PART I: INTRODUCTION

Mergers and acquisitions are a monumental episode in the life of any company. The importance involved around such events and the sheer work power expensed towards completion of any action of the kind can hardly be exceeded by any other business related circumstance.

This research paper explores stock market movements of acquirers, mid cap tech companies – with more than two billion US dollars in market capitalization – taking into account announcements of domestic North American (USA) mergers and acquisitions announcements in the last five years.

Predominantly, the academic focus is usually not targeted when studying mergers and acquisitions announcements’ impacts. The literature focuses on general arrays of companies, not from specific industries, but rather from specific countries at most.

Mergers and acquisitions are under strict regulation in the United States and require the meeting of several approvals from Federal Trade Commission, the Department of Justice and in some cases – whenever a company has significant operations in another country – even from other countries’ regulators (e.g. European Commission). Regulators’ primary objective is to prevent the creation of monopolies, which the American government first began to control under the Sherman Act of 1890.

Because of their difficulty in completion there is a level of uncertainty surrounding M&As and regarding the number of attempted mergers and acquisitions there actually are a year, since they are frequently kept secret, in some cases even from the employees. When mergers and acquisitions are go through to the public, it is in general a positive thing for shareholders. By merging forces, the newly found company should be able optimize costs while maintaining revenue, resulting in a better profit yielding. Another aspect is that if a company joins up with a competitor, the two will now have more market power and an increased market share.[1]

In this research, event study methodology has been used. Event studies can enable us to estimate and quantify asset prices’ reaction to announcements of corporate and economic events having new information regarding the underlying asset.

PART II: Literature Review

Chapter 1. Market Efficiency

1.1. Background

Basic security investing is a game of good news versus bad news. If good news related to a certain stock comes out (for instance a successful medical trial for a pharmaceutical company), immediately afterwards each and every one would suddenly want to buy the stock, to be able to gain from the potentially newly generated larger earnings.

Efficient-market hypothesis (EMH) is a theory developed by Professor Eugene Fama in 1970 in economics of finance that states that an asset’s prices entirely reflect all available information. As a direct consequence, players of financial markets assume it is impossible to “beat the market” with consistency while holding risk constant since prices on the market should only react to novel information or changes in discount rates.[2]

Moreover, the nature of information that has an impact is not limited to financial news alone. True or rumored news from political, economic and social spectrum will be reflected in the price of a financial asset. In addition, another important matter to take into consideration is the perception of the news. New academic studies emerge, such as behavioral finance, which look at the effects of investor psychology on stock picking and pricing, and that reveal that players of the market are subject to many biases and fallacies (e.g. confirmation bias, loss aversion, survivorship bias). For instance, the passing of Sarbanes-Oxley Act of 2002, requiring greater financial reporting transparency for public companies generated a decline in equity market volatility after the quarterly reports were passed in accordance to the new regulations. The investors deemed the financial statements to be more credible, and thus it made the market more efficient.[3]

This concept is also classically represented in Harry Markowitz’s efficient frontier (1952). Markowitz proposes that there are assets or combination of assets[4] referred to as “efficient” that have the highest expected level of return for their level of risk (the standard deviation of the returns)[5]. This implies that for an increase in the expected level of return the investor must accept an increased level of risk – no “free lunch”.

Figure 1.1 Efficient Frontier
Source: Markowitz, H.M. (March 1952). “Portfolio Selection”. The Journal of Finance. 7 (1): 77–91

In his 2009 study with Kenneth French, the rational markets beliefs were confirmed, concluding that the abnormal returns of US mutual funds are significantly similar to the expected returns if any of the fund managers had no skill.[6]

Fama extended and refined his research, coming with the definitions for three forms of financial market efficiency:

• Weak
• Semi-strong
• Strong.[7]

Weak-form Efficiency

The perspectives of players in the market and academicians vary. Those who think that the degree the market is in is the weak form believe that active trading[8] can generate abnormal profits.

In the weak-form efficiency, assets’ future prices cannot be predicted by analyzing information and prices from the past. It is the definition of the saying “past performance is not an indicative of future results”. This is in a sense a contradiction, because you need to start from somewhere to build your investment thesis and/or strategy, and since we are not Nostradamus or we do not have any kind of insider information, past information is the clear choice.

Technical analysis[9] will not consistently generate abnormal returns under the weak-form efficiency assumption. There are no patterns in prices of assets. This means that future price movements are generated by information not previously contained in the series. Some sorts of fundamental analyses[10] still manage to give an edge to investors in generating excess returns.

Semi-strong Efficiency

Semi-strong efficiency EMH falls somewhere in the middle. This form is implying that all public information is integrated in the current price of an asset. Not event fundamental analyses can generate excess returns now.

It is assumed that the prices respond to new information very quickly and in an unbiased manner, and such no excess returns can be yielded by trading according to that information.

Strong Efficiency

In this form, asset prices price in all information, public or private, making it impossible to earn excess returns. The legislative barriers render strong efficiency impossible, such as anti-insider trading laws.

Passive investors generally agree with Fama’s belief that the market is strongly efficient.

1.2. Anomalies

Economist Eugene Fama argues that securities trade at their fair value, and such it is impossible for investors to purchase stocks that are undervalued or sell securities for inflated prices.

Generally, there are people who do not believe in the efficient market hypothesis because of the fact that active traders continue operating. If there are little to no possibilities to earn excess returns, then there should exist no reason to become an active trader. Moreover, the fees charged by active fund managers are seen as evidence that the EMH is not correct, because it specifies that an efficient market has low transaction costs.

While event studies of stock splits are not contradictory with the efficient market hypothesis (Fama, Fisher, Jensen, and Roll, 1969), other empirical researches have found inadvertencies with the efficient-market hypothesis.

Early examples[11] [12] [13] conclude that small neglected stocks and shares with low book to market ratios (also known as value stocks) tended to achieve abnormally high returns in the long run comparative to what could be explicated by the Capital Asset Pricing Model (CAPM).

The CAPM was introduced by Jack Treynor (1961, 1962), William F. Sharpe (1964), John Lintner (1965) and Jan Mossin (1966) independently, building on the earlier work of Harry Markowitz on diversification and modern portfolio theory. Sharpe, Markowitz and Merton Miller jointly received the 1990 Nobel Memorial Prize in Economics for this contribution to the field of financial economics.

Where:

is the expected return on the capital asset

is the risk-free rate of interest (government bonds)

(beta) is the measure of the systematic risk, or the ratio of expected excess asset returns to the expected excess market returns, or also

is the expected return of the market

is known as the market premium.[14]

In the real world of investment, however, there are some arguments against the EMH. Investors such as Warren Buffett, who have beaten the market, exist. Warren Buffet investment strategy focuses on undervalued stocks. His mentor was Benjamin Graham, an investor and professor at Columbia University and at University of California, who is known as the “father of value investing”. His primary focus was on fundamental analyses that yield stocks that appear underpriced[15]. Portfolio managers who have better records of accomplishment than others do and investment institutions with more renowned research analysis than others are other examples of anomalies. Clearly, performance cannot be purely random and market unbeatable.

Another counterargument for the efficient market hypothesis is that certain patterns can be established and observed. For instance, the January effect is a pattern that indicates higher returns incline to be earned in the first month of the year[16] and the weekend effect is the inclination for asset returns to have a cyclic pattern, on Monday being inferior than those of the directly prior to Friday are.[17]

1.3. Conclusions

This chapter was a preliminary step towards understanding how markets function, therefore how market responds to merger and acquisitions announcements and newly presented information.

While the opinions are split among players of the market and academicians, one thing that must be understood is that markets have an inherently random part. Markets are not entirely rational, therefore when studying events impacts on the asset prices one must take into consideration the naturally occurring randomness.

Although no clear statement can be made regarding the form of market efficiency today’s markets embody, some signs point out to the fact that the semi-strong efficient market hypothesis is the plausible one.  A study from 2008 tests the market efficiency concerning mergers and acquisitions announcements and their effects on the stock prices. It was done on twenty mergers, and the evidence found supports semi-strong market efficiency along with a positive average gain in the sample of acquiring companies during the event period.[18]

While this paper does not study the market efficiency in respect to mergers and acquisitions announcements, we have to consider the ramifications of the efficient market hypothesis.

Chapter 2. Mergers and Acquisitions

2.1 Background

The definition of a merger is when “two or more enterprises cease to be distinct enterprises and agree to combine their equity capital to form a single new company” (Hussey, 1999, p. 54). An acquisition is when “one company buy sufficient shares in another company to give the purchaser control of that company” (Hussey, 1999, p.  54). Unlike a merger, an acquisition does not have to be a mutual decision between the board and shareholders. It is up to the target companys shareholders to accept or reject the bid from the acquirer.

Essentially, mergers and acquisitions are transactions in which the ownership of companies are transferred or combined.

From a legal perspective, a merger is a legal association of two entities into one entity, while an acquisition ensues when one entity takes ownership of another entity’s stock, equity interests or assets. Both sorts of transactions normally result in the consolidation of assets and liabilities under one entity from a commercial and economic point of view, and the distinction between a “merger” and an “acquisition” is blurry. A transaction legally structured as an acquisition may have the effect of placing one party’s business under the indirect ownership of the other party’s shareholders, while a transaction legally structured as a merger may give each party’s shareholders partial ownership and control of the combined enterprise.

When one firm acquires another, there is typically a buyer, the acquirer or bidder, and a seller, the target firm. There are two primary mechanisms by which ownership and control of a public corporation can change: Either another corporation or group of individuals can acquire the target firm, or the target firm can merge with another firm. In both cases, the acquiring entity must purchase the stock or existing assets of the target either for cash or for something of equivalent value (such as shares in the acquiring or newly merged corporation). For simplicity, we refer to either mechanism as a takeover.

A deal may be figuratively called a “merger of equals” if both companies’ management agree that joining up is in the best interest of their companies likewise, whereas when the deal is considered unfriendly (that is, when the management of the target company opposes the deal) it might be considered an “acquisition”.[19]

The term “merger” is commonly used, but it comprises several types of transactions that vary by the connection between the two companies and by the modality of payment used to close the deal.

By the functional roles in market dynamics, we can observe:

• Horizontal mergers – two businesses within the same sector decide to merge. Synergy can be obtained through increased market share, cost savings and/or new market opportunities
• A vertical merger – the acquirement of a supplier or client. Usually it targets optimizing operating costs and economies of scale
• Conglomerate – Unrelated businesses in any meaningful way. The usual objective is diversification in goods and/or services.

By business outcome, usually concerning brand identity, company’s purpose and/or corporate governance, the following types emerge:

• Statutory merger – The acquirer continue its operations whereas the target company dissolves. The main objective is usually asset and capital transfer without any additional maintenance needed.
• Consolidated merger – A new business entity is formed through the combining of the two companies. Both the acquirer and the acquired companies are dissolved as a result of the process.

Additionally, there can be observed mergers that fit in the two following type:

• Strategic merges – Long term holding of acquired company. This form of mergers aim for synergies in the long run, either by increasing the market share, customer base or overall strength of new entity formed. The acquirer can be usually willing to pay a larger premium to the target company.
• Acqui-hire – These acquisitions are the ones that were initiated for the main purpose of obtaining target company’s talent, rather than any other assets. More often than not, the operations of the target company are ceased in order for the work force to focus on the acquirer’s projects. Most commonly used in technology sector, which is the main focus of this research paper.

Now, comparing the types of mergers and acquisitions by the types of financing we have:

• Payment by stock, or “stock swap” – The shareholders of the target company are receiving stock in the acquirer’s company, switching their old stock in the now acquired company, for new stock, in the acquirer company or the newly merged entity. The issuance of stock is usually proportionally to the valuation of the acquired.
• Payment by cash – This is usually the case for acquisitions, since the shareholders of the acquired company are no longer in the scheme of things, and the target company comes under the control of acquirer’s shareholders.

Moreover, deals differ by the type of financing of the two above-mentioned favored financing options. If the bidder prefers the cash option, there are three key financing choices:

• Cash on hand – excess cash or unused debt capacity. There are no major transaction costs but the action may decrease credit rating
• Issue of debt – It usually increases cost of debt and decreases credit rating. Transaction costs occur in a more significant manner.
• Issue of stock – Can improve debt rating and will reduce cost of debt. Transaction costs are on par with the issuance of debt

If the bidder prefers the stock payment, the following financing options exist:

• Issue of stock – Effects and transaction costs are illustrated above. If the deal is effectuated with stock instead of cash, then it is not liable to taxation. There is simply an exchange of share certificates.
• Shares in treasury – Same effects as the issuance of stock. Transaction costs are not significant if the shares do not have to be purchased from market. If it is the case of the latter, brokerage fees will apply.

Acquirers tend to purchase with stock when their belief is that their shares are overvalued and with cash when they think the shares are undervalued.

Before any merger or acquisition is put in motion, due diligence is required to be able to know to a fair degree the right choice is made. Due diligence is an analysis of a business or person preceding to signing an act with a certain level of care. Although it can be a legal obligation, but the term will be more frequently related to voluntary investigations. A usual example of due diligence in numerous industries is the practice through which a potential bidder appraises a target company or its assets for an acquisition.[20]

Usually the main object of interest in due diligence is the business valuation. Factually evaluating the past and future performance of a corporation is a hard task faced by countless. Generally, entities rely on independent third parties to perform due diligence studies or business assessments. The five most employed methods to value a business are:

• historical earnings valuation,
• future earnings valuation,
• asset valuation,
• relative valuation (comparable companies and comparable transactions),
• discounted cash flow (DCF) valuation

Professionals who are valuing businesses usually do not use one single method but a mixture of some of them, as well as others that are not stated above, as to achieve a more accurate and objective value.

Merger control is the procedure of assessment mergers and acquisitions under antitrust/competition law. Over sixty nations have adopted a system for merger control. Agencies such as the European Union’s European Commission or the United States Federal Trade Commission (FTC) are usually commended with the responsibility of reviewing mergers. Merger control supervision is implemented to avert anti-competitive consequences of concentrations of market power. As such, most of the merger control procedures normally answer at least one of the questions:

• Does the concentration significantly obstruct effective competition? (EU, Germany)[21]
• Does the concentration substantially diminish competition? (US, UK)[22]
• Does the concentration prime to the formation or consolidation of a dominant market position? (Switzerland, Russia)

2.2. Historical Trends

The international takeover market is very dynamic, consisting of deals that amount to more than $1 trillion per year in transaction value.

The takeover market is also characterized by merger waves — peaks of heavy activity followed by quiet troughs of few transactions. Figure 2.1 displays the time series of takeover activity from 1926 to 2012. Merger activity is more consistent during economic expansions than during contractions and, also, shows a correlation with bull markets. Numerous of the same technological and economic circumstances that lead to bull markets also incentivize managers to reshuffle assets through mergers and acquisitions. Therefore, the same economic activities that drive expansions are most likely, similarly, driving peaks in merger activity.[23]

Figure 2.1 Takeover activity 1926-2012
Source: Berk, J., DeMarzo, P. (2014) Corporate Finance 3e: Pearson Education

A surge of M&A stories begin in the late 19th century United States. Yet, mergers correspond historically with the existence of enterprises. For instance, in 1708, the East India Company merged with a former competitor to reinstate its monopoly over the Indian trade. In 1784, the Italian Monte dei Paschi and Monte Pio banks were merged as the Monti Reuniti. In 1821, the Hudson’s Bay Company merged with North West Company, its rival.

A short history of the beginnings of modern mergers in United States, also known as “The Great Merger Movement” can be found written by Marcos Cordeiro (2016):

“The first wave of mergers and acquisitions occurred in the period between the 1890s and early 1900s when. U.S. companies tried to build monopolies in their respective industries, forming so-called “Trusts”, an extreme form of horizontal integration (when a company acquires another that produces the same type of product, i.e., a competitor that is at the same stage of production). Examples include the creation of Standard Oil Company of New Jersey, in 1899, United States Steel Corporation in 1901, and International Harvester Corporation in 1902. The U.S. Congress responded to the wave of mergers with the creation in 1890 of the Sherman Antitrust Law or the Sherman Act), which aimed to protect the interests of consumers by combating monopolies, to prevent prices in certain sectors from being controlled by conglomerates.

Therefore, for example, the Sherman Act in 1911 put an end to Standard Oil Co., a John D. Rockefeller company and largest oil group in the United States (at the time it refined 84% of U.S. oil). In this first wave, more than 1,800 companies merged or were acquired in the period from 1890-1905. Most mergers that were conceived during the first wave ended in failure because they failed to achieve the desired level of efficiency. The failure was also extended by a slowing U.S. economy in 1903, followed by the stock market collapse of 1904, and, as mentioned, the actual application of the Sherman Act made the legal environment more hostile for more mergers and acquisitions and in fact boosted other anti-trust laws, such as Clayton Antitrust Act of 1914, which complemented the terms of the first law.”[24]

As it has been mentioned in the previous chapter, there are several types of mergers, which accomplish different objectives. We can see in table 2.1. that the first wave was characterized by a sense of dog-eat-dog market, where companies would acquire competitor in order to aggressively gain market share. The famous case of Standard Oil Co. is reminded in the short history above. The second wave switched to vertical integration, in order for corporations to exploit economies of scale, efficiency in large volume production. The third wave was characterized by companies diversifying into other fields and the main reason was to smoothen out cyclical bumps of the industry, in a word, hedge an investment portfolio. The fourth wave is one that we may remember from movies or TV shows, the vultures of capitalism that seek undervalued companies in order to acquire them and transform them and their assets as they please. As we get closer to recent times, in the fifth merger wave, corporations are already more likely to acquire targets in the same field, or related to it, targets that are complementing and strengthening the acquirer.

Table 2.1 Merger Waves

Period	Name	Facet
1893–1904	First Wave	Horizontal mergers
1919–1929	Second Wave	Vertical mergers
1955–1970	Third Wave	Diversified conglomerate mergers
1974–1989	Fourth Wave	Co-generic mergers; Hostile takeovers; Corporate Raiding
1993–2000	Fifth Wave	Cross-border mergers, mega-mergers
2003–2008	Sixth Wave	Globalization, Shareholder Activism, Private Equity, LBO
2014-	Seventh Wave	TBD

Source: KPMG, Seventh Wave of M&A

Conglomerate mergers, while popular in the 1960s, have mostly fallen out of favor with shareholders because of the difficulty in the generation of value when combining two unrelated businesses.

Merger of equals, as mentioned in the previous chapter, is a combination of companies of comparable sizes. Since 1991, there have been more than 600 M&A deals announced as mergers of equals with a total value of USD 2,126b[25].

Since the focus of this research is the US market, in figure 2.2 the amount of deals and their value can be observed over time, from 2001 to 2014.

Fig. 2.2 US M&A Activity
              Source: Dealogic, Thompson Reuters

Overall, mergers and acquisitions market is here to stay, even though it comes out in different flavors at times.

2.3. Motives

Companies, managements and shareholders seek to merge or to acquire for many reasons, be them of financial, strategic or risk-reducing nature.

Often occurring are the following incentives[26] [27]:

• Synergy – Usually achieved through the elimination of duplication, optimization of processes and elimination of redundancies while still keeping newly acquired expertise and processes,
• Economies of scale – A newly merged entity can usually reduce fixed costs, increase savings from producing goods in high volume, lowering the costs of operations relative to the same revenue stream, ultimately the result being increased profit margins,
• Economies of scope – Efficiencies mainly linked with savings that come from combining the marketing and distribution channels of different types of related products or services,
• Revenue and/or market share increase – An horizontal merger with a significant player on the market (of the acquirer) that increases the market power of the newly formed corporation
• Cross-selling – Acquiring into complementary markets for acquirers’ existing products or services
• Vertical integration – There are multiple reasons for integrating upstream or downstream. One of them is to internalize an externalized process. Usually this means that the initiating party no longer has to worry about clauses, unfair price, and contractual practices. Similarly, another company might not be content with the distribution of their products, so it may decide to take over its distribution channels.
• Geographical extension – Another risk hedging possibility if done correctly, as it increases revenue streams, whilst no longer being captive in the market the company was already present in.
• Taxation – Profitable companies have to pay taxes on that profit. One such company can buy a target company with larger tax losses, especially in the form of carryforwards. In US the IRS disallows tax breaks if it can be proven that the main reason for the transaction is tax avoidance, so in itself the taxation motive is no longer a valid sole reason.
• Hiring and expertise – Mentioning once again the acqui-hire type of deal, some acquirers use acquisitions as a tool that is alternative to the classical hiring process, especially common if the target company is a small private company and/or a startup. Usually the talent is the main appeal and asset of the target company.
• Intellectual property acquirement – Innovative patents, copyrights or trademarks can be under the property of a target company and therefore this creates a huge awareness for the interested parties
• Diversification and risk reduction – Diversifying the investment portfolio is a common advice, and it is of no lesser importance in mergers and acquisitions. It is possible that companies can hedge against downturns in some industries and create value for the shareholders in another.

Alongside with the above-mentioned reasons there are also other, less objectively planned transactions.

Management errors arise, as they are human, and humans are interested of all with the personal wellbeing.  An agency cost is an economic concept relating to the fee to a “principal” (an organization, person or group of persons), when the principal chooses or hires an “agent” to act on its behalf. For the reason that the two parties have unalike interests and the agent has more information, the principal cannot directly have the guarantee that its agent is always acting in the principal’s best interests.[28]

Managers can also prefer to run a larger company due to the additional pay and reputation it conveys. Therefore, because of that, CEO’s and top executives may execute mergers and acquisitions that destroy value for the shareholders, since usually the compensation in stock is usually insignificant to total compensation of the executives they will tend to prefer to sacrifice company value in exchange for personal gain. This usually happens in the case of poor executive monitoring and when the remuneration is directly linked to the size of the company, which can also be called empire building.[29]

Overconfidence also can play a role in those errors. Psychological research has shown that it takes repeated failures for a person to change his belief that he is above average at some activity. Most CEOs perform at most one large acquisition during their tenure as CEO. In a well-known 1986 paper[30], Richard Roll proposed the “hubris hypothesis” to clarify takeovers, which sustains that overconfident CEOs pursue mergers that have low chance of creating value because they truly believe that their capability to manage is great enough to ensure success. The critical difference between this hypothesis and the incentive conflict discussed above is that overconfident managers are certain that they are doing the right thing for their shareholders, but irrationally overestimate their own skills. Under the incentive conflict explanation, managers know they are destroying shareholder value, but personally gain from doing so.

2.4. Process and Key Elements

The documentation of an M&A operation regularly begins with a letter of intent. The letter of intent commonly does not bind the parties to commit to a transaction, but may bind the parties to confidentiality and exclusivity obligations so that the transaction can be considered through a due diligence process involving lawyers, accountants, tax advisors, and other professionals, as well as business people from both sides.

After due diligence is finished, the parties may proceed to draft a definitive agreement, known as a “merger agreement”, “share purchase agreement” or “asset purchase agreement” conditional on the transaction’s structure. Such contracts are typically 80 to 100 pages long and focus on five key types of terms: conditions, representations and warranties by the seller with regard to the company, covenants, termination rights (also known as breakup fees), provisions involving the obtaining of required shareholder approvals under state law and related SEC filings required under federal law, if needed, and terms related to the mechanics of the legal transactions to be effectuated at closing (such as the determination and allocation of the purchase price and post-closing adjustments after the final determination of working capital at closing or earn out payments payable to the sellers), repayment of outstanding debt, and the treatment of outstanding shares, options and other equity interests), an indemnification provision, which provides that an indemnitor will indemnify, defend, and hold harmless the indemnitee(s) for losses incurred by the indemnitees as a result of the indemnitor’s breach of its contractual obligations in the purchase agreement.[31]

Things get more interesting if the target company is listed. Listed companies are subject to hostile takeovers. The process normally begins with the acquirer building a position, cautiously and subtly buying shares in the target company. Once the soon to be bidder starts to acquire shares in the open market, it is limited to purchasing 5% of the total outstanding shares before it must file with the SEC. Next, the acquirer must officially declare how many shares it possesses and whether it intends to buy the company or retain the shares only as an investment. In the case of hostile takeovers, there are a various number of takeover defense strategies, if the terms of the offer are not accepted:

• Poison pills – Target company’s existing shareholders are given the right to buy additional shares at a significant discount price when certain conditions are met. Because the existing shareholders can purchase stock at less than the current market price, this option dilutes the value of the shares apprehended by the acquirer. Poison pills increase the bargaining power of the target firm when negotiating with an acquirer, because of the difficulty to finalize the transaction lacking the cooperation of the target company’s board of directors.

– Flip-in – It permits shareholders with the exception of the acquirer to purchase additional stock at a significant discount. This form of poison pill makes the takeover attempt more costly and challenging, diluting shares held by the acquirer.

– Flip-over – Allows shareholders to purchase the bidder’s shares after the merger at a discount. It is generally the more used of the two strategies.

• Golden parachutes – Benefit given to top executives if the company is the target of a hostile takeover and the executives are dismissed as a result. Those severance agreements are usually generous in order to discourage any hostile actions against the owners of the company and its management.
• Recapitalization – A target company can also choose to change its capital structure to make itself less appealing. Increasing leverage is most of the time the strategy of choice, making it a less interesting prospect because of restructuring issues.
• White knights – An individual or company that acquire businesses that are almost being completely hostile taken over by what is usually called a black knight. A white knight is typically the more preferred option than the hostile company is.
• Staggered boards – Frequently, an acquirer would try to make changes in the board of directors to gain power and an upper hand on the poison pills strategies and accept the takeover offer. To defend against such acts some public companies have staggered (or classified) boards. Generally, every director serves a three-year term, and each term is staggered so that only one third of the director seats are eligible for election each year.
• Pac-Man defense – Another tactic against hostile takeovers in which the target firm tries to acquire the company that makes the hostile takeover try. Usually, the strategy involves breaking into the “war chest” of the company, a cushion of cash set aside for unknown adverse events. It is colloquially named as the famous game, since in the game the players are able to eat a power pill and be able to eat the ghosts previously chasing them.

All of these strategies are usually included in the bylaws of the companies as deterrent for any hostile situation.

2.5. Conclusions

Mergers and acquisitions are one of the most fundamental events in the life of a company, and they rightfully get a lot of attention in academics study.

In this chapter, some of the most important aspects concerning M&A transactions have been discussed, and how those aspects influence the way players of the market respond to the information transmitted.

The processes and ramifications are intricate and, as such, mergers and acquisitions are not always successful, and even though their main raison d’être should be creating value it is not always the case. Sometimes, management knowingly engage in transactions destined to fail, for personal motives, or just pure ineptitude at times. Generally, markets respond accordingly to value destruction.

The history and the trends of M&As were also analyzed, and there are periods with clear recurring characteristics, frequently called merger waves. Mergers and acquisitions can be traced as far back as commercial life itself, but significant number of deals started from late 19^th century in US. Now the wave is characterized by strengthening core operations through M&As with complementary companies, in a global context. Despite the globalization phenomenon, in the next chapter will present studies that found out that cross-border transactions performed not as favorable as the domestic ones did.

Moreover, M&A activity has been shown to correlate with favorable economic conditions, and even though this is the case, in the period 2001-2014 the number of transactions fluctuated relatively little, but the amounts differed more significantly.

In the following chapter, the impact of mergers and acquisitions and their announcements on the stock prices of listed companies will be further investigated

 

Chapter 3. Impact on Shareholders’ Wealth

3.1. Results of Mergers and Acquisitions

Since this paper focuses on the effects on the shareholder wealth, this chapter will summarize literature findings around the subject matter. The academic articles are generally not focused on such a small niche, and typically take into account a larger spectrum of transactions, such as all the deals in a certain country, or certain industry, regardless of market capitalization or domesticity of the transaction.

One study from 1992 analyzes the empirical literature concerning the influence of various factors on shareholder wealth creation in mergers and acquisitions using a multivariate framework. Overall, results indicate that while the target firm’s shareholders gain significantly from mergers and acquisitions, those of the bidding firm do not. Results also direct to the fact that the use of stock financing has a significant impact on the wealth of both the target and bidding firms’ shareholders.[32]

A paper on the marketing perspective of mergers and acquisitions (Rahman & Lambkin, 2015) came with a detailed study of 45 M&A deals carried out to develop a better understanding of how marketing performance is affected by mergers and acquisitions. The results show that marketing performance improved along two dimensions—sales revenue growth, and a decrease in selling, marketing and administrative costs as a percentage of sales revenue, suggesting the achievement of synergies in these areas — economies of scale and scope. However, the profit margins have not improved suggesting that the marketing cost savings are not sufficient to offset cost increases in other parts of the operations.

There are opinions that affirm acquirers choose to pay premiums that are so great that they effectively give out the value they produce to the target company’s stockholders. In the end, it is understandable, because besides the presence of takeover defenses, there is competition in the takeover market, too. In the moment a bid is initiated, a signal is transmitted that there is a gain to be made when acquiring that specific target company. In conclusion, own shareholders’ value must be given up in order to secure a wanted target company.

3.2. Market Reactions

The empirical studies on the effects of merger and acquisitions effects on acquirers are split mostly into those that find no statistically significant abnormal returns and those that do find some negative abnormal returns.

Looking at the studies made on the banking sector, it has been observed that  target banks mostly report positive stock returns upon the announcement of a M&A operation, for instance in study conducted in 1994.In comparison with that, the results of acquirer banks are diverse and rather uncertain.[33]

Another more recent study, in 2004, observed the long-term performance of 267 Canadian mergers and acquisitions between 1980 and 2000, with and without overlapping cases. The results of the research showed that Canadian acquirers significantly underperformed over the next three years, post-event period. Moreover, this study showed that the results are consistent with the extrapolation and the method-of-payment hypotheses, which states that equity financed deals underperform. Another finding is that cross-border transactions perform below par in the long run. Because this study is limited to domestic deals, it is expected that this further negate any performance influence on the returns of acquirers.[34]

The matter of financing mergers and acquisitions has been undertaken in a 2017 study. For acquisitions that are more credit-financed superior short-run performance resulted; takeovers financed primarily with common stock issues yielded poor announcement returns. Over the 3 years following an acquisition, the analysis revealed that capital markets efficiently price all information at the announcement. Takeovers financed with a common stock issue significantly underperform in subsequent years.[35]

Gersdorff and Bacon (2008) argue that the result of a paired sample t-test was not satisfactory enough in order to establish the connection between merger announcements and the risk adjusted asset prices. In 2013, another study presents no statistically significant abnormal returns surrounding M&A announcements in acquirers. While other researchers hypothesize a particular movement around stock prices at the announcement day, they cannot statistically show the comprehensive explanation to establish that particular movement.[36]

One study (Khanal, Mishra & Mottaleb, 2013) on US ethanol-based biofuel acquirers state that the average cumulative abnormal returns of acquiring firms suggest that the market positively responded to recent M&As in the industry. Around 4% growth on a 60-day event window was attributed to M&As using market-adjusted market portfolio. A significant positive 0.47% gain in cumulative returns in a 4-day event window and a 2.7% positive gain in a 10-day event window have been suggested as a result of this research.

3.3. Conclusions

The gains to acquiring firms are challenging to measure.

Nonetheless, some of the studies have found a slight gain in bidding companies. From management standpoints, „stockholders of acquiring firms get synergistic benefits if there is strategic fit between them”.[37]

At the same time, some other studies’ findings are proposing negative abnormal returns

 

PART III: Empirical Research

4.1. Research Context

Event studies have a long history. The first published study is possibly James Dolley’s (1933).In his research, he observes the price effects of stock splits, studying price changes at the time of the split. Using a sample of 95 splits from 1921 to 1931, he found that the price increased in 57 of the cases and the price declined in only 26 instances.

 

4.2 Research Goals

The main goals of this paper is to examine the existence and the degree of short-term abnormal returns of the domestic acquisitions in the, mid or large cap US tech companies. The focus of the study is on the shareholders of acquiring companies.

This paper is guided by the following research question:

Are there abnormal returns for acquirers in M&A announcements?

The above

Hypothesis 1₀: M&As do not have significantly negative or positive impact on the average abnormal returns of acquiring companies on the announcement day.

Hypothesis 1₁: M&As do have significantly impact on the average abnormal returns of acquiring companies on the announcement day.

Hypothesis 2₀: Investors in US stock markets cannot earn abnormal returns by trading the acquiring mid and large cap tech companies around the announcement date.

Hypothesis 2₁: Investors in US stock markets can earn abnormal returns by trading the acquiring mid and large cap tech companies around the announcement date.

4.2. Data Collected

The data for the research was collected by using Bureau van Dijk’s Zephyr, the most exhaustive database of international deal information, with a cover close to 1.5 million deals and rumors, as of April 2016. It has detailed deal and company information, comprehensive criteria selection when searching for data and it is updated hourly.

For the purposes of this research, the following population has been selected: the domestic deals in United States of America over the last five years[38], acquirers being publicly listed mid or large cap companies[39] that have their core operations in Information Technology & Communications (IT&C). In order to be able to select accurately and thoroughly the exact companies that fit the IT&C criteria, the NAICS 2012[40] has been used. An explanation of the codes is presented in the Appendix 2.

Table x Data Selection
Criterion
Total domestic deals by country	1,369,871
Less    Country (primary addresses): United States of America (US)(Acquirer AND Target)	37,201
Listed/Unlisted/Delisted companies: listed acquirer	8,940
Time period: on and after 01/01/2012 and up to and including 01/01/2017 (completed-confirmed, completed-assumed, announced)	3,324
Acquirer financials (mil USD): Current market cap: min=2,000	404
NAICS 2012(North American Industry Classification System) : Technology (Codes 3333, 334, 3352, 3359, 3361 <only Tesla Motors Co.>, 3364, 4541, 517, 518, 51913, 51919, 5415, 6117) (Acquirer)	248
Deal type: Acquisition, Merger, >50% stake acquired only    Deal amount: Any,  disclosed Less: No historical stock data (1) Multiple acquisitions in one announcement (2) Overlapping event windows (5)	243 69 68 66 61
Source: Zephyr Database

Out of the 248 M&A announcements, five cases have not been selected, since they were minority stake acquisitions. Out of the 248 mergers & acquisitions cases, one of the acquirers from data pool, namely Dell Technologies Inc.[41] is now private[42] and no longer present in the available historical stock prices databases. Dell technologies’ stock does not exist anymore because Michael Dell, the company’s founder, took the company private in 2013. However, since up to 2013 Dell was a publicly traded corporation with the symbol DELL, this deal also appeared as one of the results of the search.

Tesla Motors Co. ($TSLA) is an outstanding item in the database, since it is a car manufacturer, but many argue it is more than that, a tech giant in the making. In this paper, Tesla is considered a technology company above a motor vehicle manufacturer. By this judgement, General Motors Co. is excluded, given the fact that it falls under 3361 NAICS 2012 code but cannot be regarded as a tech corporation. With the same line of thought in mind, while code 3364 – Aerospace Product and Parts Manufacturing is present in the database criterions, The Boeing Company is also excluded, having its primary operations in aircraft manufacturing, and not primarily IT&C industry.

Approximately 50% of M&A deals in the USA are undisclosed annually[43] and because one goal of this paper is to be as accurate as possible, the undisclosed transactions have been ruled out of the population.

Almost all of the 61 M&A announcements have the corresponding deals completed, with the exception of AT&T Inc. acquirement of Time Warner Inc., awaiting further regulatory approval; European Commission has already granted its approval.

AT&T | Time Warner is also the outlier when considering deal values, with a whopping USD108.7 billion, about 4 times larger than the following one, and has been excluded out of the following analysis[44]. The analysis consists of 60 deals, excluding AT&T | Time Warner.

Table x Deal amount descriptive statistics
thou USD			Statistic	Std. Error
	Mean		1,507,473.33	554,600.56
	95% Confidence Interval for Mean	Lower Bound	397,720.16
		Upper Bound	2,617,226.50
	Median		296,500.00
	Std. Deviation		4,295,917.50
	Minimum		7,100.00
	Maximum		26,200,000.00
	Range		26,192,900.00
	Interquartile Range		845,750.00

Source: Zephyr Database, author analysis

Out of the 61, thirty are directly cash financed, twenty-four mixed financed deals and seven by stock swap only. Some of the mixed financed M&A transactions are leveraged buyouts, twelve to be concise.

Looking at the distribution of the deal opportunities – or sub-types –, we can notice that the predominant one is the exit strategy. Given the fact that the population consists of IT&C companies this is a recurring theme in the field[45], tech entrepreneurs usually looking for exit opportunities.

Alphabet Inc. ($GOOG), made the highest number of deals, nine, alongside with Apple Inc. ($AAPL). The following amount is Facebook Inc.’s ($FB), with six announcements. Microsoft Corporation ($MSFT) follows with four mergers and acquisitions transactions. Lastly, Salesforce ($CRM) and Verizon ($VZ), both announced three deals. The rest of the research population has announced either two or a single acquisition, as it can be seen in the Figure 4.3. Given the fact that the first four are some of the most prominent tech companies in the world and that altogether they make up almost half of the research database some information about their M&A modus operandi can be read in the following paragraphs.

As of June 2017, Apple is publicly known to have acquired 70 companies. The actual total of acquisitions is possibly greater as Apple does not disclose the majority of its acquisitions unless revealed by journals. Apple has not released the financial details for the majority of its mergers and acquisitions. Apple’s business philosophy is to acquire small companies that can be easily integrated into existing company projects. Of the companies Apple has acquired, 49 were based in the United States.

As of December 2016, Alphabet has purchased over 200 companies. The majority of the firms bought by Google are based in the US, and most of these are based in or around the San Francisco Bay Area, as Silicon Valley is known as the epicenter of tech companies. Many Google products originated as services provided by companies that Google has since acquired. Larry Page, CEO has explained that prospective acquisition targets must pass a kind of “toothbrush test”: Are their products potentially useful once or twice a day, and do they improve your life?[46]

Most of Facebook’s acquisitions have been ‘talent acquisitions’ or “acqui-hires” and assimilated products are often shutdown as opposed to Alphabet’s strategy. Mark Zuckerberg, Facebook CEO said, “We have not once bought a company for the company. We buy companies to get excellent people… In order to have a entrepreneurial culture one of the key things is to make sure we’re recruiting the best people. One of the ways to do this is to focus on acquiring great companies with great founders.”[47] Although that is the case, the acquirement of Instagram, seems to be the first exception to this rule.

Microsoft’s initial public offering was held on March 14, 1986. After the IPO, Microsoft had a market capitalization of $519.77 million. Since then, Microsoft has acquired 202 businesses, purchased stakes in 64 companies, and made 25 divestments has purchased. A hundred and seven of the companies that Microsoft bought were and are based in the US. Microsoft has not released financial information for most of these transactions.

One observation that can be immediately made is that these top tech companies are repeatedly acquiring companies that are based in the US. This could be due to preference or because there is a great concentration of companies that have as their core activity information technology in the area – e.g. Silicon Valley.

The historical stock data for each deal has been retrieved via Yahoo Finance. Alongside with each period needed, methodology explained in the following chapter, S&P500 index historical stock data was also procured, as benchmark, since the acquirers are listed companies and the methodology explained in the following chapter has been applied.

4.3. Methodology

In order to examine the effect of mergers and acquisitions announcements on the stock price of listed companies and to see if there are significant abnormal returns, event study methodology described by MacKinley (1997) will be employed.

Event Definition

The first task of conducting an event study is to define the event of concern and identify the period over which the asset prices of the firms involved in this event will be examined-the event window.

Firstly, trading days are not calendar days. Active trading schedule is and accounts for nationally

The announcement day is defined as the day when the acquirer or the vendor press release

A 21-day event window entirely captures the effects of an event of interest. The windows begins ten days prior to the event day and ends ten days after. It is also recommended that the estimation window and the event window do not to overlap.

Abnormal Returns and Market Model

There is no need to apply the method proposed by Scholes and Williams (1977) to account for non-synchronous trading[48] since all the cases are trading on the same market – NYSE and NASDAQ – US market.

Therefore,

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[38] 01.01.2012 – 01.01.2017

[39] Companies with a market capitalization of over 2 billion USD (at 01.04.2017)

[40] North American Industry Classification System- used by businesses and governments in Canada, Mexico, and the United States of America to categorize business entities according to the main type of economic activity

[41] acquiring EMC Corporation event

[42] i.e. not publicly listed on any stock exchange

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[44] Maddala, G. S. (1992). “Outliers”. Introduction to Econometrics (2nd ed.), MacMillan., New York pp. 88–96

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[47] Zuckerberg, M., (2010), Interview for Erste&Young.

[48] Trading not occuring at the same time, usually difference made by time-zones and national holidays