Cash Acquirers Research Articles

An exploratory study of US acquirers’ market performance: pre- versus post-Sarbanes–Oxley act of 2002

PurposeMotivated by the findings of Bhabra and Hossain (2017) that highlight an improvement in US market performance in the post-Sarbanes–Oxley (SOX) period, this paper aims to investigate how this change varies with the methods of payment used for the deals.Design/methodology/approachDeductive in nature and using an event study approach, this paper uses a sample of 675 deals between 1999 and 2006 to test three research hypotheses in a pre-post setting.FindingsResults show that at the aggregate level, there is a significant improvement in the market performance of US acquirers around the announcement day in the aftermath of the passage of SOX 2002. Considered separately, both US stock acquirers and cash acquirers did not experience any significant improvement in market performance in the post-Sarbanes–Oxley period. These results are robust to controlling for governance, firm and deal variables, as well as industry and year fixed effects.Research limitations/implicationsExploratory in nature, the results are to be interpreted in light of the sample size and the period under investigation.Practical implicationsThe results provide evidence for regulators and legislators on the contribution of SOX 2002 to curbing managerial misconduct. Significant improvement in the market performance also signals more confidence in managerial decisions and a reduction in agency problems. The insignificant change in stock acquirers’ market performance can be an indication that policymakers should exert more efforts to improve shareholders' confidence in the quality of disclosure.Originality/valueThis investigation provides unique insights on whether SOX has been effective in mitigating mispricing concerns associated with stock-financed acquisitions and whether it was effective in moderating the governance mechanism associated with cash-financed acquisitions.

Stock mergers and acquirers’ subsequent stock price crash risk

We examine the changes in acquirers’ stock price crash risk following mergers and acquisitions (M&As). We employ the three measures of crash risk most commonly used in the literature: the negative conditional skewness of acquirer-specific stock returns, a down-to-up volatility measure, and the excess of extreme negative stock returns over extreme positive returns. We find that stock acquirers experience significantly higher stock price crash risk as compared to cash acquirers. The change in risk is positively correlated with the percent of stock used as a payment method. The findings are confined to acquirers with overvalued stock, lower profitability and more financial constraints, as well as to acquisitions of public targets. We confirm that stock market crises do not drive our findings. Furthermore, our results are robust to endogeneity concerns, controlling for non-acquirers and post-merger acquirer changes.

Accrual and real-based earnings management by UK acquirers

PurposeThis study aims to investigate the occurrence of pre-merger earnings management for a sample of 197 stock- and cash-financed UK acquirers between 1990 and 2009. It also examines the earnings management behaviour around the change in the Corporate Governance Code in 2003 based on the Higgs recommendations.Design/methodology/approachMean and median accrual- and real-based manipulation are examined in the period before the announcement of a merger and acquisition. These are compared across stock and cash acquirers as well as before and after the implementation of the Higgs recommendations. Logistic regressions are also run to examine accrual- and real-based manipulation across stock and cash acquirers after controlling for variables that may affect the acquisition type.FindingsThe study found some evidence of upward pre-merger accrual-based earnings management by stock-financed acquirers, which is in line with the findings of Botsari and Meeks (2008). Furthermore, no significant changes were found in the post-Higgs period, which indicates that the recommendations put forth by Higgs may not have been successful in mitigating earnings management. The evidence also shows that cash bidders engage in pre-merger real earnings manipulation through lower discretionary expenses, possibly to enhance cash availability for the bid.Practical implicationsThe findings in this study confirm earnings management exists around mergers and acquisitions and provide some evidence that the recommendations set out in the Higgs Report do not appear to have mitigated earnings management activities. This is of interest to regulators as well as investors and academicians.Originality/valueThis provides the first analysis in the UK examining the use of real-based earnings management activities by UK acquirers. It also extends prior research around corporate governance changes that occurred in the UK.

The role of corporate governance in shaping accruals manipulation prior to acquisitions

Based on stock swap transactions involving public acquirers originating from the UK between 1998 and 2011, this paper investigates the role of corporate governance in shaping accruals manipulation prior to stock swap deals. In contrast to common claims that strong corporate governance constrains accruals manipulation, my results show that well-governed acquirers engage more aggressively in income-increasing accruals manipulation than those with weak governance. This finding is consistent with a role of corporate governance that incentivises managerial actions in the interests of firms’ shareholders. Overall, this finding highlights the setting-specific nature of the earnings management and corporate governance relation. My results are robust to different discretionary accrual models, differences in the firm's growth structure, merger and acquisition control variables, a control group of 100% cash acquirers, an analysis of buy-and-hold abnormal returns, and potential sample selection problems.

Acquirer Valuation and Acquisition Decisions: Identifying Mispricing Using Short Interest

AbstractWe use short interest as an investor-based measure of over- or undervaluation that distinguishes between the misvaluation and Q-theories of mergers. Using this measure, we find that misvaluation is a strong determinant of merger decision-making. Firms in the top quintile of short interest are 54% more likely to engage in stock acquisitions and 22% less likely to engage in cash acquisitions. Stock (but not cash) acquirers have higher short interest than their targets. Overall, our results suggest that the previously documented underperformance of stock acquirers and the overperformance of cash acquirers can be explained by misvaluation, as captured by short interest.

An empirical investigation of mergers and acquisitions by Chinese listed companies, 1997–2007

We examine 136 M&A deals from 1997 to 2007 initiated by Chinese companies listed on the Shanghai and Shenzhen Stock Exchanges, where the acquirer gains complete control of the target. Our data shows that the Chinese M&A market is dominated by domestic deals with unlisted targets that are either stand-alone private firms or wholly owned subsidiaries. Acquirers experience significant positive abnormal stock returns around the announcement date and over the three years after the acquisition. These results are largely driven by state-owned firms, cash acquirers and firms that acquire related targets. Cross-sectional tests show that announcement period returns are related to the acquirer's ownership status, industry relatedness of the acquirer and target, capital structure changes of the acquirer and the nature of the unlisted target. We find no change in operating performance from the pre to the post acquisition period for the acquirers.

Are Small Firms Less Vulnerable to Overpriced Stock Offers?

We document an inverted-U relation between targetiveness (probability of being targeted) and firm size. However, this pattern describes stock offers and is more pronounced during hot markets with greater overvaluations. For cash offers we find a negative and monotonic relation. These contrasting patterns suggest that small firms (in the bottom NYSE size quartile) are less attractive to overpriced stock acquirers, and also that their managers are less receptive to overpriced stock offers which expropriate the wealth of their long-term shareholders. Several additional results support this hypothesis. First, the stock acquirers of small targets are less overvalued than the stock acquirers of large targets, but an opposite result holds for cash acquirers. Second, the acquirer announcement returns following stock offers are less negative for small targets than for large targets. Moreover, this certification effect increases for acquirers facing greater information asymmetry. Third, the stock acquirers of small targets earn higher long-term returns than the stock acquirers of large targets.

Multimarket trading at merger announcement and completion

We examined multimarket trading in the stock and option markets during merger announcement and successful and failed completion. Using contemporary intraday stock and options data, we observed alternate call buying and stock selling for acquirer stock in cash mergers, call writing and stock selling, followed by put buying for acquirer stock in stock mergers at merger announcement. For successful completions, stock selling dominated for cash acquirers and put buying for stock acquirers. Deal failure was accompanied by initial put buying, followed by call writing and stock selling on target stock. Signalling between markets and the alternation of informed trading between markets was inferred.

Cash acquirers

PurposeThis paper investigates the Jensen's free cash flow (FCF) hypothesis in the context of UK cash acquisitions. Under this hypothesis, financial slack induces mangers to acquire targets for cash if such behaviour generates either pecuniary or non‐pecuniary rewards for them, giving rise to a potential agency problem around cash takeovers. We argue that the stronger position of shareholders, as opposed to firm managers, in the UK should help in constraining such potential agency problems around such mergers. Compared to the USA, position, this should make the FCF hypothesis less relevant in the UK.Design/methodology/approachThis paper uses short‐run announcement period returns and long‐run calendar‐time returns in testing our hypotheses.FindingsThis paper shows that low leverage and high FCF may be advantageous provided shareholder monitoring is adequate. By analysing both announcement period and long‐term returns, we show that acquirers with high levels of FCF are superior performers, and that any long‐run under‐performance of cash acquirers appears to be associated with low cash resources and low institutional ownership.Research limitations/implicationsInevitably, long‐run returns measurement is contentious, although we present results from alternative models to mitigate this. Limitations are necessarily imposed by the sample size, meaning that multi‐way partitioning of the data is not feasible.Practical implicationsThe practical implications are that the UK regulatory and institutional ownership regime may actually protect the interests of shareholders and mitigate agency problems.Originality/valueAs far as we are aware, this is the first paper to systematically test FCF, leverage and institutional ownership effects in the context of UK cash acquisitions.

Cash Acquirers: Can Free Cash Flow, Debt and Institutional Ownership Explain Long Run Performance?

Cash acquirers are an interesting sub-group of acquirers. Whereas the overall evidence seems to suggest the majority of mergers and acquisitions destroy shareholder value in the long term, cash-financed acquisitions do not appear to do so. Yet this seems at variance with the prediction from Jensen’s “free cash flow” (FCF) hypothesis, which argues that high levels of free cash flow and unused borrowing capacity are likely to encourage low-value mergers. In contrast, the “pecking order” theory offers a different perspective, where managers conserve cash flow to undertake positive NPV investments. Furthermore, having adequate financial resources available post-merger may be important in developing the potential opportunities that the merger brings. We argue that the stronger position of shareholders, as opposed to firm managers, in the UK compared to the US makes the FCF hypothesis less relevant in the UK, and show that low leverage and high FCF may be advantageous provided shareholder monitoring is adequate. By analysing both announcement period and long term returns, we show that acquirers with high levels of FCF are superior performers, and that any long-run under-performance of cash acquirers appears to be associated with low cash resources and low institutional ownership.

Merger Motives For U.S. Utility Acquirers: Evidence From Performance, Risk Metrics, And Executive Compensation

We study post-acquisition performance of US public utilities that acquired other US exchange listed firms during 1996?2002. We find that acquirer shareholders do not gain any abnormal returns from the acquisition over the two years following the acquisition and there are no unexpected gains in the underlying operating performance of the acquirers. We also find that while stock acquirers show a decrease in post-acquisition performance, their CEO salary increases relative to the industry. This suggests that method of payment may be an important factor in discerning the motivation for an acquisition. Lack of clarity regarding effects of a complex process like an acquisition, for shareholders and perhaps the even the management, combined with potential increase in prestige and salary for the management, may be the motivation for M&A activity in stock mergers. Cash acquirers may be more careful and consequently do not show subsequent underperformance.

Signaling and Value Creation in Mergers

I analyze the acquirers in both withdrawn and completed merger deals to disentangle the effects of signaling from those of target valuation and expected synergies. Completed stock (cash) acquirers earn 14 percent (10 percent) more than their withdrawn counterparts over the six months following initial announcement. However, if an announced stock merger later falls through, the acquirer suffers a negative revaluation due to the initial signal released, and the negative return is not reversed upon deal withdrawal. These results suggest that the initial negative stock price reaction in stock mergers is due to a signaling effect, but that the mergers themselves are positive NPV investments for the acquirers’ shareholders. Analysis of the acquirers’ financial positions also supports the signaling interpretation. Within stock deals, acquirers with more cash and less leverage – those that are least likely to need equity financing – have the lowest announcement returns.

Acquirer Valuation and Acquisition Decisions: Identifying Mispricing Using Short Interest

We use short interest as an investor-based measure of over/undervaluation that distinguishes between the misvaluation and Q-theories of mergers. Using this measure, we find that misvaluation is a strong determinant of merger decision making. Firms in the top quintile of short interest are 54% more likely to engage in stock acquisitions and 22% less likely to engage in cash acquisitions. Stock (but not cash) acquirers have higher short interest than their targets. Overall, our results suggest that the previously documented underperformance of stock acquirers and the overperformance of cash acquirers can be explained by misvaluation, as captured by short interest.

Cash Acquirers: Free Cash Flow, Shareholder Monitoring, and Shareholder Returns

Cash Acquirers: Free Cash Flow, Shareholder Monitoring, and Shareholder Returns

Do Acquiring Firms Manage Earnings?

We investigate possible earnings management by inflating discretionary accruals in a sample of 1,719 cash acquirers and 895 stock acquirers during 1989-2005. Following previous literature, we document higher ROA-matched discretionary accruals for stock acquirers than for cash acquirers. However, simulation evidence with quarterly data shows that ROA-matched discretionary accruals are misspecified for both high-growth and low-growth firms. This is relevant to the current investigation because the median sales growth rate equals 12.1% for cash acquirers and 38.5% for stock acquirers (besides similar differences in other growth measures). We propose a new discretionary accrual measure that controls for both ROA and sales growth. This measure is well-specified and powerful in detecting earnings management in stratified random samples, and it leads to an insignificant difference between discretionary accruals of cash and stock acquirers. Other tests of acquirer incentives to manage earnings, market reaction to earnings management, and time delay between earnings announcement and merger announcement strengthen the evidence against earnings management attributed to stock acquisitions.

Why Do Small Stock Acquirers Underperform in the Long-Term?

We study the long-term performance of acquirers with respect to their size and method of payment. Our results shed new light on why stock acquirers appear to underperform cash acquirers in some studies. We present two main results. First, there is no economically or statistically significant difference between the performance of large stock acquirers and large cash acquirers. Conversely, small stock acquirers underperform small cash acquirers by about 12 in the first 12 months following mergers and up to 18 in the first 36 months. Hence, the previously documented underperformance of stock acquirers is due to the underperformance of small stock acquirers exclusively. Second, we find evidence that this underperformance is likely caused by mispricing related to limits to arbitrage: measures of short-selling constraints, illiquidity, and information uncertainty proxies subsume the size effect in our tests. We find no evidence that underperformance is related to acquirer-target integration problems or to earnings management prior to mergers.

Glamour Acquirers, Method of Payment and Post‐acquisition Performance: The UK Evidence

We study the effect of different acquirer types, defined by financial status and their payment methods, on their short and long‐term performance, in terms of abnormal returns using a variety of benchmark models. For a sample of 519 UK acquirers during 1983–95, we examine the abnormal return performance of acquirers based on their pre‐bid financial status as either glamour or value acquirers using both the price to earnings (PE) ratio and market to book value ratio (MTBV). Value acquirers outperform glamour acquirers in the three‐year post‐acquisition period. One interpretation is that glamour firms have overvalued equity and tend to exploit their status and use it more often than cash to finance their acquisitions. As we move from glamour to value acquirers, there is a greater use of cash. Our results are broadly consistent with those for the US reported by Rau and Vermaelen (1998). However, in contrast to their study, we find stronger support for the method of payment hypothesis than for extrapolation hypothesis. Cash acquirers generate higher returns than equity acquirers, irrespective of their glamour/ value status. Our conclusions, based on four benchmark models for abnormal returns, suggest that stock markets in both the US and the UK may share a similar proclivity for over‐extrapolation of past performance, at least in the bid period. They also tend to reassess acquirer performance in the post‐acquisition period and correct this overextrapolation. These results have implications for the behavioural aspects of capital markets in both countries.