Mergers and acquisitions have been scrutinised widely in academic research according to two main perspectives: (1) the detection of equity value crea- tion, or destruction, mainly through event studies about the stock market performance of acquiring and target firms; (2) the analysis of the conse- quences for the shareholders of the bidder and the target companies in terms of systematic risk. The identification of the key characteristics of the companies or deals that distinguish value-creating from value-destroying mergers is also a matter of interest to many studies.
In this section, we offer a brief review of the existing evidence about these research questions, in general and with specific focus on cross-border and cross-industry M&As in the financial sector.
Value creation for shareholders
There is a quite extensive literature concerning the value creation potential of M&As. By and large, existing studies conclude that around the announce- ment day: (1) the shareholders of the target company earn positive and statistically significant abnormal returns,1 that sometimes come from price run-ups before the announcement date (Jensen and Ruback, 1983; Datta et al., 1992; Bruner, 2002; Campa and Hernando, 2004); (2) the sharehold- ers of the acquirer do not earn abnormal returns and may suffer share price losses (Bruner, 2002; Campa and Hernando, 2004); (3) abnormal returns of the combined entities are usually not statistically different from zero (Campa and Hernando, 2004); (4) diversifying mergers have detrimental effects on the value of equity (Mứrck et al., 1990); (5) the bidder stock price has a better performance when the deal is announced during a ‘hot’
merger market (Rosen, 2006).2 With respect to point (4) the evidence is not clear-cut. A study by Campa and Hernando (2004) conducted on European markets provides evidence of better performance of the acquirers’ stocks in domestic and in-industry M&As against, respectively, cross-border and cross-industry ones, but Goergen and Renneboog (2004) cannot find any significant difference by type of operation.
Studies on bank M&As also show mixed results (Chapter 2). Beitel and Schiereck (2001) survey a hundred papers and report that a quarter of them do find, on average, positive abnormal returns for the stocks of both acquir- ers and targets, but in most instances bank mergers do not enhance the acquirer equity value – as is common among M&As involving non-financial firms. The same conclusion is reached by studies that focus on Europe too.
In Beitel et al. (2004) abnormal returns are zero for the acquirers, but positive
Petrella (2008). Cybo-Ottone and Murgia (2000) find positive and signifi- cant value creation for the combined entities in a sample of M&As involving various types of financial institutions.
Studies on M&As among insurance companies provide mixed results as well: if Madura and Picou (1993) find evidence of value creation, Kusnadi and Sohrabian (1999) do not, except for target firms.
According to many researchers, activity and the geographical degree of diversification influence market reactions to M&A deals. Specialising M&As, that is consolidation among banks with similar products or activity focus, are more beneficial to acquirers (Cornett et al., 2003) and to the joint entity (DeLong, 2001b) than M&As that diversify the scope of the business. M&As that focus geographically produce higher abnormal return for both the acquiring bank and the joint entity (DeLong, 2001b; Houston et al., 2001) than deals with geographic diversification; also, Amihud and co-authors (2001) find negative and statistically significant abnormal returns for acquir- ers in a sample of cross-border mergers.
Nor is there any evidence that the equity value of insurance companies benefits from diversifying M&As. Elango (2006) shows that US insurers seeking international acquisitions are neither rewarded nor penalised by the stock market; however, the shareholders’ reaction is negatively related to differences between merging firms in terms of culture, environment, legal system, and geography, but depends positively on the size of the foreign market and on the intensity of the commercial activity between the domi- cile countries, assessed with respect to bilateral trade volumes.
Among European banks, Campa and Hernando (2004) and Petrella (2008) find that the stock performance of target companies is higher for cross- border than for domestic mergers, while returns are lower for acquirers and negative for the joint entity; Beitel and co-authors (2004) as well as Resti and Galbiati (2004) report similar results for both acquirers and targets, but negligible abnormal returns for the joint entity. Value creation in domestic M&As is not rejected either in the analyses by Lepetit and co-authors (2004) or in those by Cybo-Ottone and Murgia (2000). Considering the business focus of the banks involved in the deals, Beitel and co-authors (2004) find statistically significant and opposite stock-market performance for acquirers and targets depending on their respective specialisations: the equity value of the acquirer increases when the deal is focused, while the stockholders of the target earn higher returns when the deal reduces specialisation; but Petrella (2008) argues that focusing benefits the latter as well. Lepetit and co-authors’ (2004) analysis controls for variations in exposure to market risks over time: their results partially confute common evidence since they reveal a positive and statistically significant market reaction to activity- diversifying M&As, while activity specialisation does not have any influence
It is worth cautioning that the aforementioned results may conceal a high degree of variability among individual operations, because the returns of both targets and acquirers often show a broad range of responses, from very positive to very negative.
Effects on market risk
The prevailing explanations of the poor performance of M&As for the share- holders of the acquiring company point to higher than expected merger costs (for example, organisational burden and bid-premium paid for the target) that hinder cost saving and, to a lesser extent, revenue enhancement (Houston et al., 2001). Since these obstacles are probably greater when the merging firms belong to different countries or industries, it is not surprising to see domestic and activity-focused deals usually producing better returns than diversifying ones.
However, it may be the case that the market risk of the acquirer changes after the M&A is concluded, thus altering the shareholders’ expected return.3 While Agrawal and co-authors (1992) argue that the poor stock market per- formance of acquirers should not be attributed to estimation biases induced by post-merger changes in market risk, others find a significant degree of sensitivity of abnormal returns to the estimation period (Connell and Conn, 1993; Kiymaz and Mukherjee, 2001). Diversifying M&As may then have positive effects on the risk profile of the acquiring firms that compensate – or even outweigh – integration costs by reducing the cost of capital. From this perspective, what is the evidence on the risk impact of diversifying mergers? Do we observe a reduction in market risk?
The prevailing evidence from empirical studies is that M&As induce sig- nificant changes in the risk of the acquirer, often resulting in its reduction (Connell and Conn, 1993; Davidson et al., 1987; Langetieg et al., 1980;
Lubatkin and O’Neill, 1987; Mandelker, 1974). In a recent study of domes- tic US mergers, Hackbarth and Morellec (2008) find changes in the beta of the bidder both before and after the merger is announced. The direc- tion of the shift depends on the relative risk of the companies involved:
the firm-level beta increases before the announcement and then decreases when the beta of the bidder’s core assets exceeds the beta of the target’s core assets; the opposite happens when the bidder’s assets are safer than the target’s. This finding may help to explain the contrasting evidence on the benefits of diversification. For a sample of large UK companies, Thompson (1983) concludes that diversifying mergers tend to increase risk, rather than reduce it, and to produce larger beta changes than focused deals. Kiymaz and Mukherjee (2001) analyse a sample of cross-border mergers completed by US acquirers and show a significant decline in beta over the post-event period; domicile affects the size of the variation but not its sign. Amihud
market index increases after the deal, especially when targets are outside the European Union, while the beta on the domestic market does not change on average: this is often because the risk-load shifts between the acquirer and target countries.