Big Firms Lose Value in Acquisitions

Large firms have destroyed $226 billion of shareholder wealth over 20 years. In contrast, small firms, defined as companies whose market capitalization is equivalent to the smallest 25 percent of companies listed on the NYSE in each year, created $8 billion of shareholder wealth through their transactions.

Mergers and acquisitions destroy shareholder wealth in the acquiring companies. New research from the NBER shows that, over the past 20 years, U.S. takeovers have led to losses of more than $200 billion for shareholders. However, this result is dominated by the big losses experienced by shareholders in big companies. Small companies that make acquisitions create value for their shareholders.

In Do Shareholders of Acquiring Firms Gain from Acquisitions? (NBER Working Paper No. 9523), co-authors Sara Moeller, Frederik Schlingemann, and Rene Stulz calculate that takeovers by large firms have destroyed $226 billion of shareholder wealth over 20 years. In contrast, small firms, defined as companies whose market capitalization is equivalent to the smallest 25 percent of companies listed on the NYSE in each year, created $8 billion of shareholder wealth through their transactions.

The researchers use a sample of 12,023 transactions, taking the data from the Securities Data Company's U.S Mergers and Acquisitions database. They limit the sample to completed transactions worth at least $1million. Of the 12,023 transactions, 5,583 involved the acquisition of private firms, 3,798 involved the acquisition of subsidiaries, and 2,642 involved the acquisition of public firms.

The researchers concentrate on the three days around the announcement of an acquisition. They estimate the abnormal share return accruing to acquiring shareholders on their holdings measured as the share return relative to a market benchmark, the abnormal change in the value of the acquiring firm per dollar spent on the acquisition, and the sum of the abnormal changes in value of acquiring firms across all acquisitions.

In the aggregate, the abnormal return on the acquisition of a public firm is negative 1.02 percent. Shareholders lose 5.9 cents per dollar spent on acquiring a public firm. The aggregate losses on acquiring public firms were $257 billion in the past 20 years. Purchases of private firms provide better returns than purchases of public companies. On average, acquiring firm shareholders gained from the purchase of private firms, although in the aggregate shareholders lose because of big losses experienced during the merger wave of the late 1990s. It is only in acquiring subsidiaries, as opposed to whole companies, that returns are positive for acquiring shareholders in the aggregate.

Previous studies often have concentrated on whether acquisitions are paid for in cash or in stock, typically showing better returns in cash deals. Moeller, Schlingemann, and Stulz show that cash deals are associated with superior returns for acquirers as compared with equity deals only for acquisitions of public firms. They also show that controlling for financing, and for the question of whether it is a public company, a private company, or a subsidiary that is being bought, returns are still better for shareholders in smaller firms. An acquisition made by a small firm - regardless of funding and the nature of the target - has an announcement return that is 1.55 percent higher than a comparable acquisition made by a large firm.

The overall results are dominated by acquisitions made by large firms, and in particular the big value-destroying deals announced during the merger boom of the late 1990s. If the period 1994-2001 is excluded from the sample, the total dollar amount of gains/losses on acquisitions is still negative, but the sum of losses is only $10.4 billion. More than 87 percent of the money spent on acquisitions in the sample comes after 1993, accounting for 95 percent of the losses that also occurred after 1993.

Because small firms make so many acquisitions - accounting for half of the total acquisitions of private companies and a quarter of the acquisitions of private companies - abnormal returns can be positive for acquisitions even though acquisitions appear to destroy wealth as a whole. Results that put the same weight on acquisitions by small firms and large firms may be poorly suited for analyses of the social benefits of acquisitions, the researchers suggest.

Part of the explanation for why big companies make value-destroying acquisitions may be the "agency problem" that results from the separation of ownership and control in big companies with dispersed shareholders. It is also possible that when large firms make acquisitions, they signal that they have exhausted internal growth opportunities. In that case, even when the takeover is a project with positive net present value, a negative return may be observed when looking at the share price following the transaction.

Yet, even if the abnormal returns incorporate information other than an estimate of the net present value of the acquisition, this information differs across small and large companies. Small firms make acquisitions that, when announced, have an abnormal return that is systematically higher than acquisitions by large firms.

-- Andrew Balls