The Banking Relationship's Role in the Choice of the Target's Advisor in Mergers and Acquisitions

We analyse the factors influencing the target company's choice of bank advisor in mergers and acquisitions (M&As). We first examine the choice of hiring an advisor, which is nontrivial, since in one‐third of transactions our sample target companies did not hire one. We also analyse the choice to hire as advisor a bank with a strong prior relationship with the company (i.e., the main bank). Using data on 473 European M&A transactions completed in the period 1994–2003, we find evidence that the decision to hire an advisor depends on three main factors: (i) the intensity of the previous banking relationship, (ii) the reputation of the bidder company's advisor, and (iii) the complexity of the deal. We also investigate the impact of the bank advisor on shareholder wealth. We find that the abnormal returns of target company shareholders increase with the intensity of the previous banking relationship, thus indicating a ‘certification role’ on the part of investment banks.     

Do Capital Structure Adjustments by Takeover Targets Influence Acquisition Gains?

We link debt issuances by target companies around takeover announcements to enhanced target bargaining power in negotiations with bidders over merger synergy gains in completed takeovers. Announcements of debt issuances by targets—especially new bank loans—are associated with more positive target equity returns relative to those made by nontargets, particularly for debt issuances immediately surrounding the takeover announcement. At least some of these gains to targets come at the expense of bidder shareholders, as bidder equity abnormal returns at target debt issuance are negative. We further show that targets issuing debt are primarily those with relatively low acquisition abnormal returns, consistent with initially poor target bargaining power. Subsequent debt issuances by targets increase the likelihood of positive adjustments to acquisition premiums offered by acquirers.     

The effect of merger anticipation on bidder and target firm announcement period returns

This paper examines investors' anticipation of bidder and target merger candidacy and if investor anticipations about candidacy affect the distribution of value between bidder and target firm shareholders. We find that bidder firms can be predicted more accurately than target firms. To investigate how merger announcement period returns are distributed among bidder and target shareholders, we control for different degrees of predictability in bidder and target selection and find that the difference between bidder and target firm three-day cumulative abnormal returns around a merger announcement decreases significantly. Thus, the evidence supports the hypothesis that the asymmetry in investor anticipations about merger candidacy causes disparity in bidder and target firm announcement period abnormal returns.     

Convertible securities in merger transactions

This paper provides a rationale for the use of convertible securities as the medium of exchange in corporate change-of-control transactions. We argue that convertible securities can resolve the information asymmetry about the bidder’s value while at the same time mitigating the information asymmetry about the target’s value. In contrast, deals with cash or stock can only address one information asymmetry or the other but not both. Empirically, we find that a bidder is more likely to offer convertible securities, rather than all cash or all stock, when both the bidder and its target face large asymmetric information problems. We also find that both bidders and targets in convertible deals enjoy positive abnormal stock returns around takeover announcements. These findings provide empirical support for the use of convertible securities to resolve the double-sided asymmetric information problem. Finally, we find that bidder returns in convertible deals are larger than in all-cash and all-stock deals, but that target returns in convertible deals are smaller than in all-cash and all-stock deals.     

Do auctions induce a winner's curse? New evidence from the corporate takeover market

We contrast the winner's curse hypothesis and the competitive market hypothesis as potential explanations for the observed returns to bidders in corporate takeovers. The winner's curse hypothesis posits suboptimal behavior in which winning bidders fail to adapt their strategies to the level of competition and the amount of uncertainty in the takeover environment and predicts that bidder returns are inversely related to the level of competition in a given deal and to the uncertainty in the value of the target. Our measure of takeover competition comes from a unique data set on the auction process that occurs prior to the announcement of a takeover. In our empirical estimation, we control for the endogeneity between bidder returns and the level of competition in takeover deals. Controlling for endogeneity, we find that the returns to bidders are not significantly related to takeover competition. We also find that uncertainty in the value of the target does not reduce bidder returns. Related analysis indicates that prestigious investment banks do not promote overbidding. Analysis of post-takeover operating performance also fails to find any negative effects of takeover competition. As a whole, the results indicate that the breakeven returns to bidders in corporate takeovers stem not from the winner's curse but from the competitive market for targets that occurs predominantly prior to the public announcement of bids.     

Why Some Firms Use Collar Offers in Mergers

Collar offers are merger offers using all stock as the method–of–payment that specify a range within which the bidder's price can fluctuate. In this paper the wealth effects associated with collar offers are determined, and cross–sectional regressions are employed to determine if this offer type is a significant determinant of abnormal returns. Results indicate that collar offers are associated with significantly positive abnormal returns for the target firm, even greater than those of firms receiving cash offers, but significantly negative returns for the bidder. These results raise an interesting question: why do some bidders make collar offers? Since the immediate wealth gains are strictly for the target and bidders making collar offers have returns insignificantly different than those making fixed stock offers, bidders must be utilizing collar offers for non–wealth related reasons. Using existing theories regarding the method–of–payment choice, various hypotheses for why firms may make collar offers are presented and tested using a multinomial logit analysis. The choice of collar offers seems to be significantly tied to the relative size of the merger, uncertainty regarding the bidder's value, and the target's and bidder's pre–merger insider ownership percentages.     

Investor protection and the value effects of bank merger announcements in Europe and the US

Investor protection regimes have been shown to partly explain why the same type of corporate event may attract different investor reactions across countries. We compare the value effects of large bank merger announcements in Europe and the US and find an inverse relationship between the level of investor protection prevalent in the target country and abnormal returns that bidders realize during the announcement period. Accordingly, bidding banks realize higher returns when targeting low protection economies (most European economies) than bidders targeting institutions which operate under a high investor protection regime (the US). We argue that bidding bank shareholders need to be compensated for an increased risk of expropriation by insiders which they face in a low protection environment where takeover markets are illiquid and there are high private benefits of control.     

Pre-deal differences in corporate social responsibility and acquisition performance

Drawing on the portability theory, we examine how the pre-deal gap in corporate social responsibility (CSR) between the bidder and target affects announcement returns in the international takeover market. We find that the higher the bidder's CSR scores relative to the target's, the higher is the synergy captured by combined cumulative abnormal returns of bidders and targets. It supports our hypothesis that synergistic gains are higher when the ex-ante bidder-target CSR gap is positive. The results also show that the synergy effect of CSR is not shared between bidder and target firms; thereby, bidders earn abnormal returns while targets lose. We further document that the acquirers with higher CSR practices before the acquisition are more likely to engage in related and non-cash-financed deals, and capital markets reward these acquisition choices. Finally, the results show that a positive CSR gap reduces the takeover premium and the time taken to complete the deal. Overall, the results suggest a positive valuation for the shareholders of the combined firm resulting from the portability of higher CSR practices from bidders to targets. Our results are subject to a battery of robustness tests, including alternative measures of combined returns and CSR, and tests for endogeneity.     

Are Differences in Acquiring Bank Profit Efficiency Priced in Financial Markets?

We analyze 271 bank mergers for 1986–2001 to attempt to determine if differences among acquirers in profit efficiency are priced in financial markets. We find that the acquirer’s pre-merger profit efficiency (as well as its experience in handling other mergers) has positive effects on the wealth of the acquiring bank’s shareholders. We also find that more profit efficient acquiring banks produce lower abnormal returns for the target, suggesting that well managed (i.e., more profit-efficient) banks are less likely to overpay when they enter into a merger agreement. Financial market participants apparently take something akin to the econometric concept of profit efficiency into account when they make decisions about bank stock purchases and sales around merger announcement dates.      

Do CRA‐Related Events Affect Shareholder Wealth? The Case of Bank Mergers

This study explores how Community Reinvestment Act (CRA) protests and their resolution affect the market value of merging banks. We find, in contrast to earlier research, that CRA‐related events are not associated with significant negative market reactions for either bidder or target institutions. Rather, the market does not seem to respond strongly to CRA‐related events at all. The results appear to stem from the choice of an estimation period for establishing an institution's baseline stock‐market price dynamics that does not include abnormal security price movements induced by the merger announcement.     

Equity Issuance and Adverse Selection: A Direct Test Using Conditional Stock Offers

We conduct a unique test of adverse selection in the equity issuance process. While common stock is the dominant means of payment in bank mergers, stock acquisition agreements provide target shareholders with varying degrees of protection against adverse price movements in the bidder's stock between the time of the merger agreement and the time of merger completion. We show that it is the degree of protection against adverse price changes and not the percent of stock offered in a bank merger that explains bidder merger announcement abnormal returns. This result is difficult to explain outside of an adverse selection framework.     

The valuation effects of bank mergers

This paper examines the valuation effects of a sample of 558 bank mergers from 1980–1997. The overall results indicate that bank mergers create wealth. On average over a 36-day (−30, +5) event window, targets gain over 22%, bidders break even, and combined firms gain 3%. The results further indicate that mergers in the 1990s, which have not been extensively studied in prior work, have positive effects. In the 1990s over the 36-day window: target gain significantly, bidder returns are positive and statistically larger than the mid-1980s, and combined firm returns are significantly positive. These results are consistent with the notion that bank mergers occur for synergistic reasons and are not the result of empire building. However, bidder returns are sensitive to the event window implemented. Examining returns over an 11-day (−5, +5) window, target returns remain significantly positive, while bidder returns are statistically negative, and combined firm returns are statistically positive. Results over both windows indicate that overall wealth effects from bank mergers are positive over time, particularly in the 1990s.     

The random parameters stochastic frontier cost function and the effectiveness of public policy: Evidence from bank restructuring in Mexico

We apply specifications of the random parameters stochastic frontier cost function model to estimate bank efficiency. This class of model appears to resolve the long standing problem of confounding inefficiency and heterogeneity. Mean cost efficiencies from random models are higher by as much as eleven percentage points compared to pooled OLS estimates. Whilst tests show efficiencies are not drawn from the same population, rank order efficiencies are strongly associated. In a second step, we employ the estimated efficiencies to determine the effect of foreign acquisitions on bank cost efficiency following legislative reforms made as part of Mexico's bank restructuring programme in 1995. Foreign bank acquisition does not significantly affect efficiency whereas consolidation of local banks yields significant long-term improvements in efficiency. We recommend random parameters stochastic frontier models since they better accommodate heterogeneity and produce more precise estimated efficiencies.     

What do a bank’s legal expenses reveal about its internal controls and operational risk?

Excessive (substantially above peer) litigation against a bank is indicative of operational risk because it often suggests failure to maintain a strong system of internal control. We examine the relation between bank performance and weak internal control using legal expense as a proxy. We find that legal expense is a strong determinant of loan losses and stock returns. Bank regulators should require reporting of legal expense on call reports to help identify institutions with weaknesses in internal control. Current reporting creates unnecessary information asymmetries because investors are not well informed about operational risk, leading to mispricing of bank securities.     

Global diversification and bidder gains: A comparison between cross-border and domestic acquisitions

We provide empirical evidence on how cross-border acquisitions from the perspective of an US acquirer differ from domestic transactions based on stock and operating performance measures. For a sample of 4430 acquisitions between 1985 and 1995 and controlling for various factors we find that US firms who acquire cross-border targets relative to those that acquire domestic targets experience significantly lower announcement stock returns of approximately 1% and significantly lower changes in operating performance. Stock returns are negatively associated with an increase in both global and industrial diversification. Cross-border takeover activity has increased during the past decade and the observed difference in bidder gains is more pronounced for the latter half of the sample period. We find that bidder returns are positively related to takeover activity in the target country and to a legal system offering better shareholder rights. With the exception of the UK, the target country's degree of economic restrictiveness is negatively related to bidder returns.     

Is M&A different during a crisis? Evidence from the European banking sector

The financial crisis has affected the landscape of the banking sector around the world. We use a sample of transactions carried out by European acquirers in 2007–2010 to study the acquirer’s stock price market reaction to both announcements and completions of acquisitions. At the aggregate level, we find that there are no significant abnormal returns around the announcement of an acquisition while there are positive abnormal returns at completions. We study the cross-sectional determinants of abnormal returns and find that announcement returns are mainly explained by the acquirer bank characteristics, while completion returns mainly depend on opacity of the target and on the drop in idiosyncratic volatility associated with a reduction of uncertainty.     

Learning and the disappearing association between governance and returns

The correlation between governance indices and abnormal returns documented for 1990–1999 subsequently disappeared. The correlation and its disappearance are both due to market participants' gradually learning to appreciate the difference between good-governance and poor-governance firms. Consistent with learning, the correlation's disappearance was associated with increases in market participants' attention to governance; market participants and security analysts were, until the beginning of the 2000s but not subsequently, more positively surprised by the earning announcements of good-governance firms; and, although governance indices no longer generated abnormal returns during the 2000s, their negative association with firm value and operating performance persisted.     

Serial acquirer bidding: An empirical test of the learning hypothesis

Recent academic studies indicate that acquirers' cumulative abnormal returns (CAR) decline from deal to deal in acquisition programs. Does this pattern suggest hubristic CEO behaviors are significant enough to influence average CAR patterns during acquisition programs? An alternative explanation is CEO learning. This study therefore tests for learning using successive acquisitions of large U.S. public targets undertaken by U.S. acquirers. A dynamic framework reveals that both rational and hubristic CEOs take on average investor reactions to their previous deals into account and adjust their bidding behavior accordingly. These results are consistent with a learning hypothesis.     

‘Too systemically important to fail’ in banking – Evidence from bank mergers and acquisitions

In this paper, we examine the systemic risk implications of banking institutions that are considered ‘Too-systemically-important-to-fail’ (TSITF). We exploit a sample of bank mergers and acquisitions (M&As) in nine EU economies between 1997 and 2007 to capture safety net subsidy effects and evaluate their ramifications for systemic risk. We find that safety net benefits derived from M&A activity have a significantly positive association with rescue probability, suggesting moral hazard in banking systems. We, however, find no evidence that gaining safety net subsidies leads to TSITF bank's increased interdependency over peer banks.     

Partial acquisitions,the acquisition probability hypothesis,and the abnormal returns to partial targets

The acquisition of a partial stake in a target firm has been positively linked to the likelihood that the target will be involved in a follow on full acquisition involving either the original bidder or a third party bidder. Existing studies provide only suggestive evidence of this linkage by comparing the abnormal returns to partial targets that are ultimately acquired to those that are not. Using a sample of partial acquisitions, we identify characteristics that impact the probability of a full acquisition and provide a tangible link between partial target gains and the ex ante probability of acquisition. Partial targets experience positive announcement effects, and the gains are greater for subsequently acquired targets. Partial bids initiated by corporate bidders are more likely to result in a full acquisition, and the size of the acquired stake and the level of institutional ownership are positively linked to the probability of acquisition. Further, the partial target gains are positively linked to the ex ante probability of acquisition even after controlling for any increased monitoring and discipline that the partial bidder is expected to impose. The findings are robust across various time horizons and model specifications.