CFA on Corporate Takeovers & Objectives

Written by M. Mark Walker, CFA

Summarized by Brian A. Maris, CFA

Edited by Constantinos Papanastasiou, CFA

President, CFA Society of Cyprus

 

The author classifies corporate takeovers according to the strategic objective motivating the takeover and estimates the relationship between corporate strategy and the change in acquiring-firm shareholder wealth. The results indicate a negative impact on shareholder wealth for takeovers motivated by diversification if overlap exists between the two firms’ products. For takeovers based on other strategies, the average change in acquiring-firm shareholder wealth is not statistically significant.

Walker investigates the impact of corporate strategy on the shareholder wealth of acquiring firms involved in takeovers. He uses event study methodology to estimate the changes in wealth of acquiring firm shareholders during a five-day period surrounding the takeover announcement. Returns are adjusted using both the market model and the returns of firms matched by SIC code and size.

The author identifies six competing takeover objectives, as identified by firm executives, financial analysts, and other sources in articles announcing the takeover: geographical expansion, broadening the product line, increasing market share, vertical integration, diversification without product overlap, and diversification with product overlap. Walker notes that the distribution of takeover strategies changes during the sample period. Diversification strategies represented 47 percent of the takeovers during the first 10 years of the sample period but only 28 percent during the last 7 years.

The author includes takeovers completed between January 1, 1980, and December 31, 1996. The sample consists of takeovers of industrial firms in which the acquisition exceeded $50 million and the value of the acquired firm was at least 10 percent of the value of the acquiring firm. Stock price data are from the CRSP. Additional data include information obtained from the Wall Street Journal, other articles announcing the takeovers, and the SIC codes of the acquired and acquiring firms.

The analysis classifies takeovers based on mode of acquisition (hostile bid or friendly merger), form of payment (cash, stock, or mixed), and number of bidders (single or multiple). Walker finds that merger characteristics are not related to the strategic objective motivating the takeover. On the other hand, the strategic objectives of acquirers are related to the acquirer’s growth opportunities and competitive advantage as reflected by the q ratio (market capitalization divided by total assets). Acquiring firms generally have q ratios higher than those of matched firms (indicating superior competitive position), but acquirers motivated by increased market share, vertical integration, and diversifying without overlap have lower q ratios than those motivated by other objectives.

The estimated change in acquiring-firm shareholder wealth for all takeovers is –0.84 percent (based on market-adjusted returns) over a five-day window, which is statistically significant at the 0.10 level.

For mergers between firms with different two-digit SIC codes, the change is –1.6 percent (significant at the 0.05 level), whereas for mergers between firms with the same two-digit SIC codes, the change in shareholder wealth is not significantly different from zero.

Shareholders of acquiring firms lose most in mergers motivated by diversification when product lines overlap, with an average change in shareholder wealth of –3.35 percent (significant at the 0.01 level).

Similar results are obtained with returns adjusted using matched firms.

The results of this study indicate that acquiring-firm shareholders earn normal returns in most cases. The exception is takeovers motivated by diversification when overlap exists in the two firms’ products, in which case shareholders experience a loss of 3.35 percent. Walker concludes that corporate managers should consider alternatives to takeovers to accomplish firm objectives.

 

The CFA Society of Cyprus is a member society of CFA Institute, an international, nonprofit member organization of more than 88,000 investment practitioners and educators in 129 countries. CFA Institute awards the Chartered Financial Analyst (CFA) professional qualification, the designation of professional excellence within the global investment community. For more information on the CFA designation, please visit CFA Institute web page on www.cfainstitute.org or CFA Society of Cyprus web page on www.cfacyprus.com , e-mail: [email protected].