Do mergers and acquisitions pay off for shareholders?

Most M&As Create Shareholder Value!

On average, the sum of target and acquirer shareholders’ gains around the deal’s announcement date is positive and statistically significant (i.e., not due to chance). While most of the gain accrues to target shareholders because they usually have the greatest bargaining leverage, acquirer shareholders often experience financial gains in excess of what would have been realized in the absence of a takeover. In the years after a takeover, it is less clear if acquirer shareholders continue to benefit from the deal. As time passes, other factors impact performance, making it difficult to determine the extent to which a change in performance is due to an earlier acquisition.

    Researchers use a variety of approaches to measure the impact of takeovers on shareholder value. The two most common are pre-merger event returns and post-merger accounting returns. So-called event studies examine abnormal stock returns to the shareholders of both acquirers and targets around the announcement of an offer (the “event”). Event studies presume that investors can accurately assess the likely success or failure of M&As realizing expected synergy around the deal’s announcement date. Empirical studies of post-merger returns often use accounting measures to gauge the impact on shareholder value in the years immediately following a takeover.

Pre-Merger Returns to Shareholders

Positive abnormal or excess shareholder returns may be explained by such factors as improved efficiency, pricing power, market share gains, and tax benefits. Such returns are abnormal in that they exceed what an investor would normally expect to earn for accepting a certain level of risk. If an investor expects to earn a 10% return on a stock but actually earns 15% due to a takeover, the abnormal or excess return to the shareholder would be 5%.

Returns High for Target Shareholders

Average abnormal returns to target shareholders during the 2000s averaged 25.1% as compared to 18.5% during the 1990s. This upward trend may reflect bidders' willingness to offer higher premiums in friendly takeovers to preempt other bidders, the increasing sophistication of takeover defenses, federal and state laws requiring bidders to notify target shareholders of their intentions before completing the deal, and the decline in the number of publicly listed firms during the last two decades. While relatively infrequent, returns from hostile tender offers generally exceed those from friendly mergers, which are characterized by less contentious negotiated settlements and the absence of competing bids.

Returns to Acquirer Shareholders are Positive on Average

Recent research involving large samples of tens of thousands of public and private firms over lengthy time periods including US, foreign, and cross-border deals document that returns to acquirer shareholders are generally positive around the deal announcement date. Before 2009, many event studies showed on average negative abnormal acquirer returns of about 1% in cash and stock deals involving large public firms and deals in which the primary method of payment was stock. 

    After 2009, M&As showed average positive and statistically significant abnormal returns of about 1% for acquirers while stock deals no longer destroy value. Why? The Dodd-Frank reform act that passed in 2010, although aimed primarily at financial institutions, has improved monitoring and governance systems for all U.S. listed firms. This has been achieved through new mandatory disclosure rules, refining executive compensation plans, granting more powers to shareholders, and strengthening executive/director accountability.

    Earlier studies usually dealt with public firms and largely ignored deals involving private acquirers, private targets, or both, which comprise more than four-fifths of total deals. While deals involving public companies are declining in line with the shrinking number of publicly traded firms, public company transactions continue to represent a large percentage of the total dollar volume of deals. Studies including private targets and acquirers display average acquirer shareholder positive abnormal returns of about 1–1.5%. If deals involving public companies and takeovers of public firms financed primarily with stock are removed from the academic studies, acquirer returns would on average increase even more. 

    The earlier studies also fail to explain why tens of thousands of M&As are reported annually worldwide and why the number and size of M&As continues to grow. If M&As did not on average generate positive acquirer returns, we would have to argue counter-intuitively that managers were on average incapable of learning from their own and others past failures.

 Post-Merger Returns to Shareholders

The objective of examining postmerger performance measures such as cash flow and operating profit is to determine how performance changed as a result of a deal. Most studies focus on the three year period following closing. With the passage of time, it is increasingly difficult to isolate the target's impact on the combined firms due to the growing number of other factors that could affect performance. A comprehensive literature survey of post-merger performance studies prior to 2019 concluded that on average acquirer performance in the years following a deal tends to decline. Despite these findings, the conclusions of postmerger performance studies may be problematic due to significant limitations.

    These limitations include excessively short postmerger sample periods, failure to identify acquirer motives, situational differences, definitional issues, and technical differences. Other shortcomings of such studies include not knowing what would have happened had these deals not been done and a focus on public acquirers. Most postmerger studies presume implicitly that three years following closing is sufficient to reach a conclusion on the direction of long-term post-merger operating performance. In fact, many business strategies take far longer to implement fully. For example, Disney's strategy to build a dominant film library involved multiple deals and took more than decade to complete. The individual takeovers represented building blocks needed to execute the corporation's strategy. On their own, they may have created little value, but collectively they made Disney the media powerhouse that it is today.

Source: Donald M. DePamphilis, 2019. Mergers, Acquisitions, and Other Restructuring Activities: An Integrated Approach to Process, Tools, Cases and Solutions, 10th Edition, Academic Press.