1. ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 1 - - - - - - - - Chapter 8 - - - - - - - - Empirical Tests of M&A Performance Note: When the statistical results are not significant, this is stated. If not so noted, the results are understood to be statistically significant at least at the 10% level or better. The empirical patterns described below represent our judgments. Individual samples for particular time periods with different combinations of variables will yield varying results.

2. ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 2 Issues in Empirical Studies Tests of alternative theories Determine whether or not social value is enhanced by mergers –Performance improvements –Relatedness to fundamental technological, economic, regulatory, and other forces taking place in individual industries –Effects on other firms in same industry Guides to management for merger planning

3. ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 3 Merger Performance During the Eighties Successful transactions –Targets earn substantial premiums Mergers — likely to be friendly and for stock –Targets: Positive 20 to 25% –Buyers: Positive 1 to 2% Tender offers — frequently hostile during the eighties and for cash –Targets: Positive 30 to 40% –Buyers: Negative 1 to 2%

4. ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 4 –Time trend of returns to targets has been upward Increase in government protection to targets Development of sophisticated defensive tactics Opportunity to find competing bidders –Event returns to bidding firms decreased over the decades –Total wealth increase from M&As has continued to be positive

5. ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 5 Unsuccessful takeovers –Target acquired within five years Target — premiums higher than initial bids Initial bidders — zero or negative returns if rival succeeds –Targets not acquired within five years Target — stock prices return toward preoffer values Bidders — negative returns

6. ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 6 Single bidder vs. multiple bidders –Mainly applicable to tender offers –Targets in tender offers Single bidder: 25-30% Multiple bidders: 35-40% –Bidders in tender offers Single bidder: 0% Multiple bidders: negative 2-4%

7. ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 7 Method of payment –Mergers — stock-for-stock, nontaxable Targets: 20% Bidders: negative 1-2% –Tender offers — cash-for-stock or assets, taxable Targets: 35% Bidders: positive 1-2%

8. ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 8 Resisted vs. nonresisted –Resisted — often multiple bidders –Nonresisted — usually single bidder –Impact of multiple bidders stronger than management resistance

9. ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 9 Methods of payment and managerial resistance (Huang and Walkling, 1987) –Controlling for form of payment and managerial resistance — difference between returns of tender offers and mergers disappeared –Controlling for type of acquisition and managerial resistance — difference between cash and stock offers remained strong Average CARs to target –Cash offers:29.3% –Stock offers:14.4% –Mixed payments:23.3%

10. ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 10 Reasons why use of cash may result in higher returns to targets –Cash transactions are taxable — require higher premiums to compensate for taxes –Information effect — bidder uses stock when it is overvalued –Signaling effect — use of cash indicates that target has better investment opportunities –Securities transactions involve regulatory approval and longer acquisition interval

11. ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 11 Bad bidders become good targets Mitchell and Lehn (1990) –Announcement of acquisitions Negative returns — acquiring firms subsequently become targets Positive returns — acquiring firms do not become targets –Divestitures Negative returns — subsequent divestitures Positive returns — no subsequent divestitures

12. ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 12 Positive total returns vs. negative total returns –Positive total returns Targets — higher positive gains Bidders — greater likelihood of significant positive gains –Negative total returns Targets — gains not reduced Bidders — greater likelihood of large negative returns

13. ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 13 Effects of tender offer regulation –Targets Gains are higher Premiums higher after adoption of Williams Act in 1968 –Bidders Losses more likely Reduced returns due to: –Waiting period –Stronger target defenses –Increased bidder competition

14. ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 14 Runup vs. markup returns Schwert (1996) –Definitions Runup — pre-announcement CAR Markup — post-announcement CAR –Tender offers Runup16% Markup20% –Mergers Runup12% Markup5%

15. ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 15 –Successful deals — runup and markup both 15% –MBOs — runup and markup both 10% –Poison pills Runup12% Markup18% –Multiple bids Runup13% Markup18%

16. ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 16 –Insider trading cases Runup18.3% Markup21.2% –Runups vs. markups Not correlated Little substitution Runup is added cost to bidder

17. ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 17 Postmerger performance –Healy, Palepu, and Ruback (1992) Industry-adjusted operating variables –Ratio of cash flows to sales — no significant change –Ratio of sales to total assets — significant improvement –Ratio of cash flows to market value of assets — significant improvement –Annual percentage change in employment — declined significantly –Pension expenses per employee — reduction but not statistically significant

18. ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 18 Investment variables –Annual change in cash receipts from asset sales as a percentage of the market value of assets — no significant change –Annual change in the book value of asset sales as a percentage of the market value of assets — significant increase –Annual change in R&D expenditures as a percentage of the market value of assets — no significant reduction

19. ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 19 Discussion and implications –High correlation between event return measures and accounting measures of subsequent performance –Performance improvement from better asset management –Improved returns not from reductions in labor income –R&D and investment rates not significantly changed

20. ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 20 –Agrawal, Jaffe, and Mandelker (1992) Market or economy-wide benchmarks used for adjusted returns Wealth loss to shareholders of acquiring firms of 10% over subsequent five years Implication is that M&A activity takes place in industries depressed relative to the economy

21. ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 21 –Franks, Harris, and Titman (1991) Postmerger share-price performance sensitive to benchmark employed Equally weighted benchmark — negative postmerger performance Value-weighted index benchmark — positive postmerger performance Multiportfolio benchmarks — no significant abnormal performance

22. ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 22 Industry influences on M&A activity –Mitchell and Mulherin (1996) Significant differences in M&A activity by industry M&A activity due to major shocks in relatively few industries –International competition — tires, steel, autos, shoes, machine tools –Technological change — information processing –Financial innovations — banks, S&Ls, brokerage firms –Deregulation — air transport, entertainment, trucking, health care –Price shocks — petroleum, air transport, trucking

23. ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 23 –Andrade and Strafford (1999) Evidence supports an impact of industry shocks on merger activity Mergers, like internal investments, are a response to favorable growth potentials –Industries with excess capacity use own-industry mergers to achieve consolidation –In contracting industries, acquiring firms have better performance, lower capacity utilization, and lower leverage Asset reallocation from mergers results in improved efficiency

24. ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 24 Merger Performance During the 1990s Weston and Johnson (1999) –Sample 364 transactions between 1992 and mid-1998 Sample of large transactions –Price paid for target: Greater than $500 million for 1992-1996 Greater than $1 billion for 1997-1998 Accounted for 40 to 45% of total M&A deal value in most years, rising to 69% for first half of 1998

25. ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 25 –Pooling versus purchase accounting Full sample –190 pooling transactions (52.2%) –174 purchase transactions (47.8%) Bank subsample –60 pooling (80%) –15 purchase (20%) –Strong preference for pooling - banks might be strongly averse to negative impact of goodwill write-offs on reported net income Non-bank subsample –130 pooling (45%) –159 purchase (55%) –Lack of preference for pooling - economies or synergies sufficiently strong that increased earnings in new combined firm overcome goodwill write-offs

26. ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 26 – Method of payment Stock: 220 transactions (60.4%) –Bank mergers: 61 (81.3%) –Non-bank mergers: 159 (55%) Cash: 80 transactions (21.7%) Cash and stock: 64 transactions (17.6%) Debt: 1 transaction (0.3%) Big deals in the 1990s have been mainly stock for stock Smaller transactions are mainly for cash

27. ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 27 –Taxability Taxable: 91 transactions (25%) –Bank mergers: 6 (8%), all were purchase accounting transactions –Nonbank mergers: 85 (29.4%), all were purchase accounting transactions Nontaxable: 238 transactions (65.4%) –Bank mergers: 64 (85.3%), 4 were purchase accounting transactions –Nonbank mergers: 174 (60.2%), 44 were purchase accounting transactions

28. ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 28 –Premium paid Premium based on market price of seller stock 30 days before public announcement of deal Non-taxable, non-bank deals: 33-40% premium Taxable, non-bank deals: 36-44% premium Non-bank, pooling transactions: 33% median premium Non-bank, purchase transactions: 37% median premium

29. ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 29 –Analysis of event returns Sample of 309 transactions Full sample –Positive total gains: 202 (65.4%) –Negative total gains: 107 (34.6%) Bank subsample –Positive total gains: 41 (57.7%) –Negative total gains: 30 (42.3%) Non-bank subsample –Positive total gains: 161 (67.6%) –Negative total gains: 77 (32.4%) Good deals will have a favorable initial market response

30. ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 30 Returns to shareholders (Anslinger and Copeland, 1996) –In-depth study of 21 successful acquirers –These companies made 829 seemingly unrelated acquisitions from 1985-1994 –80% of the 829 transactions (611) earned their cost of capital Corporate acquirers: averaged 18% per year in total returns to shareholders over a 10 year period Financial buyers: averaged 35% per year in total returns

31. ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 31 –Findings differ from previous McKinsey and Company studies for the 70s and 80s which found that two-thirds of all mergers did not earn their cost of capital –Successful acquirers focused on a common theme Clayton, Dubilier & Rice — stockpiled management capabilities Desai Capital Management — focused on retail-related businesses Emerson Electric Company — looked for companies with core competence in component manufacturing to exploit cost-control capabilities Sara Lee — focused on branding in retailing

32. ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 32 Merger performance in the 1990s Schwert (1996) –On average abnormal returns to bidders for period 1973-1991 was not significantly different from zero –Highly competitive nature of takeovers continued through 1996 — suggests that abnormal returns to bidders continued at levels not significantly different from zero

33. ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 33 –Total wealth change continued to be positive through 1996 since abnormal returns to targets were in the 35% to 40% range –Increased ability to make value-increasing mergers Cisco Systems — high growth through acquisitions, high shareholder returns Internet companies — considerable use of acquisitions to expand customer base, high shareholder returns

34. ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 34 Efficiency Versus Market Power Ellert (1975, 1976) –Supports efficiency basis for mergers –Acquiring firms had positive residuals in prior years, and acquired firms had negative residuals in prior years Stillman (1983) –Rivals of firms did not benefit from announcement of proposed mergers –Inconsistent with concentration-collusion hypothesis

35. ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 35 Eckbo (1981) –No negative effects on rivals when merger is likely to be blocked by antitrust authorities –Main effect of merger Signal possibility of achieving economies for merging firms Provide information to rivals that such economies may also be available to them

36. ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 36 Effects on Concentration Impact on macroconcentration –Share of assets of largest 200 U.S. corporations to assets of all nonfinancial corporations Share was about 38% in 1970 Declined to 36% by 1980 and to 34% by 1984; remained stable at about 35% through 1996 Figures are biased upward since largest 200 firms in numerator are the ones that rank highest in each year of measurement

37. ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 37 –Merger activity in recent years has not greatly affected aggregate concentration High rate of divestitures Rise of new firms and new industries — computers, Internet, etc. –If international competition is taken into account, share of top 200 companies would be smaller

38. ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 38 Impact on microconcentration –Individual industries concentration measure Measures based on share of four largest firms Weighted average level of concentration in individual industries using value added measure has stayed relatively constant at about 40% over recent decades –Industry concentration taking international factors into account — drops sharply –For most industries the HHI is below the critical 1,000 level