Mergers and Acquisitions
The Market For Corporate Control
Mergers Premiums Amount to Approximately 50 to
100% of stock price prior to merger announcements
What drives these high premiums?
Gains from Mergers
Taxes
Operating Synergies
Target Incentive Problems
Financial Synergies
Types of Mergers and Acquisitions
 Strategic Acquisitions (1990's)
 Financial Acquisitions (1980's)
 Conglomerate Acquisitions (1960's and '70's)
Types of Gains
 Tax Motivations
Depreciation and Good Will
1982 Act: Step up of Basis as a result of an
acquisition
1986 Act: The stepped up basis had to be
reported as taxable income at the time of the
acquisition and then could be depreciated over
time.
Increased Leverage
Less Unique (non-market, diversifiable) risk
Less likely to report negative taxable income
Loss offsets
Prior to 1986: Firms could shift forward prior
losses of acquired firms
1986 Act: Disallowed prior loss offsets
* Operating Synergies
Vertical Mergers
Horizontal Mergers
Target Incentive Problems
 Disciplinary Takeovers
 MBO’s
 Wealth Transfers
Bondholders
Employees
Managers and Free Cash Flow
 Managerial Self Interest and Hubris
Financial Synergies
 Reduce Non-Systematic Risk
 Cash Cows and Personal Taxes
Disadvantages of M & A
 Misallocate Capital
 Reduce information in prices
 Allow cross department subsidizations
Empirical Results
1. Returns of Targets and Bidders Around the
Announcements
Event Studies
Methodology
Results:
Targets gain from 30 to 50%
Bidders lose or at best receive no significant
benefit
Hostile Bidders receive zero
Friendly takeover bidders receive 4%
Combined, there is an average increase in
value of 7% to 8.4%
Means of Financing:
Equity: experience negative returns
Cash: experience positive or zero
returns
Failed Bids
2. The Gains from Diversification
Does Diversification Pay?
‘70’s no penalty to diversification
‘60’s and ‘80’s significant diversification
penalties
3. Accounting Studies
1. Decline in Post-merger Performance of
Acquired Firm
2. But is time sensitive: Poor performance in
‘60’s and ‘70's: Good performance in ‘80’s
3. Tobin's q: Market to replacement value:
Targets are poorly managed prior to the
merger or acquisition.
4. Recent mergers appear profitable relative to
older mergers on average.
Financing of an Acquisition
Capital Gains Tax Liability
Equity Exchange is preferred to Cash Offer
because of Tax Implications.
As a result we find lower premiums for
Exchange Offerings
Pooling versus Purchase and their tax
implications
In pooling, assets are simply combined
In Purchases, increased value is amortized
Thus, Lower Earnings in Purchases than in
Pooling
Implications:
After Tax Cash Flow
EPS measures of Performance
Empirical Implications:
Cash better than Exchange
Problem is confusion with
information effects
Bidding Strategies
The Free Rider Problem
Benefits to Stockholders accrue to all
stockholders. Thus as long as the merger goes through all
stockholders will benefit.
Therefore this is no incentive to sell at a “fair” price
Bidding strategies to avoid this:
Secret accumulation of shares by the Bidder
13D report: Must state intentions once
5% of shares have been accumulated.
Accumulation of shares by Risk Arbs
Two-Tiered Offers
Winners Curse
Takeover Defenses
Greenmail
Purchase of Shares from Bidder at a
premium to ward off acquisition
Supermajority Rules
Poison Pills
Anti-takeover laws
Golden Parachutes
Valuing Acquisitions
1. Value the Target as a stand-alone firm
2. Calibrating the Valuation Model
Pre-acquisition stock prices will reflect takeover
probabilities
Pre-acquisition stock prices may not take into
account proprietary information possessed by the
bidder.
3. Value the synergies arising from the takeover.
Consider the risk of the additional net cash flows
4. Value the acquisition