Impact of Mergers and Acquisition on Shareholder Value
There has been an increasing trend in mergers and acquisitions. The main motive behind mergers and acquisitions is that they create value for both shareholders of the target and acquiring companies indicating that mergers and acquisitions result in the creation of shareholder value.
However, as we shall see, empirical evidence suggests that not all mergers and acquisitions lead to the creation of shareholder value. Some mergers and acquisitions simply occur because managers of the acquiring firm may want to see their corporations grow bigger so as to increase their bonuses or control of the company. In addition, some mergers occur simply because some firms want to gain monopolistic power. This paper provides a discussion on whether mergers and acquisitions actually lead to the creation of shareholder value by reviewing literature on studies that have studied the wealth effects of mergers and acquisitions for both bidder and target firm shareholders. This is done in section 2 below. Section 3 then provides a practical case study of a merger that occurred five years ago and determines whether there has been any increase in the value of the company as a result of the merger.
2. Overview of Mergers and Acquisitions and Empirical Evidence
Mergers and acquisitions can be regarded as a form of business combination. A distinction can be made between the two forms of business combination. On the one hand, an acquisition refers to the purchase of a part of a company by another. It could be the purchase of assets from another company, the purchase of a definable segment of another company such as a subsidiary, or the purchase of the entire company. If the acquisition takes the form of purchasing the entire company, then the acquisition is referred to as a merger. A merger on its part is therefore the absorption of one firm by another. In a merger, one of the firms ceases to exist and the other acquirer continues to exist as a separate legal entity.
The increasing number of mergers and acquisitions suggests that they could be important events. For example, in 1999, the total value of mergers and acquisitions across the globe was approximately 2 percent of world-wide gross domestic product (UNCTAD, 2000). Given the rising trend in mergers and acquisitions, post-merger performance has become one of the most researched and interesting topics in financial economics. The issue as to whether post-merger performance is positive or negative is a controversial one. That is it is difficult to make a clear cut conclusion that mergers and acquisitions lead to the creation of shareholder wealth or that they do not lead to the creation of shareholder wealth. Many studies have taken a number of different approaches to arrive at different conclusions. On the one hand, accounting studies seek to understand whether there is an improvement in accounting numbers following a merger and acquisition. The evidence from these studies remains mixed with some studies demonstrating that mergers and acquisitions result in an improvement in profitability while a significant number of studies conclude that mergers and acquisitions do not foster performance improvement. Financial and economic studies typically employ event studies, which aim at understanding how the share prices (stock returns) of the firms concerned react to the merger or acquisition announcement. The results of these studies suggest that mergers and acquisitions lead to significant positive abnormal returns to shareholders of the target firm while resulting in negative of no abnormal returns to shareholders of bidder firms (Bild and Guest, 2002). The studies also demonstrate that despite the negative abnormal returns to acquiring shareholders, there these shareholders eventually benefit from overall significant gains in the future. These results have led some authors to argue that the results obtain tend to be sensitive to the methodology employed thereby leaving one to continue doubting whether the results actually reflect reality or whether they simply reflect the authors’ beliefs about mergers and acquisitions. For example Andrade et al. (2001) argues that the measure of long-run equity returns used in the studies is not reliable. On the contrary, Tchy (2002) argues that mergers and acquisitions are overvalued around the period covering the announcement, with the long-run effects being less improvement in profitability and destruction in shareholder wealth.
Based on a financial theory perspective, in order to determine whether mergers and acquisitions result in the creation of shareholder wealth, one needs to determine whether the present value of the financial rewards expected from the merger and acquisition are greater than the present value of the costs incurred in undertaking the merger and acquisition (Bild and Guest, 2002). That is, whether the net present value of the merger and acquisition is positive or not. Despite the importance of this approach, both accounting and event studies fail to employ this approach in their analysis. In addition, to the marginal impact of the merger and acquisition, the reaction of stock markets to the announcement of take-over bids also reflect many other factors that event studies fail to take into account. Consequently, the results may be affected by issues other than the marginal impact of the merger and acquisition. Event studies therefore fail to consider these other issues and as such one cannot rely completely on their results. On their part accounting studies fail to provide an explicit account of the cost of the acquisition, the time value of money or gains beyond a limited post-merger period (Bild and Guest, 2002).
Among the accounting-based studies, Healy et al. (1992) provide evidence based on an examination of 50 largest mergers in the U.S over the period 1979-1984 that the median cash flow return on assets of the merged or combined firm is 2.8% over a post-merger period of five years. Healy et al. (1997) extends the work of Healy et al. (1997) by examining 50 largest industrial takeovers over the same period. The evidence suggests that there are significant industry takeover premiums associated with mergers where the bidder company does not pay a bid premium. The merger premium however, becomes insignificant when a bid premium is paid. Dickerson et al. (1997) provide evidence that firms that do not engage in M&A activity tend to outperform those that engage in M&A activity. Ghosh (2001) based on a study of U.S mergers over the period 1981 to 1995 argues that there are no significant differences in sales growth and operating expenses between merged firms and unmerged firms in the same industry.
Having examined accounting based studies, the remainder of this section will focus on event studies that observe the behaviour of the stock price of target and bidder firms around the announcement period of the merger or acquisition. Cybo-Ottone and Murgria (2000) provide evidence based on a study of European Bank mergers that there is a statistically significant and economically relevant size-adjusted combined performance of both target and bidder banks. Cummins and Weiss (2004) analyse the wealth effects of bidder and target firm shareholders by examining a number of European mergers and acquisitions in the insurance industry. The evidence show that these mergers and acquisitions related to a small amount of negative cumulative average abnormal returns (CAARs) for bidders on average across various around the date of the merger and acquisition transaction. On the other hand the study observes that target firms exhibited substantially higher positive abnormal returns ranging from about 12% to 15% (Cummins and Weiss, 2004). The study is then broken down into cross-border and domestic mergers and acquisitions within the insurance industry. The evidence in this case shows that cross-border mergers and acquisitions had no impact on the shareholder value of bidders while domestic acquisitions resulted in significant negative abnormal returns to bidders. Target firm shareholders witnessed a significant increase in shareholder value for both domestic and cross-border mergers and acquisitions in the insurance industry. Despite post-merger benefits to targets for both domestic and cross-border mergers and acquisitions, the evidence further suggests that the gains to target firms of domestic mergers where in part off-set by the losses incurred by bidders (Cummins and Weiss, 2004). Song and Walking (2004) observe that bidders exhibit significant positive abnormal returns of 1 percent. Compa and Hernando (2004) observe that bidders in the regulated industry lose 1.96% over 60 days around the announcement of the takeover while bidders from unregulated industries witnessed an insignificant positive abnormal return. Ben-Amar and Andre (2006) provide evidence that acquiring firms earn 1.6% over a 3-day event window for a sample of Canadian mergers and acquisitions over the period 1998 to 2000.
Some studies have made a distinction between mergers and acquisitions of related and unrelated targets. For example, Singh (1984) provide evidence that more shareholder wealth is created in mergers and acquisitions involving related targets. However, Chatterjee (1986) provides contrary evidence suggesting that the post-merger benefits of unrelated targets are higher than those of related targets.
It can be observed that the evidence from both the accounting-based and event studies is mixed. Some suggest that mergers and acquisitions lead to the creation of shareholder wealth while some argue that mergers and acquisitions do not result in the creation of shareholder wealth. It is therefore difficult to conclude whether mergers and acquisitions actually result in the creation of shareholder wealth or not. However, most of the studies are inclined to concluding that mergers and acquisitions do not result in shareholder wealth creation. Consequently, this paper concludes based on these studies that mergers and acquisitions lead to the creation of shareholder wealth but only in a limited number of circumstances. Conclusions based on the results of accounting-based and event studies must however, be treated with caution taking into consideration the methodological issues associated with these studies. Consequently, there is a need for more adequate methods of studying the impact of mergers and acquisitions on shareholder value need to be developed.
3. Analysis of the Bell South Corporation by AT&T
In 2006, AT&T took over Bell South Corporation for a total consideration of $72, 671million. This paper will be looking at how the company has performed following the acquisition. This will be done by analysing its performance 2 years prior to the acquisition and 4 years following the acquisition. The merger was expected to generate substantial cost savings for the enlarged company (Lemon, 2006).
According to the company, cost savings of $2billion were expected two years following the merger owing to reduction in operational costs, consolidation of facilities as well as the combination of the IT operations of the two companies (Lemon, 2006). Earnings per share (EPS) were expected to witness double-digit growth over the first three years following the acquisition (Lemon, 2006). In addition, the revenue forecast for 2007 were revised upward as a result of the deal. In analysing whether the merger led to a creation or destruction of value, this paper will be looking at how a number of variables including revenue, profitability, operational costs, earnings per share and return on equity have performed over the past five years. The study will also consider 5 years prior to the merger and 4 years following the merger. Specifically, the study will be conducted over the period 2001 to 2010. 2001-2005 is considered the merger period while 2007-2010 is considered the post-merger period.
Appendix 1 illustrates a 10-year summary of key figures from the income statement of AT&T over the period 2001 to 2010. It can be observed that the sales revenue for AT&T more than doubled during this period. The company witnessed a growth in revenue from $43,528million in 2001 to $113,239million in 2010. Considering the pre-merger period 2001-2005, AT&T witnessed a decline in revenue from $43,528million in 2001 to $38,623million in 2005. The post-merger period 2006-2010 shows that revenue increased from $55,888million in 2006 to $113,239 in 2010. This shows that the merger might have had a positive impact on the revenue of AT&T. As earlier mentioned, one of the objectives of the merger was to realise an increase in revenue. It can be observed from appendix 1 that following the merger in 2006, revenue jumped from $55,888million in 2006 to $107,378million in 2007, representing an increase of 92.13 percent. Since 2007, revenue has maintained an upward trend as shown in figure 1 below. However, the growth in revenue has been gradual since the merger in 2006.
Another objective of the acquisition was to reduce operating costs over the next three years following the merger. The operating cost of AT&T has also more than doubled over the period 2001 to 2010. Operating cost moved from $33,550million in 2001 to $95,001million in 2010. During the pre-merger period 2001-2005, operating cost increased from $33,550million in 2001 to $32,905million in 2005. This was the case despite declining sales. This suggests that during the pre-merger period, the operating cost of AT&T did not change significantly. However, the corresponding sales figure declined over this period which suggests that operating costs were significantly high.
Looking at the post-merger period 2006-2010, one can observe that operating cost increased from $45,007million in 2006 to $95,001million in 2010. This somewhat suggests that the merger led to an increase in operating costs rather than to a decrease. However, there was a corresponding increase in sales revenue to cover this cost, which means that the cost can be justified on the grounds that it resulted in an increase in the corresponding figure for operating income. Immediately following the merger, operating cost increased from $45,007million in 2006 to $89,174million in 2007. This was followed by a corresponding increase in operating income from $10,881million in 2006 to $18,204million in 2007. Since 2007, operating cost has declined but not to its pre-merger level.
To a certain extent the objective of reducing operating cost was achieved as the increase in operating cost after the merger can be justified on the grounds that there were corresponding increases in sales revenue and operating income.
In order to determine whether shareholder wealth was created or destroyed following the merger, this paper conducts an analysis of the movement in net profit margin, earnings per share, return on equity (ROE) and return on assets (ROA) for the pre- and post-merger periods. Appendix 1 provides a 10-year summary of these figures. Figure 2 illustrates the movement in net profit margin, ROE and ROA while figure 3 illustrates the movement in EPS.
In can be observed that the net profit margin in 2001 is almost the same as net profit margin for 2010. Specifically, the respective figures for 2001 and 2010 were 15.3% and 15.4 percent. However, some changes have taken place within this period. Two phases can be observed in the movement of the net profit margin: a declining phase covering the period 2002 to 2008 and an increasing phase covering the period 2008 to 2010. During the pre-merger period, AT&T mainly witnessed a decline in its net profit margin. Following the merger, AT&T continued witnessing a decline in its net profit margin right up to the year 2008. The year 2008 appears to be the worst year for AT&T over the last decade. The company actually realised a net loss during 2008 which translated to a net profit margin of -2.1 percent.
Immediately following the acquisition, net profit margin declined gradually from 11.7 percent in 2006 to 10.0 percent in 2007. It then witnessed a drastic decline to -2.1 percent in 2008, jumped to 9.9 percent in 2009 and increased further to 15.40 percent in 2010.
The movements in the EPS, ROA and ROE were similar to that of the net profit margin over the period 2001 to 2010. The EPS in particular declined slightly immediately following the acquisition, declined drastically in 2008 and rose significantly in 2009 and 2010. AT&T targeted the increase in EPS as one of its objectives for the merger. The evidence suggests that this objective was achieved.
Overall, the evidence above suggests that the takeover resulted in the creation of wealth for AT&T’s shareholders. However, to draw conclusions, it is important to analyse a comparative company (a control company) which did not merge during this period to see if the results are similar or different. The company that has been chosen for this purpose is Verizon Communications Inc., which operates in the same industry as AT&T. The results for the control company are summarised in Appendix 2 and figures 4, 5 and 6 are used to analyse the performance of the company over the period 2001 to 2010 vis a vis that of AT&T.
It can be observed from figure 4 that Verizon Communications Inc. has maintained an upward trend in its sales revenue, operating cost and operating income throughout the period under investigation. Unlike AT&T the company has not witnessed a prolonged period of declining sales revenue or operating income. Like AT&T its operating income for 2008 was negative, which reflects the impact of the global financial crisis.
Looking at figure 5 it can be observed that Verizon Communications’ net profit margin, ROE and ROA have been more volatile compared to those of AT&T. Two clear phases can be observed in AT&T’s figures. This shows that the two companies did not perform the same during the period under investigation. As shown in figure 6 below, the EPS figure for Verizon Communications is also more volatile compared to that of AT&T. The post-merger period for Verizon Communications does not show any marked improvement in performance. However, AT&T shows significant improvement in performance after the merger. This suggests that a significant portion of the improvement in the performance of AT&T can be attributed to its takeover of South Bell Corporation. Only a small fraction can be attributed to industry dynamics.
It can therefore be concluded based on the foregoing analysis that AT&T created value for its shareholders as a result of its takeover of South Bell Corporation. Particularly, the takeover enabled the company to increase sales revenue, reduce relative operating costs and increase operating income. In addition, the company increased the takeover resulted in an increase in the earnings per share of AT&T which means that each individual shareholder benefited from an increase in his/her claim on the company’s assets.
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Appendix 1: AT&T, 10 Year Summary of Income Statement Extracts
Operating Costs ($Millions)
Operating Income ($Millions)
Total Net Income ($Millions)
Tax Rate (%)
Net Profit Margin (%)
Source: Source: MSN Money Central (2011) Available online at: http://moneycentral.msn.com/investor/invsub/results/compare.asp?Page=TenYearSummary&symbol=US%3aT [accessed: 13th December 2011].
Appendix 2: Verizon Communications Inc., 10 Year Summary of Income Statement Extracts
Operating Costs ($Millions)
Operating Income ($Millions)
Total Net Income ($Millions)
Tax Rate (%)
Net Profit Margin (%)
Bottom of Form
Source: MSN Money Central (2011) Available online at: http://moneycentral.msn.com/investor/invsub/results/compare.asp?Page=TenYearSummary&symbol=US%3aVZ [accessed: 13th December 2010].