According to Fama’s(1970) “efficient market theory, when the market presents new material information, the stock price of a company will adjust immediately”. It is said that portfolio managers and owners cannot obtain abnormal returns in an efficient market.
However, many literatures references have studied long-run stock performance which follows important corporate decisions.(e.g. initial public offering、SEO、mergers and acquisitions、the payment of dividends、stock repurchases… …) . This finding, in contrast to the prediction of the efficient market hypothesis, is both interesting and puzzling because it presents an efficient market anomaly in general and is an unknown entity for merger activity in particular.
This section provides a brief review of prior research on post-merger underperformance in both the US and the UK markets. A more comprehensive review is available in Agrawal and Jaffe (2000). It begins with studies that use US market events.
Langetieg (1978) reports significant negative cumulative abnormal returns over a six-year period after a merger. Magenheim and Mueller (1988) report a significant CAR of -2.4% in three years after the merger announcement. Anderson and Mandelker(1993) also find significant negative five-year CARs under a size and book-to-market adjustment model respectively. Loughran and Vijh(1997) report a statistically significant five-year BHAR of -15.9% following mergers relative to a size and book-to-market adjusted benchmark.
Agrawal and Jaffe (2000) conclude that the long-run post-merger stock performance is significantly negative. In addition, Malatesta (1983) Agrawal et al. (1992) Rau and Vermaelen (1998) documented the underperformance on M&A activity in their papers.
Many prior research reports on post-merger stock price performance of UK firms are also provided.
Franks and Harris (1989);used a large comprehensive sample of 1800 UK mergers between 1955 and 1985 and found that acquiring firms suffer significant value loss in two-years after the merger.
Chatterjee (2000), Aw and Chatterjee (2004), used the market model; and found significant negative
CARs. In addition, Barnes (1984), Dodds and Quek (1985), Limmack (1991), and Limmack and McGregor (1995) documented the underperformance on M&A activity in their papers. A general conclusion from these studies using UK data; is similar to that seen for the US market, statistically significant underperformance following the merger on using different event study metrics.
However, managerial timing ability explains the abnormal returns of acquiring firms after a merger. On M&A activity, the managerial timing ability hypothesis states that managers or owners can predict their stock price and decide to merge their target firms when the acquiring firms were overvalued. There are many examples of literature about the managerial market timing hypothesis which can explain the abnormal returns. Loughran, Ritter and Rydqvist (1994) find little evidence for an ability of IPO activity to forecast future returns. Baker and Wurgler (2000) provide evidence that the proportion of equity issuance in total securities issuance predicts future equity returns in the US. Spiess and Affleck- Graves (1995) discovered long-run negative abnormal returns in SEOs. Baker, Greenwood, and Wurgler (2003)found that managers carefully adjusted the duration of liability to control the change of the yield rate. Ikenberry, Lakonishok and Vermaelen (1995, 2000), as well as Chan, Lkenberry and Lee (2006) discovered that companies with stock repurchases have long-run excess returns. Thus, Loughran and Vijh (1997), Pagano, Panetta and Zingales (1998), Cornett, Mehran and Tehranian (1998), Teoh, Welch and Wong (1998a, 1998b) and Ahn and Shivdasani (1999) also supposed that managers have the ability to predict future returns.
Andrade, Mitchell and Stafford(2001) documented that full merger results hid an important distinction based on the financing of these transactions. In particular, mergers financed with stock, at least partially, have different value effects from mergers that are financed without any stock.
Loughran and Vijh (1997) separately calculate long-term abnormal returns for acquiring firms using stock financing and those paying with cash over the period covering 1970-1989. They find that acquiring firms using stock financing have abnormal returns of -24.2 percent over the five-year period after the merger, whereas the abnormal return is 18.5 percent for cash mergers. Travlos
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(1987) and others have attributed the negative CARs for merger announcements of acquisitions financed by using stock to this. A firm might be more likely to use stock to finance an acquisition when its stock price has been increasing and, thus, is more likely to be overvalued. Based on mergers financed with stock, this thesis discusses whether the stock price of mergers financed with stock is more likely to be overvalued.
Another grouping that produces a large difference in long-term abnormal returns is based on the book-to-market equity ratio. Firms classified on the basis of high book-to-market are commonly referred to as "value" firms, and tend to have higher returns on average. Firms identified as low book-to-market ratios are referred to as "growth" or "glamour" firms, and have relatively low returns on average. Interpretations of these findings vary. For example, Fama and French (1992, 1993) argue that the relatively high returns of value firms are due to increased risk, perhaps related to distress. On the other hand, Lakonishok, Shleifer and Vishny (1994) argue that the differential returns of value and growth stocks are not related to risk, but instead arise because investors mistakenly estimate future performance by extrapolating from past performance. Using the value/growth distinction, Rau and Vermaelen (1998) calculate the three-year abnormal returns of -17.3 percent for glamour acquirers and 7.6 percent for value acquirers over the period 1980-1991.
Based on the book-to-market ratio, this thesis discusses whether the stock price of growth firms is more likely to be overvalued.
In recent years, some papers have allowed the rejection of managerial timing ability. In contrast to the findings described above, other studies find phenomena and behavior patterns on US capital markets that contradict the market timing hypothesis. For instance, on the basis of data about insider-trading, Lee (1997) shows that some managers buy shares prior to price declines. This is contradictory if managers have market timing abilities. Spiess and Affleck-Graves (1999) find stock underperformance as a following to debt issuance. According to market timing, firms tend to issue equity in times of overvaluation and debt in times of undervaluation. Thus, market timing implies that
the there is over performance after debt issues. Rehkugler and Schenek (2001) have to reject the market timing hypothesis as they find larger underperformance for firms that went public in periods of low IPO activity. Similarly at odds with market timing, Loughran, Ritter and Rydqvist (1994) detected a positive correlation between the number of IPOs and future returns.
Other researches alternatively choose to study this issue by means of pseudo market timing. Schultz (2003) proposes an explanation for the apparent long-run underperformance of firms that go public. This explanation is based on the assumption that IPO activities rise with market prices and especially with prices of recent IPOs as managers’ or owners’ propensity to go public increases with potential IPO proceeds irrespective of their ability to predict future market returns.
He argues that the underperformance may be a statistical illusion caused by the clustering of IPOs after a period of unusually high abnormal returns on previous IPO firms. This effect is known as pseudo market timing.
Although managerial timing ability offers an explanation for the phenomenon from prior researches, the pseudo market timing hypothesis also provided another way to explain it. The aim of this thesis is to try to find a better explanation of abnormal returns of acquiring firms after merger. The thesis proceeds via three questions: Could managers predict event-time abnormal returns reasonably between growth firms and value firms? Are the future returns associated with the number of acquiring firms in calendar time and/or event time? Are the future returns associated with the number of acquiring firms on stock mergers in calendar time and/or event time?
The findings of this thesis are easily summarized as follows. First, according to managerial timing ability, the stock price of growth firms are overestimated compared to the stock price of value firms, so the growth firms’ abnormal returns should be lower than the returns of the value firms’. This thesis discovered that the growth firms’ abnormal returns are higher than value firms’. By definition, it is not consistent with the managerial timing ability hypothesis. Secondly, this
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paper tests whether event-time abnormal returns after the merger are negative which is consistent with pseudo market timing and managerial timing ability. Furthermore, this paper tests whether the number of M&As at the decision point is significantly related to the M&A index after the merger in calendar time. However, this thesis discovered that event-time abnormal returns after the merger are negative and that the number of M&As are not significantly related to the M&A index after merger in calendar time. By definition, it is partly consistent with the pseudo market timing hypothesis but allows for a rejection of managerial timing ability. This thesis explains this by using 144 monthly data spanning from 1995 to 2006. Finally, analogically, according to managerial timing ability, they will be more intense to merge by utilizing stock mergers if managers have the timing ability to predict the overvalued price. This thesis detects that the number of M&A activities are not significantly related to the future M&A index in calendar time. However, this thesis discovered that event-time abnormal returns after the stock merger are negative and that the number of M&As on stock financed is not significantly related to the M&A index after the stock merger in calendar time. By definition, it is partly consistent with the pseudo market timing hypothesis but allows for a rejection of managerial timing ability. This paper examines a phenomenon that we refer to as pseudo market timing partly and shows that it can explain the poor event-time performance of stocks that have recently undergone M&A activities.
The remainder of the paper is organized as follows. Section II introduces the pseudo market timing hypothesis. Section III describes the research method. Section IV introduces the research results and section V offers conclusions for this study.