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2 1. Introduction Corporate finance research frequently concentrates on the issue how decisions of corporate managers and external market events affect shareholder wealth. The maximization of shareholder wealth is one of the central objectives corporate managers aim for, not least because shareholders, as legal owners of the respective corporations, incentive them to do so. Consequently, research on corporate decision making has largely dedicated itself to the broad scope of corporate decisions regarding financing and investment options corporate managers face. Financing comprises the wide set of issues concerning the satisfaction of corporate capital requirements by, e.g., internal financing, bank loans, bond issues, so as primary and secondary equity offerings at the stock markets. Investment decisions focus on how corporate funds are used to ascertain operative business performance and achieve strategic goals. Thus, funds are used to, e.g., perform research and development, acquire machinery and equipment, extend production facilities, expand into foreign markets, or involve into mergers and acquisitions (M&A). In addition to organic growth, M&A transactions enable corporations to, a.o., achieve business expansion at an accelerated pace, diversify a potentially risky portfolio, achieve cost synergies, or obtain access to new investment opportunities. Apart from internal decision making, shareholder wealth is also affected by external events to the corporation. These external events may impact the economy as a whole but most probably impact certain corporations more than others due to geographical location, industry affiliations, or company specific characteristics like financial leverage, diversification degree, cost structure, or private versus public ownership. Hence, corporate finance scholars have also dedicated a considerable amount of their research effort to scrutinize how expected and unexpected external events impact shareholder wealth. Among expected events one understands, e.g., the scheduled announcements of GDP growth rates, unemployment rates, federal fund rate adjustments at regular meetings, election outcomes, or newly enacted laws. All these may in fact carry some unexpected information, too, as announcements can exceed or fall below expectations. Nonetheless, they clearly distinguish from truly unexpected events such as major corporate or bank failures, natural catastrophes, terrorist attacks, or nuclear power plant disasters like those of Chernobyl or Fukushima. One econometric method to analyze the effect of events on shareholder wealth that has been very popular among financial economists over the past decades is the event study. Corrado (2011) provides an extensive overview of the refinement of the event study methodology over more than forty years. Since the

3 2 Introduction landmark papers by Ball and Brown (1968) and Fama et al. (1969) this methodology has been one of the central workhorses of financial researchers and also migrated to other disciplines like economics, marketing, and management so as law, history, and political science. The economic skeleton of the financial event study is based on the market model that in itself derives from the capital asset pricing model (CAPM) of Sharpe (1964). To simplify, the respective theory presumes that a stock s daily return depends on the general market return, and the relationship is described by the beta-factor. Beta is also denoted as the systematic risk indicator implying that the more risk a stock carries in relation to the market the higher is its expected return. Under the assumption that beta is stable throughout time, one can determine abnormal returns around the event under investigation subtracting actual returns from expected returns dependent on actual market returns. The statistical testing of the abnormal returns enables the scholars to draw a conclusion on potential shareholder wealth effects induced by the event under examination. However, the assumption that the beta-factor as systematic risk estimator is stable throughout time has sparked off a wide discussion among financial economists. E.g., Jagannathan and Wang (1996), Collins, Ledolter, and Rayburn (1987), Bos and Newbold (1984), Sunder (1980), and Fabozzi and Francis (1978) have argued against the assumption of beta stability, and have shown that beta is actually stochastic and thus conditional. In such a setting beta may also be determined as the product of an asset-to-market correlation coefficient and the asset s volatility divided by the market s volatility. Engle (1982) and Bollerslev (1986) found that financial stock market data follows certain stylized facts among which volatility clustering over time is highly prevalent. There are time periods of high volatility and others of low volatility showing that the autoregressive characteristic of daily volatility estimates cannot be neglected. Consequently, they developed a model to estimate daily volatility measures incorporating mean reversion, the previous day s volatility measure, as well as the respective stock return. The generalized autoregressive conditional heteroscedasticity (GARCH) model thus enables scholars to estimate daily volatility changes and, as a subsequent step, daily adjustments in the systematic risk estimator beta. The studies discussed in the main part of this book all concentrate on shortterm risk adjustments applying the above elucidated GARCH model. My findings on risk changes add to previous evidence applying event study methodology which in many cases leads to the observation of significant abnormal returns. The new perspective on, e.g., the systematic risk estimator beta uncovers that the assumption of a constant beta over time can result in erroneous statements of shareholder wealth effects. As positive and negative abnormal returns are de-

4 Introduction 3 termined it is common practice to derive conclusive statements on increased shareholder wealth or destruction of the same. However, when the risk analysis returns evidence of an increase or decrease in the beta-factor this critically affects the consolidated effect on shareholders wealth. Exemplarily, a beta risk increase may offset a positive abnormal return as the basic assumption underlying the latter is a stable systematic risk factor. Any combination of zero, positive, and negative abnormal returns and risk changes may occur which can potentially result in offsetting or enhancing wealth effects. There may of course also be no interference. In the five consecutive studies this dissertation comprises I address the implications on shareholder wealth of two strategic investment decisions of corporate managers and of two external events. The respective research titles are: I. Does Vertical Diversification Create Superior Value? Evidence from the Construction Industry II. III. IV. How Consolidation Changes the Risk Profile of a Whole Sector: Evidence from the Brewing Industry Bank Failures and Real Estate Investment Trust (REIT) Returns Bank Bailouts: REITs and their Performance as Financial Stocks V. Banking Crisis and Government Intervention: How Bailouts versus Failures Affect Financial Stocks The first two studies concentrate on systematic risk changes and build upon previous evidence that has yet identified abnormal returns. The first study sheds light on the decision making process corporate managers of construction companies face when they pursue a M&A transaction which urges them to choose between horizontal (predominant business), vertical (related business), or lateral (unrelated business) diversification. The second study sheds light on the strategic investment decision brewing managers face in a contracting market and a strongly consolidated industry where M&A target companies are scarce and competition for these is fierce. The other three studies concentrate on external events induced by the recent financial crisis starting in 2007, measuring the effect of U.S. bank failures and bank bailouts on REITs and other financial stocks. Study three examines a set of 130 bank failure dates and their impact on REIT mean returns and beta risk to potentially uncover whether REITs as hard assets outperform common equities

5 4 Introduction during times of high market uncertainty. Study four shifts focus to the opposite event, being bank bailouts, and examines if moral hazard theory is supported by positive systematic risk changes and REITs as hard assets here devalue relative to other equities. Finally, study five builds upon the reverse findings of studies three and four and extends the scope to the general financial services industry. Incorporating a second major stylized fact of financial return data, the asymmetry in volatility reaction to positive and negative return shocks, the exponential GARCH (EGARCH) is applied to even better observe the opposing effects of bailouts and failures on stock return volatility and beta. In the subsequent paragraphs the reader will be provided with some more detail on the chapters of this dissertation, elucidating the background, relating the respective research questions to previous evidence, reporting core findings, and commenting on general implications. Study I, chapter 2 Corporate Diversification Strategies The discussion of diversification discounts is one of the most controversial in corporate finance and strategic management. I am eager to reexamine this issue from the standpoint of vertical versus lateral diversification, and horizontal growth through construction industry M&As. I build on previous evidence of positive acquirer abnormal returns for vertical M&A, and I add new insight into stock return risk. Considering the high idiosyncratic risk levels of builders, I expect to find considerable informational content in systematic risk (beta) behavior, which has been neglected to date. In fact, I find that vertical M&A experience a negative asset beta shift, lateral M&A experience an increase in systematic risk, and only horizontal M&A exhibit no risk changes. Hence, risk and return-induced wealth creation from vertical M&A shows that related industrial diversification (vertical M&A) is superior to unrelated (lateral M&A) at least in the construction industry. Study II, chapter 3 Consolidation and Rival effects Consolidation has been and continues to be a major trend in the brewing industry as multi-national breweries, in an attempt to offset the decline in beer volumes in mature markets (in particular Western Europe), seek to expand their activities into new emerging markets. I analyze short-term risk implications of horizontal M&A on acquirers and rivals in the brewing industry. Based on a sample of 75 takeover announcements between 1998 and 2010, I document significant negative acquirer abnormal risk shifts for cross-border transactions, especially when targets are in emerging markets. Furthermore, I document evidence of significant abnormal negative risk shifts to the big four (Anheuser- Busch Inbev, SABMiller, Heineken, and Carlsberg) when announcing a M&A and significant positive abnormal risk shifts when missing out on a potential

6 Introduction 5 M&A as rivals. Thus, my study shows that consolidation may result in contrary risk implications on different industry players. Study III, chapter 4 Bank Failures and REITs I reexamine the case whether Real Estate Investment Trusts (REITs) behave rather comparable to common equities versus to real estate. Bredin, O Reilly, and Stevenson (2007) analyze monetary rate increases, as external shocks, increasing the price of liquidity. They find decreasing REIT returns and increasing risk levels similar to common equities. I introduce bank failures, which can be contagious, as an internal shock that may decrease liquidity supply. My results show that Equity REITs in general and especially Retail, Residential, and Healthcare REITs experience positive abnormal returns relative to common equities. This implies that market participants regard Equity REITs comparable to direct real estate which as hard asset is seen as safe haven during turbulent times. In contrast, indirect real estate investments like Mortgage REITs devalue. I show that primarily the capital investment type but also property focus are major determinants whether REITs behave like real estate versus common equities during crisis. Study IV, chapter 5 Bank Bailouts and REITs Previous evidence on monetary policy finds positive value effects on REITs when federal fund rates are decreased in order to strengthen the market s liquidity pool. Bank bailouts can also be seen as positive monetary shocks to capital markets as government intervention restores bank liquidity and by this market liquidity. However, empirical evidence on moral hazard shows that bailing out banks may weaken risk adversity and potentially benefit relatively risky assets. Therefore, I expect REITs as hard assets to be outperformed by the market on a short-term scope. In fact, I find supporting evidence, i.e., negative abnormal returns and beta risk increases for Equity REITs around the bank bailout announcements. This extends my previous research on bank failures and REIT returns where positive abnormal returns around bank failures prescind Equity REITs as a safe haven in times of market uncertainty. Furthermore, I complete my research by investigating other financial stocks, finding comparable results. Study V, chapter 6 Banking Crisis and Government Intervention After the devastating bankruptcy of Lehman Brothers the U.S. government announced a bailout program of unprecedented size to prevent a cascade of bank failures and by this a potential meltdown of the total system. The intention was to calm down financial markets preventing a spillover effect on the real economy. I analyze the effects of bank bailouts, controlling for failures, on the financial services industry (FSI) to scrutinize if government intervention properly calmed markets without benefitting financial stocks. I find FSI subsectors react

7 6 Introduction ambiguously to bank bailouts: while banks show two-sided significant abnormal returns, insurances react positively and REITs negatively. Reverse effects are found for bank failures. EGARCH (1,1) estimated variances generally decrease around bailouts indicating enhanced system stability. However, beta strictly increases around government intervention and offsets any respective positive FSI valuation effects. Policy makers should be aware that short-term stability comes at the price of increased systematic risk. I draw three main implications of my research that are relevant to corporate managers so as corporate and private investors. First, optimal diversification at the firm level is different from that of individual (private) investors. Corporate managers should possess exceptional expertise in their area of business and I find it to be valuable to limit diversification efforts to related businesses. Unrelated or wider diversification should only be done by the uninformed investor who is commonly the private investor optimally holding a mixed portfolio of (all) stocks and risk free securities. Second, my research shows that corporate managers face rigorous capital markets when their companies find themselves in the highly competitive environment of a declining market. Missing out on potential growth opportunities can result in a harmful two-sided worsening of their stocks risk-return profile. To ensure the survival end enforce the competitive advantages of their companies corporate managers must excel in their efforts to realize growth opportunities either via horizontal M&A or, if missing out, via an adjustment of their corporate strategy. Otherwise, they will destroy shareholder wealth relative to their rivals. Third, my analyses on REITs show that they should not unambiguously be seen as hard asset and save haven investment in times of high market uncertainty. In fact REITs can generally behave very much like common stocks and less like conventional real estate especially during times of crises. Nevertheless, Equity REITs and among this type low risk Residential and Healthcare REITs clearly outperform common equities around bank failures that increase market uncertainty. As real estate is core to private investments and most businesses it is vital to understand that REITs may differentiate substantially from pure real estate values and only certain REIT types carry the hard asset and save haven properties.