The Effects of Mergers

Burcin Yurtoglu
University of Vienna
Department of Economics

Three sets of consequences of mergers

1) They can affect the performance of the merging
firms such as
Profits, growth rates, markets shares, productivity, ...

2) They can affect industry and aggregate

concentration levels.
3) They can affect social welfare
-

As a result of (1) and (2)

Profitability
Major Studies
Ravenscraft and Scherer (1987) analyze 6000
mergers between 1950 and 1977.
Meeks (1977) 1000 mergers after WW II in the UK.
Gugler, Mueller, Yurtoglu, and Zulehner (2003)
analyze 2753 mergers from around the world.

Ravenscraft and Scherer (1987)

They regressed the profits of individual lines of business
in the years 1975-77 on industry dummies and a variable
that measured the fraction of the line of business that
had been acquired since 1950.
They also controlled for other aspects of mergers
Hostile vs friendly
Market share
Accounting convention: pooling vs purchase accounting

The profit rates of the acquired lines of business were

2.82 % below those of non-acquired units

A typical regression equation

Profit rate 75-77 = [257 Industry dummies] + 0.68 POOL
- 2.82* PURCH + 0.84 NEW + 1.46 EQUALS
+ 30.15* SHR - 3.65 HOSTILE - 3.77 WHITE
-2.23 OTHER
Adj. R2 = 0.182
N = 2,732

GMYZ (2003): Prediction of Sales

S C tn

S G t 1

S Ct n S G t 1

S IG t n
S IG t 1

S IG t n
S IG t 1

S Dt

S Dt

S ID t n
S ID t

S ID t n
S ID t

S Dt 2

S ID t n
S ID t 2

S S t 3

S IS t n
S IS t 3

GMYZ (2003): Prediction of Profits

IG t 1,t n

IG t n
K IG t n

C t n G t 1

C t n G t 1
D t 2

K IG t n
K IG t 1

K IG t n
K IG t 1
K ID t n
K ID t 2

IG t 1
K IG t 1

K G t 1 IG t 1, t n D t

K G t 1 IG t 1, t n D t

K ID t n
K ID t

K ID t n
K ID t

K D t 2 ID t 2, t n S t 3

K D t ID t , t n

K D t ID t , t n

K IS t n
K IS t 3

K S t 3 IS t 3, t n

GMYZ (2003): Main results

Profits
Years
after
the
merger

Number
of
Mergers

Difference
in Mn $

t+1

2,704

t+2

Sales

p-value

%
Positive

Difference
in Mn $

pvalue

%
Positive

5.91

0.062

57.0%

-214.16

0.000

51.5%

2,274

11.11

0.009

57.2%

-382.81

0.000

49.5%

t+3

1,827

10.79

0.056

54.8%

-549.59

0.000

46.4%

t+4

1,517

19.68

0.007

57.8%

-633.46

0.000

46.3%

t+5

1,250

17.81

0.046

57.6%

-714.04

0.000

44.6%
8

Analysis of variance in year t+5 by country

categories
Country/country group

Profits
Difference in Mn $

t-value

Sales
Difference in Mn $

t-value

Average

17.8

2.00

-714.0

6.63

USA

-0.4

0.33

-16.2

0.70

UK

6.3

0.38

168.3

1.13

Continental Europe

24.5

0.37

47.6

0.55

Japan

-59.4

0.85

-1615.0

1.83

Aus/NZ/Can

-51.4

1.32

-91.4

0.45

Rest of the world

98.1

1.26

432.5

0.63

Adjusted R

-0.0006

0.0003

Number of Observations

1,250

1,250

Analysis of variance in year t+5 in the

manufacturing sector by merger categories
Category

Profits
Difference
in Mn $

t-value

Sales
Difference
in Mn $

t-value

Average

3.1

0.27

-660.0

5.19

Horizontal

38.7

2.07

464.1

2.25

Vertical

-91.4

1.82

-329.1

0.59

Conglomerate

-9.0

1.13

-164.7

1.87

Adjusted R
Number of
Observations

0.0066

0.0045

702

702

10

Market Power or Efficiency

S 0
S 0

1
Efficiency
Increase

3
Market Power
Reduction (?)

2
Market Power
Increase

4
Efficiency
Decline
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S > 0

S < 0

> 0

< 0

Small

34.7

17.5

Large

23.4*

12.7*

All

29.1

15.1

Small

20.4

27.4

Large

34.8*

29.1

All

27.6

28.2
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Effects on Market Shares

Mueller (1985, 1986) examined the effects of mergers for
a sample of 209 acquired firms from the 1,000 largest
companies of 1950 in the USA.
The methodology compared the market shares of firms
acquired between 1950 and 1972 with those of nonacquired firms of similar size in the same industries
Typical regression equation:
mi 72 = 0.011* + 0.885* mi 50-0.705* Dmi50
N =313
R2 = 0.940
D : a dummy variable for acquired firms.
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Mergers Effects on Productivity

Lichtenberg and Siegel (1987)
between 1972 and 1981 productivity fell in plants
before an ownership change and rose afterward
spin-offs of plants obtained in previous mergers

Baldwin (1981)
similar results for Canada

McGuckin and Nguyen (1995)

Plant productivity increases following mergers in the
USA

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Mergers Effects on Firm-level Employment

If a merger results in an optimal employment level different from the

total employment of the merging firms, then a profit maximising firm
will adjust its labour force via an active policy of hiring or firing.
Dynamic models of labour demand place great emphasis on the
costs of this adjustment process.
In general, the a priori predictions on the effects of mergers on
labour demand are ambiguous:
A merger may lead to a reduction in output, e.g. because the merger
increased market power or the technologies of the acquiring and
acquired company exhibit increasing returns to scale, and a consecutive
reduction in employment.
A merger may, on the other hand, lead to an increase in output, e.g.
because the merger significantly increased the efficiency of the
combined firm or led to product improvements and demand shifts.
Thus, the employment of the combined entity may rise or fall relative to
the sum of the pre-merger employment levels
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16

Gugler and Yurtoglu (2004)

If mergers are used as a general device to restore a firms optimal

employment level, we would expect differential effects depending on
labour market institutions.
High labour adjustment costs make hiring a worker a somewhat
irreversible decision.
Therefore, it appears likely that in countries with very rigid labour
markets some firms carry excess labour with them.
Fewer such firms are expected to exist in countries whose labour
markets allow quick adjustment of the workforce.
Mergers and acquisitions are an effective means to achieve a desired
restructuring, since the managerial team is likely to be new and
therefore less likely to be committed to upholding past contracts with
stakeholders (Shleifer and Summers, 1988).
Since Europe has more rigid labour markets than the USA, mergers
may be used as a device to reduce excess labour. Thus, we expect that
the demand for labour is reduced by more after a merger or acquisition
in Europe than in the USA.

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Mergers Effect on Share Prices

Event Study Methodology:
announcement new information changes in share
price reflect the markets expectations of the effects of
mergers

Problems:
when does the share price change occur?
How does one separate it from other events?
select a control group and assume that the acquiring
firms share price would have performed over the
chosen period exactly as the control group
relative to the control group (start earlier)
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Capital Asset Pricing Model

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The Market Model

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Alternatives

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Findings: The first wave 1972 - 83

Strong belief in the short horizon (announcement) effects,
i.e., strong belief in the efficiency of capital markets.
Consequently, several studies ignored post-merger
performance of acquiring companies.
Studies that ignored post-merger performance
tended to find small and often insignificant changes in acquirers
share prices around the announcements.
The acquirers shareholders were judged not to have lost as a
result of the mergers,
the acquired shareholders were clear winners,
and thus the studies that ignored the post-merger performance of
acquiring companies concluded that M&As increased total
shareholder wealth.
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Studies that did report post-merger returns:

Firth (1980) and Malatesta (1983): the acquiring
companies shareholders had suffered significant
losses.
Firth: all losses occurred in the announcement month
Malatesta: they occurred over the year following the
mergers.
They also add up the absolute wealth changes for
both groups of shareholders and find found that the
aggregate losses to the acquiring companies
shareholders exceeded the gains in wealth of the
targets.
The remaining studies that reported post-merger
losses for acquiring companies dismissed them as
surprising or puzzling, or simply ignored them.
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Findings: The second wave post -1983

Debates on
the proper benchmark, and
the length of the window

The Proper Benchmark: Estimates using CAPM

imply
Pre-merger performance

CAPM
Estimates of

High

+ High

Lower

Low

Low or normal

Higher

e it R it R it

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The natural choice for a benchmark period is some interval before

the merger announcements.
However, several studies estimate post-merger abnormal returns
using a post-merger period.
This choice results in much lower estimates of post-merger losses.
Example: Magenheim and Mueller (1988)

Benchmark

Cumulative losses to acquirers

over +1 to +12 months

- 36 to - 3 months pre-merger
period

-11.3%
(significant)

post-merger benchmark

-3.2% (insignificant)
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Long-Horizon Studies:
Agrawal, Jaffe and Mandelker (1992):

Returns over five post-merger years

1955-87: -10% significant
negative significant ARs for the 1950s, 1960s and 1980s
insignificantly positive ARs for 1970s

Estimates by Loderer and Martin (1992) and Higson and

Elliott (1998) are also sensitive to the time period in
which M&As occurred.
Rau and Vermaelen (1998):

2823 acquisitions over 1980-1991 period:

mergers: -4% significant
tender offers: significant and positive
acquirers with high market values relative to their book values:
-17.3% over the 3 year post-merger period.

Conclusion:
The evidence compiled so far is consistent with the idea that
stock market run-ups lead to unsuccessful mergers.
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Additional Findings
Managerial discretion and the gains to
acquirers
Hubbard and Palia (1995): Managers with small
stakes tend to overpay

Diversification:
Diversification mergers produce losses to acquirer
shareholders at the announcement date.
Diversification is negatively related to returns, Tobins
q, and market value of a company. Discount for
diversification is quite large (13%-15%).
Spin-offs that increased focus produce positive ARs
and improvements in operating performance.

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