24)
M&A to use excess cash generally destroys value except when redeployed profitably. Cash-rich firms have a choice of returning the cash to investors through dividends, or reinvesting it through such activities as M&A. Studies11 report value destruction by the announcement of M&A transactions by firms with excess cash. However, Bruner (1988) reports that the pairing of slack-poor and slack-rich firms creates value. Before merger, buyers have more cash and lower debt ratios than nonacquirers. And the return to the buyers’ shareholders increases with the change in the buyer’s debt ratio due to the merger.
Tender offers create value for bidders. Chapters 32 and 33 survey the tender offer process and research on returns. Mergers are typically friendly affairs, negotiated between the top management of buyer and target firms. Tender offers are structured as take-it-or-leave-it proposals, directly to the target firm shareholders, often hostile in attitude. Some research summarized in Chapter 32 suggests that targets of hostile tender offers are underperformers with relatively low share prices. Thus, the better returns from tender offers may reflect bargain prices and/or the economic benefits of replacing management and redirecting the strategy of the firm. Several studies report larger announcement returns to bidders in tender offers, as compared with friendly negotiated transactions.12
When managers have more at stake, more value is created. Studies suggest that returns to buyer firm shareholders are associated with larger equity interests by managers and employees.13 In assessing the pattern of performance associated with deal characteristics, Healey, Palepu, and Ruback (1997) concluded, “While takeovers were usually break-even investments, the profitability of individual transactions varied widely … the transactions characteristics that were under management control substantially influenced the ultimate payoffs from takeovers.”14 A related finding is that leveraged buyouts (LBOs) create value for buyers. The sources of these returns are not only from tax savings due to debt and depreciation shields, but also significantly from efficiencies and greater operational improvements implemented after the LBO. In LBOs, managers tend to have a significant portion of their net worth committed to the success of the transaction. Exhibit 3.11 summarizes the findings of several studies about LBOs and reveals that cash flow increases and capital spending declines materially in the years following the transaction. Chapter 13 relates more research findings about LBOs and other highly levered transactions.
The initiation of M&A programs is associated with creation of value for buyers. Asquith, Bruner, and Mullins (1983), Fuller, Netter, and Stegemoller (2002), Gregory (1997), and Schipper and Thompson (1983) report that when firms announce they are undertaking a series of acquisitions in pursuit of some strategic objectives, their share prices rise significantly. That these kinds of announcements should create value suggests that M&A generally creates value, and that the announcement is taken as a serious signal of value creation.
EXHIBIT 3.11 Summary of Performance Studies for M&A: LBO Results
| Study | Change in Operating Cash Flow/Sales | Change in CapEx Sales | Sample Size | Sample Period | Event Window (Years) |
|---|---|---|---|---|---|
| Kaplan (1989) | 11.9% | –31.6% | 37 | 1980–1986 | (–1,2) |
| Muscarella, Vetsuypens (1990) | 23.5% | –11.4% | 35 | 1976–1987 | Various |
| Smith (1990) | 18.0% | –25.0% | 18 | 1976–1986 | (–1,2) |
| Opler (1992) | 16.5% | –42.2% | 42 | 1985–1989 | (–1,2) |
| Andrade, Kaplan (1998) | 54.5% | –40.7% | 124 | 1980–1989 | (–1,1) |
FINDINGS FROM SURVEYS OF EXECUTIVES
The findings of scholars in large-sample surveys are supplemented by studies by scholars and practitioners who focus on smaller samples and typically draw some or all of their findings from questions of managers directly. Ingham, Kran, and Lovestam (1992) surveyed chief executive officers in 146 large firms in the United Kingdom. Of them, 77 percent believed that profitability increased in the short run after merger; 68 percent believed that the improved profitability lasted for the long run.
Surveys by practitioners are often rather casually reported, limiting our ability to replicate the study and understand the methodological strengths and weaknesses. For this reason, scholars tend to give practitioner surveys rather less attention. Nevertheless, a sample of these surveys is reported here for the sake of comparison with the scholarly studies. It is interesting to consider whether managers tell us something different from the large-sample scientific studies.
The absence of statistical tests in these surveys limits the assertions one can make, but a qualitative review of results offers results surprisingly similar to the scientific studies. Exhibit 3.12 tabulates the results of 12 studies. Six of the 12 studies suggest negative results. The remainder seem neutral or positive. The similarity between these findings and the findings from the scholarly studies is striking. In the bulk of deals, it appears that investments in acquisitions at least pay their cost of capital.
To explore some of the problems of stability in executive surveys about M&A, I polled 50 business executives via the Internet. As with other surveys of this type, no effort was made to ensure representativeness or reduce bias, thus limiting our ability to generalize the results to all executives or all M&A deals. Nevertheless, the findings offer important insights about M&A profitability.
First, the survey considered all respondents, and asked their opinion about the percent of all M&A deals that create value and meet their strategic objectives. The resulting distributions of opinion were quite wide. But on average, the respondents said that only 37 percent of deals create value for the buyers. Even worse, the sample believes that only 21 percent of the deals achieve the buyers’ strategic goals. These findings are similar to results of some other surveys of executives.
Next, the survey focused only on those respondents who had been personally
