Contact: Ralph Walkling, (614) 292-1580
Written by Anna Rzewnicki, (614) 292-8937
[email protected]
RESEARCH FINDS WHY MERGERS BENEFIT OTHER FIRMS IN SAME INDUSTRY
COLUMBUS, Ohio, -- Merger watchers have noticed an interesting phenomenon over the years: When one company is suddenly targeted for acquisition, its rival companies tend to experience a sudden jump in market value.
A new study confirms one reason is the increased probability that rival firms of the takeover target will become targets themselves. The rival firms that reap the highest returns are those with characteristics similar to other targeted firms.
Researchers at Ohio State University and San Diego State University studied 141 firms in unregulated industries that were the initial takeover targets in their industry from 1982 to 1991. They also examined 2,459 rival firms in the same industries.
"We found that the rival firms of takeover targets earn abnormal returns in proportion to the probability that they will be targets for mergers themselves," said Ralph Walkling, professor of finance at Ohio State's Fisher College of Business.
Walkling conducted the study with Moon H. Song of San Diego State University. The research will be published in an upcoming issue of the Journal of Financial Economics.
This study fills a void created when researchers rejected a popular earlier explanation for why rivals of merger targets reap benefits in the stock market. This explanation suggested that horizontal mergers eliminate competitors, opening the door to collusion among the remaining firms. The possibility of collusion within an industry supposedly would make the remaining companies more profitable and thus more attractive to investors, Walkling said.
This explanation, however, did not explain the wide differences in abnormal returns among the rivals, nor why only 50 percent to 60 percent of the rival firms experienced the higher stock values.
"The reason that only some firms reap benefits is because these are the firms that are probably the next takeover targets in the industry," Walkling said. "These are the firms with characteristics bidders desire."
Some of the characteristics that affect whether a rival company is a likely 'next target' include firm size and the level of managerial ownership, the study found. Smaller firms with low managerial ownership, and greater debt capacity have an increased probability of acquisition.
The new research also showed that rivals that actually became targets in the year after the initial industry bid had a financial profile similar to the initial industry targets. Moreover, rivals that subsequently became targets had higher announcement-period returns than non-targeted firms in the same industry. That is, the market seemed to correctly assess which rivals would be subsequent targets months before it actually happened, Walkling said.
The study also found that rival firms earned higher abnormal returns if the initial merger in the industry was considered a surprise. The degree of surprise surrounding the initial acquisition is associated with the length of the dormant period without acquisition activity in an industry. Longer dormant periods -- which suggest greater surprise surrounding a merger -- are associated with a higher abnormal return to the rival firms.
Acquisition attempts occur when the expected gain exceeds the cost, Walkling explained. An unexpected acquisition within an industry signals that the expected gain from bidding exceeds the cost for at least one firm in the industry. Those attractive firms that are more easily acquired receive the greater revision in their market value. Moreover, regulated firms experience lower abnormal returns since government intervention reduces the probability that they will be acquired.
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