Impact of mergers and acquisitions on shareholder’s wealth

The previous article focused upon the need for mergers and acquisitions, i.e. the need for value creation. This value creation arises in the form of improved business operations and financial performance. The financial performance is linked to shareholder value which in turn affects the capital structure of the businesses. Generating more wealth for the shareholders can help to build a strong capital structure which is essential for long term growth of businesses (Haleblian, et al, 2009). Therefore, it is important to examine the impact of mergers and acquisitions on the wealth of the shareholders.

The variation in the shareholder’s wealth occurs in the form of change in stock prices. This change takes place after the announcement of the merger and acquisition. Positive or negative stock returns may reflect the extent of success or failure of merger (Cefis, Marsili, & Schenk, 2009). In this context, the present article focuses on the announcement effect of mergers and acquisition. It highlights the situations wherein the announcement effect leads to change in expected returns. Furthermore, the article highlights how these expected returns affect the values of the cumulative abnormal returns.

What is the announcement effect?

Announcement effect is linked to the investor behaviour which arises due to uncertainty in the market. This effect arises in the short run due to the asymmetric and incomplete information in the market. Due to this, investors end up making irrational decisions by overreacting to the market circumstances. The investor’s reaction is the result of the change in the overall corporate restructuring (Sachdeva, Sinha, & Kaushik, 2015). The forms of restructuring can be characterized into owner, business and asset restructuring. Ownership restructuring could arise due to the buyback of shares, joint ventures and strategic alliances. Business restructuring emerges due to changes in the reformation of the business units or its divisions. This could be due to the diversification of business into another domain. Asset restructuring arises due to the sale or purchase of the existing ownership structure. (Malhotra & Chauhan, 2018).

The restructuring forces the investors to take instant decisions to switch. Investors move from low valued stocks to high valued stocks. The investors respond by evaluating the growth prospects of the merged entity. It leads to biased behaviour in the group of investors and impacts the current and future stock prices. This eventually affects the long-term valuation of the business (Sylvani & Yunita, 2017).

Factors affecting shareholder’s wealth

The announcement of merger and acquisitions can generate a certain level of expectations and assumptions in the market. This information has a major impact on the stock prices based upon the rational decisions of the investors. Though these assumptions may not be realistic, it can create efficiency gains in the market. This, in turn, affects the extent of the shareholder’s wealth (Rani, Yadav, & Jain, 2015).

Market efficiency effect

The market efficiency effect reflects the value of stock prices. These stock prices depend on the value of the business. This value, in turn, depends on the available information that can generate excess or abnormal returns post announcement of the merger or acquisition. On the other hand, investors may think that the formation of the merger could negatively impact the efficiency of the merged firm (Vij, 2017). In such a situation, the stock prices of the merged or acquired firm may drop. Fluctuations in the stock prices also depend on the bid that is conducted at the time of acquisition. Businesses with higher bid values can generate long term gains for the financial markets. These bid values can lead to a rise in the stock prices that in turn positively affects the wealth of the shareholder(Sylvani & Yunita, 2017).

Volatility effect

Formation of mergers and acquisitions can also generate uncertainty about the value of the business. As the announcement of mergers and acquisitions can generate huge risk in the form of high leverage value. Additionally, it may result in low profitability in the initial years of the formation of the merger. Investors tend to avoid investing in stocks with a high level of uncertainty in the market. This may result in a high level of price volatility. As a result, the returns on the existing stocks could be extremely low (Vij, 2017).

Characteristics of the businesses

The profitability and average returns depend on the characteristics of the business. This depend on factors such as the type of industry and the geographic location of the industry. Vertical mergers can generate economies of scale and deliver a competitive advantage in the market. This could raise the stock prices of the merged business. Additionally, the horizontal mergers could help the business is expanding its domain (Gupta & Gerchak, 2003). This allows the business to generate new ideas and innovation in the production process. Furthermore, acquisitions may allow businesses to combine strength by geographical expansion. This could improve the operational efficiency of the businesses. A higher level of operational efficiency can generate long term profits for the business that can generate long term gains (Goergen, 2002).

Trading volume

The trading volume activity is defined as the ratio of the number of stocks traded to the number of stocks distributed during a given period. The amount of trading volume affects the investor’s as well as the market’s reaction. The market reaction posts the announcement of merger and acquisition could be in the form of rising and falling trade volume. The rise in the trade volume indicates that the markets will be profitable. This could be the effect of increase in the investor’s investment in certain stocks. This can either lead to a rise in the exiting stock prices or future abnormal gains (Sylvani & Yunita, 2017).

Country-wise effect

The announcement effect as a result of the formation of merger and acquisition could be affected by business-specific determinants of mergers and acquisitions. Specifically, in context to the cross-border merger and acquisitions, shareholder value could vary due to the cross-country determinants such as corporate governance. The extent of the impact of merger and acquisition on the shareholder wealth also depends on the host country. The corporate laws, regulations, the extent of premium and macroeconomic conditions could affect the shareholder’s wealth. The macroeconomic conditions determine the long term returns for the shareholder’s wealth. High inflation may discourage the shareholders due to the fall in purchasing power parity. This may lead to a low level of share demand and fall in the stock prices. Thus, country-wise variations can play a major role in affecting the wealth of the shareholders (Rossi & Volpin, 2004).

Size of the business

The size of the business could lead to variation in terms of product and market coverage. When larger businesses acquire smaller businesses, this may lead to combined effects in the form of new synergies and innovations. Furthermore, the larger acquiring business could increase its market reach. This could generate a higher abnormal return for both businesses. However, there could be situations in which smaller businesses could prove cost-saving. On the other hand, it could lead to efficiency losses for large businesses. In such a situation, the existing shareholders of the small business generate higher wealth gains (Cefis et al., 2009).

Comparing the pre and post-merger performance

The announcement of mergers and acquisitions affects the behaviour of investors. These investors are rational decision-makers who consider multiple factors before investing their money in the merged firm. The acquiring business may face abnormal returns in the pre-merger period which can result in significant losses in the post-merger period. Formation of the mergers or acquisition deal can unfold the market situation and reverse the entire performance scenario. Thus, in order to examine the impact of mergers and acquisition, it is important to compare the pre-merger and post-merger abnormal returns.

References

  • Cefis, E., Marsili, O., & Schenk, H. (2009). The effects of mergers and acquisitions on the firm size distribution. Journal of Evolutionary Economics, 19(1), 1–20. https://doi.org/10.1007/s00191-008-0105-9
  • Goergen, M. (2002). Shareholder wealth effects in large European takeover bids Shareholder wealth effects in large European takeover bids. European Financial Management, 10(February), 0–45.
  • Gupta, D., & Gerchak, Y. (2003). Quantifying Operational Synergies in a Merger/Acquisition. Management Science, 48(4), 517–533. https://doi.org/10.1287/mnsc.48.4.517.209
  • Haleblian, J., Devers, C. E., McNamara, G., Carpenter, M. A., & Davison, R. B. (2009). Taking stock of what we know about mergers and acquisitions: A review and research agenda. Journal of Management, 35(3), 469–502. https://doi.org/10.1177/0149206308330554
  • Malhotra, A. K., & Chauhan, A. K. (2018). Market Response of Mergers and Acquisitions’ Announcement and Its Predictive Ability in Forecasting Post Merger Long Term Performance of the Acquiring Company. Academy of Accounting and Financial Studies Journal, 22(2), 1–16.
  • Rani, N., Yadav, S., & Jain, P. (2015). Impact of Mergers and Acquisitions on Shareholders’ Wealth in the Short Run: An Event Study Approach. Vikalpa: The Journal for Decision Makers, 40(3).
  • Rossi, S., & Volpin, P. F. (2004). Cross-country determinants of mergers and acquisitions. Journal of Financial Economics, 74(2), 277–304. https://doi.org/10.1016/j.jfineco.2003.10.001
  • Sachdeva, T., Sinha, N., & Kaushik, K. P. (2015). IMPACT OF MERGER AND ACQUISITION ANNOUNCEMENT ON SHAREHOLDERS’ WEALTH AN EMPIRICAL STUDY USING EVENT STUDY METHODOLOGY. Delhi Business Review , 16(2).
  • Sylvani, N. F., & Yunita, I. (2017). Market Reactions Toward Mergers and Acquisitions Announcement in Telecommunication Firms Listed in. Proceedings of Academicsera 3rd International Conference, Jakarta, Indonesia, (March), 24–28.
  • Vij, R. (2017). Impact of M&A Announcement on Stock Returns of Acquirer Companies: New Evidence from Indian Stock Market. World Journal of Business and Management, 3(1), 86. https://doi.org/10.5296/wjbm.v3i1.11248

Priya Chetty

Partner at Project Guru
Priya is a master in business administration with majors in marketing and finance. She is fluent with data modelling, time series analysis, various regression models, forecasting and interpretation of the data. She has assisted data scientists, corporates, scholars in the field of finance, banking, economics and marketing.
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