Merger by Dell and Silver - Essay Example

? EVENT STUDY METHODOLOGY al Affiliation Mergers and Acquisitions have become common phenomena in the recent few decades. The fact that financial markets have also grown have seen the need to assess the impact mergers and acquisition on the firm value. One of the methods commonly used to assess the effects of mergers is the event studies which form a core area of study in finance, industrial organization, corporate governance and economic law. Scholars have for a long time been fascinated by the need to understand the underlying forces around the mergers and acquisitions within the constraints of financial market such as a stock exchange. Another impact of this study of effects of merger events is the impact it has on the competitiveness of the post merger firm in terms of profitability and efficiency. The competitiveness is a critical aspect to be considered by investors and managers before deciding on whether a merger is an appropriate financial decision to make. The way stock markets react to events around a merger and specifically the announcement of a merger can be used to reasonably predict the future financial and operational performance of firm in a financial market so long as it is efficient. This research looked at the stock performance of some of the listed stocks before a merger announcement and after the announcement. The daily stock prices were noted and analyzed statistically to highlight the changes in return and correlated with the stated event and other similar competing firms’ stock prices. It was generally noted that the announcement of a merger generally resulted in certain changes in the prices of stock. Review of literature points out that there is a negative correlation between the stock returns and hence the value of the firm after an announcement of a merger. This could be explained using hypothesis put forward by behavioral finance scholars. This particular empirical study further reinforces the studies in which the post merger firm values as indicated by the stock prices using the cumulative average abnormal returns CAARs reduce with the announcement of a merger, just a few days of the announcement and well after the announcement has reached the public. Introduction Economists and financial analysts are sometimes faced with the challenge of figuring out the magnitude of the effect an economic event has on the underlying value of firms. This implies that they have to measure the impact based on a particular cause or event. To achieve this the event study methods have developed that assist in the construction of effective models that easily predict the value of a firm based on an event. This is basically an event study that employs residual analysis to evaluate and analyze how a market behaves to an announcement of a merger. A company merger would mean that a company would inherently have more capital size, increased in operations and more diversification. This however does not always result in improved profitability as it could be hindered by excessive costs of acquisition and regulation obstacles. In previous studies it has been noted that an event such as the announcement of a merger had a positive market reaction. This can be investigated using abnormal stock returns noted during such events. As earlier stated the announcement of a merger and or acquisition shall be regarded as the event for the purposes of this study. This research paper has the following objectives: (a) to investigate whether news or any other publicly available information can influence the price patterns of the acquirer and (b) to examine the impact a merger announcement has on the stock prices of the acquired. The research shall be carried out by comparing the stock prices and daily returns before the merger announcement and immediately after the merger announcement using the daily closing stock prices. This particular paper is organized into four sections. The first section shall review the literature on previous research on event studies related to mergers and acquisition. The methodology and data analysis shall be presented in the following section 2. Finally the empirical findings and the conclusion shall be in sections 3 and 4 respectively. Literature Review Event Studies. According to (Schwert and William 1981) in finance and accounting event study has been used on many occasions to analyze specific and even economy wide occurrences. Major example of events researched include earnings announcements, mergers and acquisitions, issue of new bonds or equity announcements and other announcements of macroeconomic indicators such as inflation and balance of trade deficits. Event study is not only restricted to the field of finance as it is also applied in the field of economic law to measure the effect on the value of an asset or firm caused by changes in the regulatory environment and in litigation where there is a proven liability, the case event studies are often used to estimate the damages (Mitchel and Netter 1994). In most of the studies the major focus is usually the impact of a particular event on the prices of a stock and thus the value of an asset or firm in a particular financial market. The most common event study is mainly that which involves common stock equity though debt securities can also be analyzed but with some modifications. Historically event studies began in the early 1930s with the first ever published study being done by (Dolley and James1933). In this particular study he researched on the effect of stock splits by looking at the changes in the nominal prices around the time the stocks were split. He performed this research using a sample of 95 splits taken from a period between 1921 and 1931 Merger Events In the corporate world, especially in the financial markets, mergers are usually given a lot of attention by both skeptics and optimist. This is because of the impact such an event can have on the value of a firm. A merger could either cause an increase in firm value or a decrease depending on other macro and macroeconomic factors. Therefore the event study methodology is one of the ways in which a market can evaluate the impact of a merger on the stock prices of the acquirer or the target company. There have been several studies about the effect of mergers on efficiency and profits. (Cox and Portes 1998). Another similar study was done in 2003 by pautler who provided a summary of the event study method when applying in mergers and acquisitions. The common practice for an event study methodology on the effect of a mergers and acquisition announcement is to compare the stock returns of the company that does the acquisition before the announcement dated and immediately after. Also it is critical for a comparison to be made with other similar competing firms to determine whether the proposed merger or acquisition would be competing for a particular firm (Putler 2003). Post Merger Events After a merger the actual performance of a firms’ value is a critical area of study for many researchers looking at event study. This helps many of the empirical researchers to stipulate and prove various hypotheses that can be proved using the data collected. Among the first researchers to provide a comprehensive review of long run post merger underperformance was (Agrawal and Jaffe 2000). Another researcher (Langetieg 1978) found in his analysis that CARs or the cumulative abnormal gains ranged between -2.62% and -2.32% for a period not exceeding six months after an acquisition or merger. In another study it was discovered that the acquiring firms particularly had a 7.2% decrease in their CAR one year after their mergers were finalized. Another almost similar result was published by (Malatesta 1983) who found that CAR of -7.6% was evident after one year since a merger announcement is made. A more comprehensive study of seven studies by ( Ruback 1983) showed that the average CAR one year after the merger was -5.5%. A different result was obtained by (Magenheim and Mueller 1988) who concluded that the significant CAR three years after a merger was -2.4%. There were other studies that looked at the post merger performances of companies after three or more years. Some of the significant studies are by (Loughran and Vijh 1997) which found at a five year buy and hold abnormal return of 15.9% which is the book to market value adjusted benchmark. Another study by (Rau and Vermaelen 1998) reported a three year CAR of -4%. A more recent research by (Agrawal and Jaffer 2000) concluded that in general firm value after a merger is always negative. Data and Methodology The research was done using some 50 announcing firms and the major focus was their share price reaction especially the acquiring firms. At the time = 0; represents the time at which the acquiring firm announces its merger. The data set being investigated included the share prices from time = - 100 i.e. some 100 trading days before the merger announcement was made and time = +5 some 5 days after the merger announcement. The share prices were gotten from Thompsons and Reuters terminals. In the cases where the market announcements were made after the close of the trading period the announcement date (time = 0) was taken to be the following day. This is mainly because information is most likely to get into the public domain and hence a reaction the after the following day. Using the actual day of the announcement would have resulted in a wrong estimation in examination of the existence of any abnormal returns. As a way of eliminating any such bias in the announcement date, the day ‘0’ was the date at which the announcement appeared on national dailies and the immediate day that followed if it happened to be a trading day. The daily return calculated using the formula for residual analysis as follows Rjt = (Pjt – Pjt-1)/ Pjt-1 Where right is the daily return for security jon day t, and Pjt is the closing price for security j of day t. Calculation of the daily average returns: Pt – Pt-1 Pt-1 Log returns: logPt – log Pt-1= log(Pt/Pt-1) In order to evaluate calculations are done for the variation and the magnitude of the announcement the prices of the stock before the announcement, actual merger and after the merger, the daily abnormal returns, and cumulative abnormal returns. The formula for calculating cumulative average abnormal return is given as follows CAARt = CAARt-1 + AARt , Where it refers to the event period. Hypothesis Testing Based on the discussion above the following hypothesis can be formulated H1: The abnormal returns of the acquiring firm on and around the announcement of a merger is less than or equal to zero. If the result shows a different trend let’s say that the CAR and AAR values of the post announcement is more than zero then and that they are statistically significant, then it would show that the market reaction to the announcement of the merger was positive. To simplify the analysis various event windows are taken into considerations for instance -6, +8 where the former imply 6 days before the announcement and the latter represents 8 days after the merger announcement was made public. Descriptive statistics are then used to validate and ascertain the reliability of the information using t-statistics and other tests for equality of means. The assumption that is made is that normal distribution would occur. The average abnormal return is normalized analytically using the periods standard deviation. TAAR= Similarly the t-test statistic for CAR is given by the equation DELL FTSE alpha 0.0819 return return beta 1.2440 expected ret abnormal ret CAR -5.00 0.20 -0.38 -0.39 0.59 0.59 -4.00 -0.54 -0.54 -0.59 0.06 0.64 -3.00 -1.76 -0.51 -0.55 -1.21 -0.57 -2.00 1.10 1.03 1.36 -0.26 -0.83 -1.00 0.74 0.56 0.77 -0.03 -0.87 0.00 -2.15 -0.37 -0.38 -1.77 -2.64 1.00 -1.00 -0.33 -0.33 -0.66 -3.30 2.00 -0.05 -0.23 -0.20 0.15 -3.15 3.00 0.25 1.10 1.46 -1.20 -4.35 4.00 -1.66 -1.23 -1.45 -0.21 -4.56 5.00 -2.56 -1.80 -2.16 -0.41 -4.97 Table 1: alpha, beta and abnormal return Calculation for JMAT Results The expected results provided there are no abnormal price movements before the announcement day then the AAR and CAR are expected to fluctuate at about zero. However, if there was insider trading or an element of leakage of insider information just before the announcement date then there would be a positive or negative daily average abnormal return as t?0 which also corresponds to the building up in the CAAR. Table 2: average abnormal returns in relation to announcement event The efficient market model is then used to check whether the merger announcement event affected positively or negatively the abnormal return to the stock being investigated. The graph above shows the cumulative average abnormal return for the merger announcements. It can be observed that prior to the merger and especially two days before the shareholders of the company had significantly more positive cumulative abnormal returns. This later drop continuously to around -6% before picking up some time after the announcement specifically at day 5 after the merger announcement date. These results are consistent with other similar results such as (Athanasoglou & Brissimis 2004) who studied merger deals between the years of 1998-99 and discovered that there was a positive abnormal return just before a merger announcement. However, there is a contradicting study which was noted was that there is a weak or semi strong positive abnormal return (Stengos & Panas 1992). To better understand whether a merger deal was value enhancing or destructive, the analysis of the combined entity was done using the suggestions given (Houston, James & Ryngaert 2001). This is done by weighing the abnormal returns with their respective market capitalization at the end of the stated event window period. Some of the shortcomings of this event study method is the fact that the actual merger announcement details were not investigated in detail. Merger details can take many forms such as cash buy out or hostile acquisitions. To get a more accurate understanding of industry specific firm valuation before and after an acquisition it’s important to do a targeted sectorial analysis such as in the banking sector or within a certain region to get more actionable results. Discussion of Results From the above empirical study it can be noted that some twenty days before the announcement of the merger the average abnormal return started to decline and went on till way after the merger announcements. This is similar to other empirical studies which go to reinforce the fact that the announcement of a merger generally lowers the expected rate of return of the investors in a particular market. Another point to note is that it's not when the actual announcement date that the market reacts, but the reaction usually starts way before the actual merger announcement. Therefore when the news is released it merely does not change much since the markets automatically adjust to the prevailing financial changes before the merger. It may imply that the markets usually have their own way of detecting mergers before they happen. Conclusion In this empirical study the impact of announcement of a merger by Dell and Silver lake Partners woth $24.9 billion that was announced on the 12th September 2005. This particular study has looked at the various technological stocks to compare the average daily returns. In conclusion, this particular research was aimed at taking an empirical event study of mergers and acquisitions and specifically examines the effect it has on the stock returns of the acquiring firm. This study is quite important as it would help practitioners, consultants and business executives in decision making regarding whether or not a merger is a competitive strategy. From the statistical analysis it could be noted that there was a negative correlation of an announcement of the merger and the stock return. This negative correlation could be attributed to the fact that most of the financial market is driven by the news and information received to speculate on the profitability of a firm. It has been noted in behavioral finance that people often behave irrationally as a group therefore an announcement of a merger cause such irrational behavior. The major perception is usually that mergers are risky and could lead to decreased profitability due to increased organizational complexity and costs of acquisition in the early years could be quite significant. Finally, we establish that empirical evidence shows that event study methodology is quite relevant in the analysis of the competitiveness of a merger of the acquiring firm. To be specific, this research was able to show the abnormal returns of the post merger firm as a measure of profitability and efficiency. The analysis of the competitiveness of a merger is also used worldwide as a pillar in the determination of antitrust policies. The event study therefore helps to analyze the competitiveness of a merger by giving the projected profitability post merger and hence help the regulators to formulate and implement. References Agarwal, A., Jaffe, J.F. (2000), “The post-merger performance puzzle”, JAI Series: Advances in Mergers and Acquisitions (JAL, Elsevier Science, Vol1, October), 7-41. Athanasoglou, P. & Brissimis, S. (2004). The impact of mergers and acquisitions on the efficiency of banks in Greece, Bank of Greece Economic Bulletin, 22, 7-34 Cox, A.J., and J. Portes (1998), “Mergers in regulated industries: The uses and abuses of event studies, Journal ofRegulatory Economics, 14, 281-304. Dolley, James C. (1933). “Common Stock Split-Ups, Motives and Effects.”Harvard Business Review,12(1): 70–81 Houston, J.F, James, C.M., and Ryngaert, M.D. 2001. “Where do merger gains come from? Bank merger from the perspective of the insiders and outsiders.” Journal of Financial Economics60: 285–331. Langetieg, T. (1978), “An application of a three factor performance index to measure stock holders gains frommergers”, Journal of Financial Economics, 6, 365-384. Magenheim, E.B., and D.C. Mueller (1988), “Are acquiring firm shareholders better off after an acquisition”, in J.C. Coffee, Jr., L. Lowenstein, and S. Rose-Ackerman, editors, Knights, Raiders and Targets: The Impact of theHostile Takeover, New York, Oxford University Press. Malatesta, P.H. (1983), “The wealth effect of merger activity and the objective functions of merging firms”,Journal of Financial Economics, 11, 155-182. Mitchell M.L. and J.M. Netter, The Role of Financial Economics in Securities Fraud Cases:Applications at the Securities and Exchange Commission, Business Lawyer, 49, 1994, 545-590 Loughran, T., & Vijh, A. M. (1997). Do long-term shareholders benefit from corporate acquisitions? / Tim Loughran and Anand M. Vijh. Putler, P.A. (2003), “Evidence on mergers and acquisitions”, Antitrust Bulletin, 48, 119-221 Rau, P.R., and T. Vermaelen (1998), Glamour, value and the post-acquisition performance of acquiring firms”,Journal of Financial Economics, 49, 223-253. Ruback, R. (1983), “Assessing competition in the market for corporate acquisitions”, Journal of Financial Economics, 11, 141-153. Schwert, G William, 1981. "Using Financial Data to Measure Effects of Regulation," Journal of Law and Economics, University of Chicago Press, vol. 24(1), pages 121-58, April. Stegnos, T.$ Panas, E (1992). Testing the efficiency of the Athens Stock Exchange: some results from the banking sector. Empirical Economics, 17, 239-252,doi:10.1007/BF01206285,http://dx.doi.org/10.1007/BF01206285 Read More