MERGERS MORE LIKELY WHEN FIRM VALUATIONS ARE HIGH AND DISPERSED

Mergersare more likely when the valuations of companies are higher and when there is a wider range of these valuations. That is the central finding of research by Dr Zafeira Kastrinaki and ProfessorPaul Stoneman, presented at the Royal Economic Society’s 2011 annual conference.

The authors, who analyses UK data on merger activity for the past 20 years, also find that an increase in the valuations of companies does not always lead to an increase in merger activity, as previous studies have suggested. An increase in valuations will not lead to an increase in merger activity when the range of valuations by bidding companies is low.

But mergers do lead to more mergers. Each additional merger is associated with a 0.05% higher merger rate for that industry.

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Merger waves occur not only in periods of increased levels of valuation but also when valuation dispersion is high. This is the central finding of new research by Dr Zafeira Kastrinaki and Professor Paul Stoneman presented at the Royal Economic Society’s 2011 annual conference. What’s more, there is interdependence of takeover activity over time with past mergers in the sectors of both acquiring and acquired firms affecting the probability of mergers.

The authors use UK data covering merger activity over the period from 1990 to 2010 to establish the role played by the valuation of firms and its dispersion in driving merger waves. They find that:

  • Valuation dispersion and its interaction with valuation levels may create a wave-like behaviour of mergers. Consequently, it is not only the increased levels of valuation that matters but also the dispersion.
  • An increase in the dispersion of valuation (as measured by Tobin’s q ratio) of 1 standard deviation, other things constant, will result in a 4% increase in the probability of mergers,
  • An increase in the valuation levels does not always lead to an increased merger activity as existing studies suggest. For this to be the case, the valuation dispersion should be low enough, specifically below 3.33 standard deviations.
  • The very act of trying to use the information contained in the merger decisions of others may create a bandwagon phenomenon, which, once rolling, prompts firms to merge because others are merging. An additional merger is associated with a 0.05% higher merger rate. This indicates that as the number of completed mergers in the sector increases, so incentives to merge increase and the probability of merger increases.

These results may guide predictions of future patterns of merger activity, inform policy analysis and also further clarify the driving forces behind mergers and thus contribute to the understanding on success and failure in M&A activity.

A theoretical framework is constructed that lays due emphasis on the behaviour of sellers as well as bidders, draws attention to the separation of ownership and control, locates mergers within a market for corporate control and treats mergers as bidding games.

At any point in time there may be a bidding war, where a number of different firms interested in acquiring any particular target bid until the level of the bidding reaches the value the bidder places on the target or until all other bidders have dropped out. In principle, any firm may be a target for all other firms.

Whether a merger will occur or not depends on bidders’ and targets’ strategies, which are, in turn, affected by the distribution of firms’ valuation. This research shows that for a given mean of the distribution of valuation across all potential bidders (the whole market), the higher is the dispersion the greater will be the size of the bid, and for a given dispersion, the greater is the mean the larger will be the size bid and thus the more likely is for a target to sell.

Merger activity starts dissipating when the number of merged firms is very large and the sector has become concentrated with only a few firms. Further mergers may no longer be profitable or allowed by antitrust authorities.

ENDS

‘Mergers, merger waves and the distribution of Tobin’s q’ by Zafeira Kastrinaki and Paul Stoneman

Zafeira Kastrinaki is at Imperial College Business School; Paul Stoneman is at Warwick Business School

Contact:

Zafeira Kastrinaki

Telephone: 07986 859101

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Paul Stoneman

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