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The impact of corporate takeover announcements on target stockholder wealth

 

Contribution of the study

The contribution of the research is to provide recent evidence on the empirical efficacy of the takeover theory. This study also tends to find out whether the findings for the recent samples is consistent with previous findings. If not, more insight or research may be done to exploit the cause of the indiscrepancies. The findings may be used to explain other stream of research such as mangement hubris which is a behavioral factor of the so-called systematic overpay. The results from examining differnet control groups such as the form of payment and target managerial resistance may generate implications for the takeover strategies used by both acquring and acquired firms. The potential findings may add value to the financial analysis of other groups of players in the market of corporate control such as takeover-driven hedge funds and other potential investors as their involvement may be an important source of maintaining efficient market. Moreover, the reseach is also meaningful from the public policy perspective as the takeover activities create considerable influence over stockholder wealth both in the short term and long term.

 

Research questions

Three hypotheses are framed to obtain conclusions on how shareholders of acquired firms are affected by croporate takeover announcements. The research uses capital market data as a measure to examine the extent  to which stockholders’ expectation would be affected surrounding the announcement period. The null hypotheses and althernative hypothses are illustrated below:

 

H1: Acquired firms make no significant abnormal return surrounding the takeover announcement.

 

H2: Stock offers experience no significantly different abnormal return than cash offers for acquired firms.

 

H3: Acquired firms with friendly attitude against being taken over generate no significantly different abnormal return than those with hostile attitude.

 

The null hypotheses describe the research questions that will be examined in the research. Technically, the first hypothesis suggests that the abnormal return for the total sample is statistically zero. The remaining two suggest that there is no statistically significant difference in the abnormal return experienced by different control groups. On the other hand, the alternative hypotheses suggest the opposite.

 

Research aim

The objective of the research is to analyse the  announcement effect of the US corporate takeovers over shareholder wealth of target firms. Previous scholars  have at least used three approaches to examien whether takeovers on average create wealth. some papers examined the financial characteristics of acquiring and acquired companies and construct predictive models of takeover behaviors. Accounting data may sometimes used as well as financial market data. The research that will use financial market data may help to explain existing evidence on the directiona and magnitude  The paper also aims to provide recent evidence on the takeover empirical literature and may help explaining existing evidence on the direction and magnitude of the market reaction to the takeover announcement.

 

Literature review

In the previous papers, some researchers generally found that target firms receive positive abnormal return surrounding takeover announcement (Bradley, 1980; Franks and Harris, 1989). But some found zero or negative abnormal return (Mueller, 1969; Asquith, 1983; Wier, 1983). It is argued that the different conclusion may results from the different sample, control groups and methods used. Researchers also examined the potential causes of different market reaction such as monopolistic hypothesis by Ellert (1976) and managerial hubris hypothesis by Roll (1986). Studies on the distribution of gain further claim that most of the gain is received by acquired firms (Dodd, 1980; Asquith, 1983). Scholars also studied the characteristics such as the payment form, management resistance and toehold position held by acquiring firms. Research generally documented that cash offers result in higher abnormal return (Asquith, Bruner and Mullins, 1987; Eckbo, Giammarino, Heinkel, 1990; Amihud, Lev and Tralos, 1990). Studies on another characteristic of takeover, managerial resistance of acquired firms, showed that positive abnormal returns are associated with resisted target firms (Kummer and Hoffrneister, 1978; Parkinson and Dobbins, 1993). Nevertheless, Dodd (1980) found negative stock reaction when takeover proposals are rejected. Huang and Walkling also found that there is no statistically significant difference in abnormal return between groups of resisted and unresisted targets.

 

Event study methodology have been widely used by previous researchers to examine the effect of a partibular corproate event on firms’ share prices. Compared to long horizon studies, schoars generally believe that ther results of short horizon studies can be more convincing. For example, Kothari and Warner (2007) documented several charateristics of short term studies. Short horizon studies are generally believed to be trouble free, powerful in detecting abnomral returns and insensitive to the choice of asset pricing model. There are also a number of econometric problems in event study methodology such as event-driven volatility, serial and cross-sectional dependence of abnormal returns. Kothari and Warner (2007) also pointed out that the correction for these problems are generally unimportant. In terms of thin trading problem that may lead to biased beta estimation, Kallunki (1997) proposed several approaches to alleviate the adverse impact in event studies such as lumped return procedure and uniform return procedure. Scholes and William (1977) and Dimson (1979) also contributed to the solution to thin trading problem. However, Brown and Warner (1985) argued that unbiased beta does not necessarily lead to misspecification in an event study.

 

Research methodology

The research philosophy in this research is positivism that takes a quantitative approach to examine the issue of interest.  Since the research interest in this paper is empirical, the method should be quantitative to exploit the message hidden in the market data. The understanding of the positivism ensures that the researcher is independent of the topic studied, and that the method chosen depends on objective. Therefore, causality may be exploited by utilising the positivism.

 

The research approach here is deductive. Since the objective of the research has particular interests, the research construct corresponding hypotheses listed above. After understanding the takeover theory, the deductive approach is important to test the validity of those theories empirically by using secondary data.

 

The event study methodology is used in this research for examining the market reaction of the acquired firms surrounding the announcement period. The main trust of the methodology is that when any information concerning the company value is unveiled, it will result in the adjustment of the company value from the market and hence the share price. Based on the efficient market hypothesis proposed by Fama (1970), efficient market will react immediately when information becomes known to the public. Therefore, it is possible to draw conclusions or causality in statistical sense on the impact of takeover announcement over shareholder wealth. The main sources of data are Zephyr, a specialised database on takeover and Center for Research in Security Prices (CRSP) of the University of Chicago. The research will indentify deals and their characteristics from Zephyr and then extract the required data based on the methodology such as daily returns for individual security and corresponding index.

 

In this research, a short horizon event study will be performed to evaluate the direction and magnitude of the market reaction. Therefore the measurement interval for collecting the data is daily. The event study will take 150 days before the day -10 relative to the event day which is day 0 as estimation period. A period of 20 days i.e. between day -20 and day 0 will be excluded from estimation period in order to eliminate the potential effect of information leakage on beta estimation. Multiple event windows within the period [-10, 10] will be used to estimation the abnormal return for the purpose of sensitivity analysis. The abnormal return is the difference between the estimated normal return from estimation period and actual return from the event period. Normal return is defined as the return that may be generated without the occurrence of corporate event i.e. announcement of takeovers. In estimating the normal return, multiple asset pricing models such as market model and Fama-French model may be used for testing the sensitivity of beta. The choice of benchmark used as input to estimate the beta is also vital. After the estimation of abnormal return, cumulative abnormal return is used for event period with multiple days. In order to derive the statistical significance for the abnormal return detected, multiple test statistics may be used such as Patell test and standard T test.

 

There are several statistical issues that should be addressed.  First, serial correlation occurs when abnormal returns are serially correlated (Newey and West, 1987; Lo and Mackinlay, 1988). This will lead to estimation error in variance of abnormal returns, and hence the validity of test statistic. Second, cross-sectional correlation of abnormal returns is due to the fact that events may be clustered on the event windows specified (Collins and Dent, 1984; Kothari and Warner, 2007). This will result in estimation error in the abnormal return since the magnitude or sign may be affected by others due to systematic factors. The variance of abnormal return is also affected, which again further bias the test statistic. Therefore, the different choice of asset pricing model and test statistic used address these problems and tend to give out more refined conclusions.

 

 

Reference

 

Amihud, Yakov., Lev, Baruch., and Travlos, N. G., 1990. Corporate control and the choice of investment financing: the case of corporate acquisitions. Journal of Finance, 45 (2), 603-616.

 

Asquith, Paul. 1983. Merger bids, uncertainty, and stockholder returns. Journal of Financial Economics, 11 (1-4), 81-83.

 

Asquith, P., Bruner, R. F., and Mullins, D. W., 1987. Merger returns and the form of financing. Working paper, University of Virginia.

 

Bradley, M., 1980. Interfirm tender offers and the market for corporate control. Journal of Business, 53 (4), 345-376.

 

Brown, S. J., and Warner, J. B., 1985. Using daily stock returns: The case of event studies. Journal of Financial Economics, 14, 3-31.

 

Collins, D. W., and Dent, W. T., 1984. A comparison of alternative testing methodologies used in capital market research. Journal of Accounting Research, 22 (1), 48-84.

 

Dimson, E., 1979. Risk measurement when shares are subject to infrequent trading. Journal of Financial Economics, 7, 197-226.

 

Dodd, P., 1980. Merger proposals, management discretion and stockholder wealth. Journal of Financial Economics, 8 (2), 105-138.

 

Eckbo, B. E., Giammarino, R. M., and Heinkel, R. L., 1990. Asymmetric information and the medium of exchange in takeovers: theory and tests. Review of Financial Studies, 3 (4), 651-675.

 

Ellert, J. C., 1976. Mergers, antitrust law enforcement and stockholder returns. Journal of Finance, 31 (2), 715-732.

 

Fama, E. F., 1970. Efficient capital markets: a review of theory and empirical work. Journal of Finance, 25 (2), 383-417.

 

Franks, J. R., and Harris, R. S., 1989. Shareholder wealth effects of corporate takeovers: the U.K. experience 1955-1985. Journal of Financial Economics, 23 (2), 225-249.

 

Lo, A. W., and MacKinlay C., 1988. The size and power of the variance ratio tests in finite samples: a Monte Carlo investigation. Journal of Econometrics 40, 203-38.

 

Mueller, D. C., 1969. A theory of conglomerate mergers. Quarterly Journal of Economics, 83 (4), 643-659.

 

Newey, W. K., and West, K. D., 1987. A simple, positive semi-definite, heteroskedasticity and autocorrelation consistent covariance matrix. Econometrica, 55 (3), 703-708.

 

Kallunki, J., 1997. Handling missing prices in a thinly traded stock market: implications for the specification of event study methods. European Journal of Operational Research, 103, 186:197.

 

Kothari, S. P., and Warner, J. B., 2007. Econometrics of Event Studies, in Handbook of Corporate Finance (Editor: B. Espen Eckbo), North Holland Elsevier, 3-36.

 

Kummer, D. R., and Hoffmeister, J. R., 1978. Valuation consequences of cash tender offers. Journal of Finance, 33 (2), 505-516.

 

Parkinson, C., and Dobbins, R., 1993. Returns to shareholders in successfully defended takeover bids: UK evidence 1975-1984. Journal of Business Finance & Accounting, 20 (4), 501-520.

 

Roll, R., 1986. The hubris hypothesis of corporate takeovers. Journal of Business, 59 (2), 197-216.

 

Scholes, M., Williams, J., 1977. Estimating betas from nonsynchronous Data. Journal of Financial Economics, 5, 309:327.

 

Wier, P., 1983. The costs of antimerger lawsuits: evidence from the stock market. Journal of Financial Economics 11, 207-224.

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