Evidence from UK Markets

As globalization continues to dominate the scene in business operations, developing competitiveness has become the order rather than an exception. Economies of scale is a major competitive strategy that both local and international corporations are embracing. One way of doing this has been through mergers and acquisitions within or even outside the industries. Such companies are able to enjoy broader market presence while production and operation efficiency may improve significantly. To generate understanding of how well the ‘synergy effect’ between the target and the acquirer, numerous studies have been conducted. Much emphasis has been placed due to the effect that mergers and acquisition has on both the economy and the firm (Duffhues & Renneboog 2006). When firm merge, they bring their resources together with intention to achieve similar objectives. Shareholders from the merging firms become joint owners of the resultant entity. 

One area that has attracted research is on the effect of successful mergers and acquisition on the returns to the shareholders. There is a coincidence of observation by various researchers that, ordinarily, there is a positive return to mergers and acquisition. In most cases the target company tends to experience higher returns to the shareholders while that of the acquirer tend to be normal or significant loss while announcing a merger or acquisition (Libby & Short 2011).

Event Study

This refers to a statistical method that helps in measuring the changes in the price of the securities following a certain event. This methodology is used in measuring both the magnitude and direction of of changes in price of the stock. It is also used to determine the effect of any event on the stock prices and hence the shareholder’s returns. According to Anderson, C., and G. Mendelker 1993, event study help to get any abnormal return associated with the event in question by adjusting for the returns result from price fluctuation of the market within a considerably short period.

Merger Event

Many studies have been conducted on merger event application and methodologies. Some such as those by MacKinlay (1997), Serra (2002) and Khotari and Warner (2005) are published while others are not. These studies provide techniques and review of traditional events.

Literature review

A merger may be financed by use of all-equity, all-cash or a mixture of both equity and cash. Where cash offer is used, shareholders in the target firm exchange their shares for cash (Clougherty & Duso 2007). In case of a stock merger, there negotiation for the number of shares from the target firm that will be for each in the acquirer. A research conducted by Andrade et al 2001 on 4000 mergers in UK between 1973 and 1998, revealed that use of stock as a method of payment had gained popularity. A research by Hansen in 1987 asserted that the target firm will prefer equity where there is an undervaluation of the firm so as to take advantage of forthcoming gains (Mellen & Evans 2010).

Mergers and acquisition in UK have been seen to occur in waves.  This depends on the macro and micro environment that may prevail in a particular period. A common phenomena observed in UK is that such waves arise when price/earning ratios and share price are high. According to Brakman et al (2005) the first wave in UK was in 1920s, second one in 1960, third one in 1970s and the fourth one in 1980s. Table below capture some statistics of companies that has merged in UK since the year 2000.

Summary of mergers and acquisitions in the UK by UK companies (£ million)

Source: Thomson Financial (2005, 2006) “Mergers & Acquisitions Review”

Studies have indicated that in the days around announcement of mergers and acquisition, target stock holders enjoy significant positive returns. According to Schwert (1996), 1814 UK takeovers shareholders experienced abnormal gains f about 10.1% in between 1975 and 1991. Frank and Harris (1989), conducted a study among 1898 UK target firms between 1955 and 1985 and established significant returns of 23.3%.  George and Renneboog (2004) agreed with the previous studies by establishing a 9.01% abnormal gains to the shareholders.

Conclusion

A market is said to be efficient if investors are able to predict what is likely to happen in the market with some reasonable accuracy. This depends on information asymmetry and hence decision making among the shareholders. Shareholders in target companies are able to anticipate leakage of information and this leads to an increase in stock prices few days prior to announcement. However, due to those that may overreact one announcement are made, the cumulative average abnormal return tend to reduce few days after announcement. Such reflection of information on UK stock market means the market is efficient.       

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