The Determinants of Positive Long-Term Performance in Strategic Mergers: Corporate Focus and Cash

Abstract

Using a sample selection and benchmarking methodology designed to more accurately assess merger-related changes in corporate focus, we find a significantly positive relationship between corporate focus and long-term merger performance. We find that focus-decreasing (FD) mergers result in significantly negative long-term performance. On average, FD mergers result in an over 18% loss in stockholder wealth, a 9% loss in firm value, and significant declines in operating cash flows three years after merger. Mergers that either preserve or increase focus (FPI) result in mostly insignificant changes in long-term performance. These results are consistent with prior corporate focus studies, suggesting that existing merger studies finding the opposite result are the result of measurement error. After controlling for other variables related to post-merger performance - method of payment, managerial resistance, and book-to-market ratio - we find that the positive relationship between changes in focus and long-term performance continues to hold. A continuous measure of focus change (DHI) also indicates that the magnitude of focus changes is significant. Every 10% decrease in focus results in a 9% loss in stockholder wealth, a 1+% decline in operating performance, and a 4% discount in firm value. Cash is positively related to long-term performance, but the relationship is significant only for operating performance. Cash-financed FPI mergers exhibit the best and stock-financed FD mergers the worst long-term performance. The negative performance of stock-financed FD mergers is driven by pure conglomerate mergers in the early years of our study. FPI mergers outperform FD mergers in both time periods, but differences are significant only in the earlier years. However, the DHI variable is significant in both time periods, indicating that the magnitude of corporate focus changes is the more important measure of corporate focus or diversification.