It has long been known that while shareholders of corporations that are targets of a successful takeover gain substantially?on the order of hundreds of billions of dollars. In contrast, studies during the 1980s and early 1990s of acquiring company stock performance reported results ranging from no statistically significant stock price effect to statistically significant losses. By some estimates, up to half of acquiring companies lost money on takeovers during that period. A more recent study, covering the period 1998-2001, finds spectacular losses for acquiring shareholders but those results are skewed because a few acquirers may particularly bad investment decisions:
ABSTRACT: Acquiring-firm shareholders lost 12 cents around acquisition announcements per dollar spent on acquisitions for a total loss of $240 billion from 1998 through 2001, whereas they lost $7 billion in all of the 1980s, or 1.6 cents per dollar spent. The 1998 to 2001 aggregate dollar loss of acquiring-firm shareholders is so large because of a small number of acquisitions with negative synergy gains by firms with extremely high valuations. Without these acquisitions, the wealth of acquiring-firm shareholders would have increased. Firms that make these acquisitions with large dollar losses perform poorly afterwards.
Why do some acquirers make such spectacularly bad decisions? In my book Mergers and Acquisitions, I advance three explanations for why bidders might make negative synergy acquisitions:
- The Winner's Curse: An auction of corporate control is the most likely situation in which such an outcome might result. Bidder One makes an offer for Target. Bidder Two then makes a competing, slightly higher bid. Several rounds of competitive bidding follow. In the end, the bidder with the highest reservation price should prevail. Yet, that bidder is the one most likely to overpay. In behavioral economics, this phenomenon is known as the "winner's curse." Suppose Target's stock was trading at $10 before the bidding began. Due to the familiar problems of uncertainty and complexity, nobody knows for sure what Target is really worth. Bidder One's reservation price is $20, Bidder Two's reservation price is $22. All else being equal, Bidder Two should win the auction. Suppose Bidder Two ends up paying its reservation price of $22, but later discovers that Target really was worth no more than $20. Bidder Two has experienced the winner's curse: it won the auction, but lost the war. It overpaid. Target shareholders are better off by $12, but Bidder Two's shareholders are worse off by $2. Net, this is still a value creating acquisition, of course, but that fact may not assuage Bidder Two's shareholders.
- Acquisitions made for the sake of empire building: Bigger is typically better from management's perspective. Just like putting oriental rugs down on the floor, bigger organizational charts on the wall are a management perk. If size reduces the chances of firm failure, management even has a financial incentive to pursue such acquisitions. As with acquisitions motivated by a desire for intra firm diversification, empire building acquisitions doubtless reduce shareholder wealth. Free markets are self correcting, however. Empirical studies confirm that bidders motivated by considerations other than shareholder wealth maximization themselves tend to become targets.
- Acquisitions made for the sake of diversification: Around the middle of the 20th Century, the idea grew up that good managers could manage anything. This view was operationalized via conglomerate mergers, in which companies intentionally sought to diversify their product lines and business activities horizontally across a wide array of unrelated businesses. The theory was that a cyclical manufacturer could buy a noncyclical business, making the combined company stronger because some division would always be doing well. Diversification necessarily reduces the maximum gains a conglomerate can produce. When one segment is doing well, it is being pulled down by a segment that is doing less well. To be sure, diversification reduced the conglomerate's exposure to unsystematic risk. But so what? Investors can diversify their portfolios more cheaply than can a company, not least because the investor need not pay a control premium. Management of a conglomerate may be better off, because their employer is subject to less risk, but the empirical evidence is compelling that intra firm diversification reduces shareholder wealth. The self correcting nature of free markets is demonstrated by what happened next: during the 1980s there was a wave of so called "bust up" takeovers in which conglomerates were acquired and broken up into their constituent pieces, which were then sold off. The process resulted in a sort of reverse synergy: the whole was worth less than the sum of its parts.
Does the prospect that some acquirers lose money for their shareholders - and some lose a whole lot of money for them - have any policy implications? Should we do anything from a legal perspective to make it harder for one company to acquire another? No. As we just discussed, markets tend to be self-correcting. Firms that make bad acquisition decisions tend themselves to become targets. The market for corporate control is far more likely to make sound judgments in this area than some bureaucrat in Washington.
