decision to raise capital and are often not publicly announced as a repurchase of stocks or a merger, whereas it often is not detected before the financial reports are published. Daniel and Timan (2001) argue that due to the fact, that R&D investments are intangible assets, investors find it hard to process such information whereas the market takes time to incorporate the value of such an investment, which supports the statement that the stock market does not incorporate the correct value of an R&D investment in the short run presented by Eberhard et al. (2004). Furthermore, they argue that the positive abnormal operational performance, due to the increase in R&D, can be detected in the long run. Based on the studies presented above it seems likely to detect the same tendencies within the British and the Scandinavian companies included in this thesis. 14

19 An empirical study of the value creation in M&A in relation to the strategic rationale 4. Event studies Ball and Brown (1968) and Fama et al. (1969) introduced the event study methodology that is essentially used today and it has become the preferred method when measuring performance induced by an event. The notation event study methodology has come to refer to different procedures for estimating abnormal returns. Examples of such events are earnings announcements, issues of new debt, macroeconomic announcements or acquisitions. In an event study the objective is to measure the effect of a specific event upon the value of the firm - this can be measured by the change in stock prices. One advantage of event studies is that the methodology is applicable for various purposes and it is fairly simple to implement. Since the early literature about event studies was published by in particular Brown and Warner (1980, 1985) the application of the event study methodology have extended and these papers have inspired the main part of the research literature that have been published in recent years. Seeing that an event study is an examination of the effects of a certain event upon the value of the firm, the first thing to do is to determine what is meant by an event in this thesis the event is defined as the time of the announcement of a merger or an acquisition. In order to detect if any value is created as a result of the event it is necessary to detect abnormal performance. To detect abnormal performance a measure for the normal performance needs to be constructed. The normal performance is the performance that would be expected in the absence of an event. In order to perform a test trying to detect abnormal performance by means of an event study attention must be paid to the Efficient Markets Hypothesis (EMH). According to Fama (1970) the EMH is available in three forms - Weak, semi-strong and strong - depending on how information is incorporated into stock prices. When assuming the weak form, it is expected that all historical information be reflected in the stock prices. The semi-strong form assumes that all public available information is incorporated into the stock prices and lastly, the strong form expects all information public as well as private to be incorporated into the stock prices. Elton et al. (2003) as well as Fama (1991) conclude that the financial markets are efficient and it is not possible to consistently earn an abnormal return, because all available information is incorporated into the security prices immediately. 15

20 An empirical study of the value creation in M&A in relation to the strategic rationale 5. Measuring abnormal performance based on stock prices The description of the event study procedure for stock prices is outlined in the following way: First, a definition and a determination of the estimation period, the event day and the event window are presented. Second, the expected or normal return and afterwards the abnormal return is defined and estimated, and finally the tests for abnormal performance are presented Estimation period, event day and event window When setting up an event study it is important to consider the choice of estimation period, and event window (presented in figure 5.1). The estimation window is the period over which the market model is estimated. The estimation of the market model is applied to determine the normal or expected return in the absence of an event. In order for the market model to represent the normal return the estimation period has to be set to a period that is ideally unaffected by any abnormality. In this event study the estimation period is set to a 250-day period immediately prior to the first day in the event window that is about a year of trading prior to the event window. Consistent with MacKinlay (1997) it is generally recommended that the event window is excluded from the estimation period in order to make sure that the event does not influence the estimation of the market model. In prior research literature the length of the estimation window varies but according to Armitage (1995), an estimation period of about 100- days prior to the event window is sufficient though it is common to choose an estimation period between 200 and 300 days. In accordance to Dodd & Ruback (1977) the event day is set to the day of the announcement of the deal and not the day the deal is completed. According to the efficient market hypothesis new information will be incorporated in the stock prices 16

21 An empirical study of the value creation in M&A in relation to the strategic rationale immediately and therefore the announcement day 3 is the day in which the stock prices will react. The announcement day is registered from Zephyr, which is considered a reliable source of information in relation to correctly determining the announcement day. In fact the determination of the announcement day is critical in conducting an event study, since this day is the reference day against which abnormal performance is detected. In expecting that the efficient markets work perfectly it would have been sufficient to restrain the event window to include only the event day. However, according to Elton et al. (2003) the stock prices might react over time and not just on the event day. When examining the time interval around an announcement it is common to detect abnormal returns on both sides of the event day. The reason for abnormal returns appearing after the announcement day can be due to either the fact that the announcement took place too late in the day for the market to fully react or because it took time for the information to be reflected in the stock price. Explanations for the abnormal returns being present prior to the announcement day could be that before an announcement is made a news release is posted to notify the public about the upcoming event. This action would in an efficient market be reflected in the stock price prior to the actual announcement. Another explanation could be that information about the announcement is leaked to the market. The above mentioned, supports the assumption of a semi-strong form of the efficient market hypothesis and therefore, the event window in this thesis is set to ± 5 days of the event day. Another reason for choosing an event window of 11 days is the fact when thin trading occurs a security might not be traded on the announcement day and therefore, if only including the event day it is likely that an effect will not be detected Creating a benchmark for the normal performance Different alternatives are available when creating the benchmark to be used as a measure for the normal performance (expected return) both statistical and economic methods. In this thesis the measure for the normal return is created on the basis of the market model. This choice of benchmark model is in line with recommendations from 3 The day a deal becomes publicly known. 17

22 An empirical study of the value creation in M&A in relation to the strategic rationale several research papers in particular Brown and Warner (1985), Barber and Lyon (1997), and Bartholdy et al. (2007). The market model is a statistical model that relates the return of a given security to the return of a market portfolio and in estimating the normal return a linear regression is estimated based on ordinary least squares (OLS). In this thesis the market portfolio is chosen as the market index in the acquirer s home country that is, as mentioned, FTSE 100, OMXS30, OMXH25, OMXC20, OMXI15, and OSEBX. The market model assumes a linear relation between the security return and the market return and under the presumption that a particular security correlates with the market index the expected return is derived from the market index for the country in question. The market model is estimated by use of the estimation period, and the parameters α and β from the OLS estimation, are derived for each security. The abnormal return is afterwards calculated as the difference between the actual return for the security and the expected return based on the market model. These abnormal returns are calculated for each security at each point in time over the period of analysis Choice of tests Parametric or Non-parametric Event studies can as mentioned earlier be conducted by means of both parametric and non-parametric tests. As concluded by MacKinlay (1997) and in accordance with most research literature a test for abnormal returns induced by an event should consists of both types of tests. A parametric test is a statistical test, which is subject to certain assumptions in relation to the distribution. It is assumed that the abnormal returns are normally distributed and if the assumptions hold the power of the parametric test is large and outperforms the power of the non-parametric tests. Nevertheless, in cases when the assumptions are violated the non-parametric test should be used instead of a parametric test because the main advantage of non-parametric is that the distribution of returns is not required to be normal. In addressing the potential problem of violation of assumptions the use of both parametric and non-parametric tests allow the researcher to verify the robustness of the parametric test. 18

23 An empirical study of the value creation in M&A in relation to the strategic rationale Abnormal performance based on stock prices is tested by means of the following four tests: Parametric t-test Rank test (Corrado, 1989) Sign test (Corrado and Zivney, 1992) Generalized Sign test (Cowan, 1992) These four tests are presented afterwards as well as the motivation for including the specific test. Focus will be upon the most essential aspects of each test and not a complete presentation of each aspect. The research approach in this thesis is in full agreement with tests performed in other event studies trying to detect abnormal performance in stock prices The parametric t-test Overall parametric t-tests for abnormal performance are based on calculating the difference between two means and if transferred to this specific research problem the question is whether or not the abnormal returns are significantly different than zero. Under the null hypothesis of no abnormal performance no difference between means can be detected. In accordance with the research question the purpose of this thesis is not an examination of the effects of M&A on a specific acquiring company, instead the purpose is to examine whether or not an effect can be detected based on a group of companies motivated by the same strategy. In order to examine the general effects of mergers and acquisitions the abnormal returns calculated for each company at each point in time need to be aggregated both through time and across companies. As mentioned above, the abnormal return is calculated for each security at each point in time by subtracting the estimated normal return from the actual return. In MacKinlay 4 (1997) this is calculated as: AR i,t = R i,t + α i - β i R m,t In aggregating the abnormal returns it becomes possible to observe overall inferences for the event. The aggregation of daily abnormal returns is measured by the cumulative abnormal return (CAR). CAR is measured for each security as well as across securities as an average cumulative abnormal return by summing the daily abnormal returns for each security in the case of CAR and by summing the average daily abnormal returns 4 α and β are the parameters estimated in the market model 19