# The Importance of the Bidder Motive in the Wealth Effect of Takeovers

Constance Phelizon

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Constance Phelizon. The Importance of the Bidder Motive in the Wealth Effect of Takeovers. 2000. halshs-03774133

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The Importance of the Bidder Motive
in the Wealth Effect of Takeovers

Constance PHELIZON

2000.51
« THE IMPORTANCE OF THE BIDDER MOTIVE IN THE WEALTH EFFECT OF TAKEOVERS »

Constance PHELIZON

TEAM, Université Paris I Panthéon-Sorbonne
# « The Importance of the Bidder Motive in the Wealth Effect of Takeovers »

Constance PHELIZON

TEAM, University Paris I Panthéon-Sorbonne

This research was supported by the Caisse des Dépôts et Consignations foundation

**Abstract:**

Event studies on shareholder wealth effects of American and French takeovers find out that targets clearly gain, and bidders do not lose. We estimate in this study the abnormal returns associated with takeovers in the French market during the period of intense acquisition activity of 1991-1997. We find out the classic result that takeovers contribute to an increase in the target expected profitability but yields no short-term profits for the bidder.

We improve these findings further by testing the hypotheses of the literature accounting for wealth creation associated with takeovers. We put ahead the importance of the bidder motive for the target expected value. Actually, operations that were not industrially justified by the development of the bidder activity, either by the expansion of its productive capacity or by its vertical integration, were found to generate non-significant abnormal returns. These findings seem to support the synergy hypothesis. Nevertheless we do not solve the bidder enigma, as long as industrially justified takeover abnormal returns remain insignificant for this subsample.

**Key-words:** Takeovers, Industrial Synergies, Event Study Methodology

**J.E.L. classification:** G34 (mergers, acquisitions, restructuring)

## « L'impact des offres publiques sur la richesse des actionnaires : une étude des anticipations des agents selon le motif du rachat »

**Résumé :** Cette étude évalue l'impact des OPA et des OPE sur la valeur boursière des entreprises françaises. Elle aboutit au résultat classique d'une répartition asymétrique des gains boursiers entre l'entreprise initiatrice et l'entreprise cible, cette dernière étant l'unique bénéficiaire d'un effet d'annonce positif sur le cours de ses actions, tandis que l'entreprise initiatrice n'en retire aucun bénéfice. Les modifications législatives des offres publiques entreprises dans la perspective européenne, censées aller dans le sens d'une profitabilité accrue des opérations de croissance externe, n'ont donc pas eu d'effet visible sur les anticipations des agents, puisque nos résultats sont cohérents avec les conclusions des études antérieures.

Nous mettons en évidence l'importance du motif du rachat dans les anticipations des agents concernant la profitabilité des prises de contrôle pour les entreprises cibles. En effet les opérations n'ayant pas pour objet le développement de l'activité de l'entreprise, soit par l'augmentation de ses capacités productives, soit par son intégration en amont ou en aval du processus de production, se traduisent par des rendements anormaux non significatifs au niveau de cet échantillon. En revanche l'énigme de l'acheteur reste entière, puisque la prise en compte du motif du rachat ne permet pas d'aboutir à des rendements anormaux significatifs au niveau des entreprises initiatrices.

**Mots-clefs:** OPA, OPE, synergies industrielles, études d'événements

**Classification J.E.L.:** G34 (fusions, acquisitions, restructurations)

Correspondance : Constance PHELIZON

✉ TEAM, Maison des Sciences Economiques, 106-112, Boulevard de l'hôpital 75013 PARIS

<figure><img src="image_2.png" /></figure>

Telephone: 01.43.37.24.52. 📧 E-mail: phelizon@univ-paris1.fr

WWW : http:\\panoramix.univ-paris1.fr\\CEBI\\

<footnote>I have received helpful comments from Patrick Artus (Caisse des Dépôts et Consignations/FMR), from Thierry Chauveau (TEAM, University of Paris I - CDC/FMR), and from Patricia Charléty-Lepers (ESSEC and CREST).</footnote>
# I INTRODUCTION

For ten years, takeovers have been expanding increasingly in the French stock market. Empirical studies based on the event study methodology have estimated the impact of such operations on the stock returns of targets and bidders, by measuring their variation around the event announcement date. Results prove homogenous over the period 1980-1990 for the French market, and bring to light a value enhancement associated with takeovers (Husson, 1987; Charléty-Lepers and Sassenou, 1994). Furthermore, the gains appear asymmetrically shared between targets and bidders, as long as the former clearly gain, while takeovers have no significant impact for the latter.

This study estimates the abnormal returns associated with takeovers in the French market during the intense acquisition activity of 1991-1997.

Our aim is to test the importance of the takeover motive for the agents expectations about the future profitability of the bidder and the target. Do industrially justified operations generate extra returns in the short term ? Specifically, do takeover announcements generate significant abnormal returns for the bidder, if these operations can be expected to generate synergies ? If so, the bidder enigma receives an explanation : takeovers prove non significant for the bidders because unprofitable non synergistic operations overwhelm the gains associated with industrially justified profitable ones in this subsample.

The first section briefly reviews what factors may explain the occurrence of mergers and takeovers, the evidence from previous empirical studies that can support some of these hypotheses, and the questions remaining unanswered. We introduce in the second section the Event Study Methodology and its theoretical limitations. We turn in section three to the empirical results for the target and the bidder subsamples, and we test the impact of the merger motive by dividing our sample into industrially-justified and conglomerate operations. The concluding section exhibits the implications of our findings from an Industrial Organization point of view.
## II THE WEALTH EFFECT OF TAKEOVER ACTIVITIES: A SURVEY

The literature on mergers advances two major trends of thought for the motives of takeovers. If we consider that bidder managers act for their own interest, to the prejudice of shareholders, takeovers can be thought as costly operations revealing agency problems between the two. If we consider on the contrary that managers maximize shareholders wealth, these restructurings can be considered as value-enhancing operations.

### II 1 Sources of potential losses

A first trend in the literature considers takeovers as a wealth transfer between shareholders and managers. The latter are able to implement them because the separation of ownership and control produce information asymmetry with the former. Under such hypotheses, not only are firm repurchases unable to solve agency problems, but also they are the evidence of their existence. The literature advances three hypotheses to explain the gain for bidder managers.

The managerialism theory (Mueller, 1969) stands that managers have an incentive to implement these operations because the firm's size is positively linked with their remuneration.

Jensen's Free Cash-Flow hypothesis (1986) says that managers of firms producing excessive liquid assets have an incentive to make external growth in order to avoid their distribution as dividends to the shareholders. Actually, the payment of the Free Cash Flow to the shareholders reduces the managers' power, by reducing the resources under their control.

According to Roll's Hubris hypothesis (1986), takeovers are the result of a mistaken estimate of the target. Bidder managers overestimate their ability to obtain the maximum value from target firm resources. Under this hypothesis, managers are not aware to depart from the maximization of the stockholders' wealth. Contrarily to the managerialism hypothesis, they sincerely believe that they maximize the shareholders' wealth.
## II 2 Sources of potential gains

If mergers are value enhancing operations, we can identify five actions that successful bidding firms can take in order to increase the productivity of target assets.

The merger of two firms is said to produce industrial synergies when the value of the resulting firm is higher than the sum of the initial firms, because of a better use of the production factors. Horizontal mergers, involving the buying back of a firm in the same industry can generate synergies by reducing the unit cost of goods (economies of scale). Vertical integration on the other hand, meaning the buying back of a firm upstream or downstream the production process, can decrease costs by reducing the go-betweens and/or by securing the supplies.

Horizontal mergers can increase market power, thus allowing the buyer to rise its prices because of its dominant position in the market, without modifying its production process.

The diversification of activities can also be a source of value. Information asymmetry between the firm and potential investors can actually keep positive net present value projects off (Myers and Majluf, 1984). Diversification avoids this bias by generating a miniature capital market, the conglomerate. The funds allotment becomes internal to the firm.

Furthermore self-financing firms are bound by the investment constraint to assign incomes to their source. This bias can generate suboptimal investments. On the contrary, a conglomerate can assign incomes from one production unit to another, thus maximizing its profit while self-financing its activity (Williamson, 1970).

Corporate mergers can also result in tax gains. Some firms do not generate enough profits to take advantage of a potential fiscal gain. A profitable firm will be able to reduce its taxes by repurchasing this kind of firms. There is a transfer from the State to the firm, the net gain being a burden to the Government (Smirlock, Beatty and Majd, 1986).

Finally, mergers can increase efficiency by replacing managers failing to maximize shareholders wealth (Marris, 1964; Manne, 1965). Corporate gains are owed to the solving of target agency problems by the market external control of managers.
## II 3 Previous empirical results

Most empirical studies estimate the effects of takeovers by measuring the variation of bidder and target stock returns around the time of announcement, using the event study methodology (Fama, Fisher, Jensen and Roll, 1969).

These studies indicate that targets of successful takeover attempts realize substantial and statistically significant increases in their stock returns (Jensen and Ruback, 1983; Husson, 1987; Charléty-Lepers and Sassenou, 1994).

The evidence on bidder returns is mixed. On the whole, it suggests that returns to takeover bidders are approximately zero, and are often statistically insignificant. Since targets gain and bidders do not appear to lose, the evidence suggests that takeovers create value. Still the asymmetrical sharing out of the gains between targets and bidders is a conundrum. We can actually wonder why the bidder spends time and energy in an operation bringing in no benefits for him.

The next section describes the empirical process followed in this study. We first exhibit the event study methodology used. Then we expose our empirical procedure and findings. Finally we test several hypotheses of the literature in order to explain our results.

## III EXPERIMENTAL PROCESS

### III 1 Event study methodology

#### III 1 1 Estimation of abnormal returns

The market's reaction to a merger bid is measured using daily stock return data to compute excess stockholder returns. These excess returns are a measure of the stockholder's returns from new information that becomes available to the market. This methodology relies on semi-strong form market efficiency, asserting that all public available information is impounded into market returns as soon as investors are aware of it. We assume that the agents' expectations are not erroneous, which is an accepted custom in Finance<fnref n="1" />.

<footnote n="1">¹ In spite of these strong hypotheses, the Event study methodology has the great asset to measure *expected* takeover gains on the short term. Estimating the *observed* gains would require a long-term study, as long as real effects on the firm benefits would take time to appear. Besides, the simplicity of the estimate- the stock market share price- allows to avoid biases encountered in long-term studies. The traditional parametric</footnote>
Let the abnormal return AR of a firm i in day t :

$$AR_{i,t} = R_{i,t} - K_{i,t}$$

where

$R$=observed return over the period;

$K$=predicted return over the period

Individual abnormal returns are then computed for each day of the event period, to form the average abnormal returns AAR:

$$AAR_t = \frac{1}{N} \sum_{i=1}^{N} AR_{i,t}$$

where N is the size of the sample considered

Finally cumulative average abnormal returns over an interval of days 1 to T are defined as:

$$CAAR_t = \sum_{i=1}^{T} AAR_i$$

## II 1 2 Predicted returns computation

Two techniques are mainly used to estimate the predicted returns for each security i. They are the Capital Asset Pricing Model (CAPM), first introduced by Sharpe (1964), Lintner (1965) and Mossin (1966), and the Mean Model.

We use the Mean model in this study. Actually, Brown and Warner (1980, 1985) demonstrate that the explanatory power of these models are quite similar, as long as the abnormal returns variance is not significantly improved with a sophisticated model such as the CAPM, rather than with the Mean Model. Besides, the firms of our sample are subject to an irregular quotation, making the use of the CAPM impossible to estimate the theoretical returns. We can show in that particular case that the Mean Model gives the best estimate of the stock price.

Actually, the CAPM stands that the ex ante profitability of an asset i follow:

$$E(R_{i,t}) = R_{f,t} + \beta_i [E(R_{m,t}) - R_{f,t}] (1)$$

Where

$R_{i,t}$=rate of return on security i over period t,

$R_{m,t}$= rate of return on the value-weighted market portfolio, and

$R_{f,t}$=risk-free return over t

approach is subject to the bias of a bad estimate of the production function. Important factors can be omitted or non-measurable.
Given ordinary least squares estimates of βᵢ and Rᵢₜ, (1) generates an unbiased linear forecasting model for E(Rᵢₜ)-Rᵢₜ, conditional on the information set available at t-1 and on the values taken by Rᵢₜ and Rᵢₜ.

The forecasting error can then be interpreted as a measure of the impact on the value of security i of the new information arriving at period t, which is specific to security i. Assume that date t is a period during which new information pertaining to an economic event arrives. Then the forecasting error can be related to hypotheses concerning the event.

If the coefficient β is not significant, the ex ante profitability of asset i follow the Mean Model:

$$R_{it} = \mu_i + \xi_{it}$$

$$E[\xi_{it}] = 0$$

$$Var[\xi_{it}] = \sigma_{\xi_i}^2$$

where

$R_{i,t}$ = rate of return on security i over period t,

$\xi_{it}$ = zero mean forecasting error.

We test the H₀ hypothesis: the cumulative abnormal returns mean is different from zero, against the alternative H₁ hypothesis: the cumulative abnormal returns mean is equal to zero.

Specifically, let:

$$T = \frac{\frac{E(CAR_i)}{N}}{\sqrt{\frac{\sigma^2(CAR_i)}{N} - 1}}$$

where:

CARᵢ = cumulative abnormal returns for security i over period T;

N = sample size

If T is Student t-distributed with (N-1) degrees of freedom, we accept the hypothesis H₀, and the cumulative abnormal returns mean is significantly different from zero.

In the opposite case, we reject the H₀ hypothesis, and the obtained results are not significant.

### III 2 Data

The sample of firms included in this study is formed of targets and bidders of takeovers announced in the French Stock Market between 1991 and 1997, that were listed by the DATASTREAM database, over a period of one year at least before the takeover announcement date.
The dates on which information regarding takeovers became available to the market participants were found in the SBF (French Stock Market Society) CD-ROM, headed: « Awards and announcements ». We use the takeover first public announcement as the event date, and the ten days before through the ten days after the offer announcement as the event window<fnref n="2" />.

For the target sample E₁, the event date is the issue date of the takeover notice by the bidder. The event window is formed of the ten days before this issue date, and the ten days following the quotation recovery- the target quotation being systematically adjourned by the SBF following a takeover notice.

For the bidder sample E₂, we define the event date as the date of the first SBF notice mentioning the name of the bidder. In case of a takeover paid cash, the name of the bidder is first mentioned in the takeover project notice, following the takeover announcement. Actually in that case, the latter mentions solely the name of the target. On the contrary, in the case of a takeover paid in shares, the takeover notice mentions both the name of the target and the name of the bidder; we then define the event date as the date of the takeover notice.

Besides, whatever the mean of payment, the event window is always ten days before through ten days after the event date for bidders, as long as the SBF only adjourns target - not bidder - quotations following a takeover announcement.

### III 3 Empirical results

#### III 3 1 Takeovers generate extra returns asymmetrically shared between targets and bidders

The evidence indicates that shareholders of target firms realize large positive abnormal returns in completed takeovers. The cumulative average abnormal returns (CAAR) are positive and statistically significant for the target firm sample E₁; they amount to 15.28 from day -10 to day +10 and are significant at the 1% level (t=3.74) (see charts 1 and 2).

<footnote n="2">² Early event studies of takeovers use the effective date of merger, that is the date of final approval by target shareholders) as the event date (Mandelker, 1974; Ellert, 1976; Langetieg, 1978). Nevertheless, the market starts to react on the announcement date (Dodd et Ruback, 1977). Using the effective date as the event date makes it difficult to identify changes that are due to the takeover event itself. Because of this difficulty, we estimate abnormal returns around the time of the first public announcement of a takeover.</footnote>
<figure><img src="image_3.png" /><figcaption>Chart 2: Cumulative average abnormal returns for target firms</figcaption></figure>

<figure><img src="image_4.png" /><figcaption>Chart 3: Daily average abnormal returns for bidder firms</figcaption></figure>

<figure><img src="image_5.png" /><figcaption>Chart 4: Cumulative average abnormal returns for bidder firms</figcaption></figure>

<figure><img src="image_6.png" /></figure>
On the contrary, the bidder firm sample E2 does not reap the rewards of takeover announcements, as long as cumulative abnormal returns are positive (CAR=1.76) but are not statistically significant over the period (see charts 3 and 4).

Since targets gain and bidders do not seem to lose, the evidence suggests that the total gains are positive: takeovers create value. Nevertheless cumulative abnormal returns of mixed targets and bidders are not statistically significant<fnref n="3" />.

Our results are consistent with the previous empirical literature. They indicate that takeovers generate stock market gains asymmetrically shared between targets, who benefit from a favorable announcement effect, and bidders, who neither lose nor gain from the announcement.
We take the analysis further by testing several hypotheses in order to solve the bidder enigma.

### III 3 2 Testing the corporate control hypothesis

Anglo-saxon studies explain the bidder conundrum by competition in the stock market (Bradley, Desay and Kim 1988; Franks, Harris and Titman, 1991). They distinguish between takeovers leading to outbidding from several potential acquirers, and single bidder operations. In a competitive setting, bidders have no choice but to offer the target shareholders the higher premium they can, equal to the benefit they expect the takeover will bring in. This premium is necessary if bidders want targets to sell their shares; it also has the aim to discourage possible competitors. Thus competition pushes the target price up to its post-acquisition expected value, resulting in non-significant positive abnormal returns for the final acquirer, contrary to single bidder operations that prove profitable for the acquirer. These studies support the external control hypothesis, and explain value enhancement by the replacement of inefficient target firm managers following hostile takeovers.

<footnote n="3">³ However, because bidding firms tend to be larger than target firms, the sum of the returns do not measure the total gain. Actually, the dollar value of small losses for bidders could excess the dollar value of large gains for targets.</footnote>
However this hypothesis is unlikely to explain our empirical findings, as long as most takeovers announced in the French stock market over the 1991-1997 period did not result in stock market fights. Actually these operations were in most cases simplified takeovers following the sale of a block of shares (see table 1).

This takeover procedure is not compatible with stock market fights, because only a majority shareholder is up to gain control over a company by the acquisition of a block of shares. Thus there is only one potential buyer.

<table><caption>Table 1: Sample composition by operation</caption><thead><tr><th></th><th>Target firms</th><th>%</th><th>Bidder firms</th><th>%</th></tr></thead><tbody><tr><td>Simplified takeovers</td><td>62</td><td>70.5</td><td>30</td><td>61</td></tr><tr><td>Regular takeovers</td><td>26</td><td>21.5</td><td>19</td><td>39</td></tr><tr><td>Total</td><td>88</td><td>100</td><td>49</td><td>100</td></tr></tbody></table>

The widespread ownership structure in Anglo-Saxon markets, as opposed to a concentrated structure of ownership in the French market, accounts for this difference in the competitive behavior of firms. The weak capitalization of French firms also favor non offensive takeovers: if the average size of the target is important, so does its price.

### II 3 3 Testing the takeover motive effect on the agents expectations

If the external control of the market is not the relevant hypothesis for our sample, we remain with the synergistic and the conglomerate hypotheses. We thus test the bidder motivation impact by dividing both samples into two, distinguishing industrially-justified takeovers from conglomerate strategies. If abnormal returns associated with synergistic operations exhibit significant superior abnormal returns as compared to these associated with conglomerate acquisitions, we conclude that the diversification hypothesis proves erroneous to explain expected value creation. In that case, both market power and synergy hypotheses receive support. We could then interpret the non significant positive abnormal returns for the bidder as a consequence of the dilution of the extra returns generated by industrially justified operations, by the bad expectations associated with unprofitable conglomerate takeovers.
We decompose target and bidder samples E₁ and E₂ into four subsamples E₁₁, E₁₂, E₂₁ and E₂₂. Subsamples E₁₁ and E₂₁ contain respectively targets and bidders of industrially justified takeovers, either by vertical or by horizontal integration.

Subsamples E₁₂ and E₂₂ stand respectively for targets and bidders of operations that do not seem industrially justified. There are three main motives for these operations in our subsample. The bidder can be a financial holding, which aim is to invest in different sectors in order to diversify its risks. The authorities, through local development companies, to prevent or to delay business failures can initiate some takeovers. Finally, many takeovers result from the willing of major French groups to simplify their shareholding structures. We use the database DAFSAPRO in order to determine the different motivations underlying takeovers.

The results obtained with target subsamples E₁₁ and E₁₂ provide support for the idea that the agents valorize better industrially justified takeovers. A mean test between the two subsamples shows that their cumulative abnormal returns do not appear significantly different. Nevertheless, the estimate of the cumulative average abnormal returns of each subsample speaks figures. Not only are they four times lower when takeovers are not justified industrially, than when they are (the respective values are 10.2 for E₁₁ and 36.07 for E₁₂), but the CAR are not significant for subsample E₁₂ while they are significant at the 1% level for subsample E₁₁ (see charts 5, 6, 7, 8). The fact that agents take the takeover motive into consideration demonstrate that the announcement effect of such operations is insufficient to generate positive and significant cumulative abnormal returns. On the other hand the study of the bidder subsamples E₂₁ and E₂₂ does not lead to any conclusion : neither does t-statistic between both series nor individual ones exhibit significant values. Thus the aggregation of synergistic and conglomerate acquisitions in our bidder sample E₂ does not explain the non-significant abnormal returns for the acquirers (see table 2 for a summary of the results).

<table><caption>Table 2: Empirical results</caption><thead><tr><th></th><th></th><th>Full sample</th><th>Synergistic takeovers</th><th>Non-synergistic takeovers</th></tr></thead><tbody><tr><td rowspan="3">Targets</td><td>CAAR</td><td>15.28**</td><td>36.07**</td><td>10.2**</td></tr><tr><td>T statistic</td><td>3.73</td><td>4.02</td><td>1.42</td></tr><tr><td>Sample size</td><td>E₁=88</td><td>E₁₁=49</td><td>E₁₂=34</td></tr><tr><td rowspan="3">Bidders</td><td>CAAR</td><td>1.76</td><td>2.58</td><td>Too limited sample</td></tr><tr><td>T statistic</td><td>1.001</td><td>0.62</td><td>Too limited sample</td></tr><tr><td>Sample size</td><td>E₂=50</td><td>E₂₁=41</td><td>E₂₂=9</td></tr></tbody></table>

<footnote>**Significant at the 1% level</footnote>
<figure><img src="image_7.png" /><figcaption>Chart 6: Cumulative average abnormal returns for synergistic takeover target firms E 11</figcaption></figure>

<figure><img src="image_8.png" /><figcaption>Chart 7: Daily average abnormal returns for non synergistic takeover target firms (E 12)</figcaption></figure>

<figure><img src="image_9.png" /><figcaption>Chart 8: Cumulative average abnormal returns for non synergistic takeover target firms (E 12)</figcaption></figure>

<figure><img src="image_10.png" /></figure>
CONCLUSIONS

This study confirms the empirical findings of previous event studies in the French stock market, on the impact of takeover announcements. We find that shareholders of target firms benefit from a positive announcement effect of such operations, while it has no effect for the shareholders of bidder firms. In other words, it appears that target firms were undervalued by the Stock Market. We try to solve the enigma of non-significant abnormal returns for the bidder.

This expected value enhancement can be interpreted as the result of the misuse of the firm productive capacities. The takeover can solve this productive inefficiency either by industrial synergies-the target of a takeover benefits from equipment it could not invest in- or by the replacement of the managing team- the latter proving unable to valorize the firm assets properly.

We show that the hypothesis of an external control of the market, standing that the most profitable firms take over undervalued firms on the stock market, can not be put forward as far as our sample is concerned. Actually the corporate ownership structure of firms and the low capitalization are a brake to hostile takeovers in the French market.

We demonstrate that these empirical findings can be explained by synergistic motives, as long as synergistic takeover targets exhibit significant higher abnormal returns than conglomerate takeover targets. Nevertheless, we are not able to explain the absence of gains for the bidders, as long as synergistic takeover acquirers still exhibit non-significant abnormal returns.
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