Using financial event study method, we examine the impact of merger announcements on shareholder wealth of Canadian companies during an exceptional worldwide merger boom. Our results show that both target companies and the acquirer companies earn significant positive abnormal returns in the short term. However, beyond five days after the event, we observe that abnormal returns diminish to become significant and negative for acquiring companies and diminish to be non-significant and positive for target companies. Consistent with previous Canadian studies, merger announcements have positive signaling effects on stock performance. Our large sample study updates and fills a void in Canadian merger studies during this important and recent time period in merger and acquisitions.
The current decade has been an extraordinary period to study mergers unlike any other periods studied in the finance literature. That is, since the 1980's decade of merger activity, there has been a worldwide merger boom. (Pryor, 2001) characterizes this merger boom in the 1990's as a distinct decade of mergers from the 1980's in the US, Canada and OECD countries. Indeed, in the 1990's, we witness some spectacular merger activities such as the frenetic initial public offerings and subsequent acquisitions of multitudes of dot.com companies, the prominence of global business and transnational mergers, and unprecedented mega-merger deals such as the 165 billion AOL-Time Warner deal. Quantitatively, (Pryor,2001) estimates that between 1992 and 1999, the total recorded value of merger deals grew at an annual rate of 35.7 percent, and from 1985 to 1999, the total volume of mergers rose at 20.8 percent annually. He notes that this merger boom is much greater (measured in terms of number) than previous merger booms with peaks around 1900, 1929, 1963 and the early 1980's (Golbe and White, 1993). Finally, to truly understand the exceptional nature of this merger boom, (Pryor,2001) finds this merger boom to be greater than any other merger boom in past U.S. history.
The study of mergers and acquisitions focuses on understanding what motivates managers to engage in this type of activity and the impact that mergers and acquisitions have on shareholder returns. Mergers and acquisitions are an important means to grow a company. Managers' motivations for mergers could be empire building through growth in size, (Mueller, 1969) sales and assets (Berle and Means, 1932), (Schipper and Thompson, 1983). Managers choose to merge or acquire with others for potential market gains, for overcoming technological barriers, and for gaining a technological edge, as well as for building diversification on existing strengths. Managers are also pursuing efficiency improvements through mergers and acquisitions. Efficiency improvements can be gained from synergy of target and bidding firms due to economies of scale and use of excess capacity. For example, vertical mergers create economies of scale by enabling more efficient coordination of the members of the vertical chain. (Berry, 2000) and (Williamson, 1971) further promotes that vertical mergers increase shareholder returns by creating internal transfer pricing transactions. Managers may pursue mergers and acquisitions to lower the cost of capital and improve shareholder returns. They may see that acquisitions can reduce the probability of default due to the co-insurance effect (Lewellen, 1971) thus reducing bankruptcy costs and increasing the debt capacity of the combined firm. By increasing debt capacity, a manager can reduce the cost of capital through interest tax shields and add value to the firm. (Levy and Sarnat, 1970) support this managerial motivation. They find that in conglomerate mergers, large firms enjoy significant cost savings when securing their financing needs. These cost savings presumably reflect, at least in part, the reduction in lenders' risk achieved through diversification. However, recent studies [(Lang and Stulz,1994), (Berger and Ofek, 1995), (Maquieira, Megginson and Nail, 1998)] challenge value creation in conglomerate mergers; that there are no synergies created through diversification or horizontal mergers.
For the above motivations and more, Canadian managers are very active in mergers and acquisitions between 1994 and 2000. In this paper, we examine the impact of mergers on shareholder wealth of Canadian companies.
The first contribution of this paper is to examine current return patterns after a merger given the extraordinary period of this worldwide merger boom. (Henry,2002) reports that nearly $4 trillion worth of mergers were done from 1998 through 2000--more than in the preceding 30 years. Indeed, such changes are anticipated as the literature has noticed temporal effects on M&A performance.
Moreover, there are very few current studies on Canadian M&A, and the key studies date back to the 1980's. Like the U.S., Canadian managers are very active in mergers and acquisitions between 1990 and 2000. In contrast to US studies of shareholder returns, Canadian studies appear to consistently show positive and significant returns to acquiring firm shareholders. Yet, the Canadian studies are few and more evidence is needed; this paper provides the most current evidence. Differences in Canadian industry, capital markets and regulations appear to justify the difference in the Canadian experience. While the Canadian merger studies show similarities with U.S. findings, there are differences between Canadian companies, markets and regulations and their U.S. counterparts to justify this study. This paper as a Canadian study would be generalizable because of the similarities and contribute new findings because of the differences. It will serve to fill a void in the empirical work in Canada that is largely done in the 1980's to gain insight of the largest worldwide merger boom in history.
The first part of the paper summarizes the key research findings from the literature on mergers and acquisitions. We then formulate our hypotheses, describe the sample of firms, data acquisition, and analytical methodology and present our results. We conclude the paper with a discussion of directions for further research.
Most financial research in mergers and acquisitions use event study method to examine the impact of merger announcements on stock prices. Various researchers [(Dodd, 1980), (Dennis and McConnell, 1986)] conclude that as a result of merger, the returns go to target firms. Returns to target shareholders range from 20-30 % [(Dodd and Ruback, 1977), (Dodd, 1980), (Bradley and Wakeman, 1983), (Jensen and Ruback, 1983), (Malatesta, 1983)]. On the other hand, the impact of merger on returns for the acquiring firms has largely been either significant negative abnormal returns [(Dodd, 1980), (Firth, 1980), and (Eger, 1983)] or non-significant positive abnormal returns [(Asquith, 1983), (Eckbo, 1983), (Dennis and McConnell, 1986) and (Amihud, Dodd and Weinstein, 1986)].
Over time, short-term event studies do consistently find that the nature of the merger deal create gains and losses for acquirers. How the deal is made as a friendly merger or hostile takeover, or how it is paid for through stock or cash does matter. Indeed, managers pursuing mergers can make decisions on how the merger deal is...