Int. Journal of Business Science and Applied Management, Volume 12, Issue 1, 2017

Porcelænshaven 24A, 2000 Frederiksberg, Denmark; Magnusson Law, Copenhagen

Tel: +45 20342652

Email: car.int@cbs.dk; caspar.rose@magussonlaw.com

Daniel Sørheim

Hammerstads gate 11, 0363 Oslo, Norway

Tel: +47 47858798

Email: Daniel.sorheim@gmail.com

Magnus Lerkerød

Abstract

The international literature on M&As is extensive, but surprisingly little evidence exists for the Nordic

countries. This article attempts to fill the gap by studying 184 merger announcements from 1995 to

2014. Our findings differ in a number of ways. “First, we extend the current literature since we find

that diversifying acquisitions” generate a higher bidder abnormal return compared with focused

transactions. A possible explanation is that in diversifying acquisitions acquirers overpay for target

firms within their core industry because they overestimate operational synergies. The managerial

current literature since we find that low-valued bidders with excessive free cash flows experience

negative returns prior to an announcement. Furthermore, our results imply that a bidder company must

be able convincingly to justify an acquisition to the market by communicating the presence of a sound

and coherent integration plan.

Keywords: M&A value creation, means of payment, free cash flow, diversifying acquisitions

Acknowledgement: We are grateful for comments by two anonymous referees.

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average, they found that M&A destroyed value for the shareholders of bidding companies. Accounting

for the gain of target shareholders, more than 56% of deals did in fact create value, implying that the

creation of value was mostly to the benefit of target shareholders.

Several scholars have investigated the performance of M&As, but the evidence on the Nordic

markets is scarce. In general, the results are not promising for the acquirer’s shareholders. Franks et al.

(1988) did not find any significant gains for shareholders in the UK. Similarly, Eckbo and Thorburn

(2000) found no significant abnormal returns when analyzing Canadian bidding firms. Mulherin and

Boone (2000) found slightly negative, but insignificant gains from M&A activity. In the US, Walker

(2000) documented an insignificant negative abnormal return when analyzing US deals between 1980

and 1996. More recently, Campa and Hernando (2004) reported zero cumulative abnormal return for

a large body of research on the topic of value creation from M&As.

This is quite reasonable as M&As have a large effect on both bidder and target. An M&A

transaction involves high risk and is a good example of the metaphor “double-edged sword” – there are

both large up and downsides of a transaction. Second, the research of M&As in the Nordic countries is

limited. However, the Nordic M&A market is growing and in 2014 reached its highest year since 2006.

Due to the lack of relevant literature in the Nordic region, it seems especially important to investigate

value creation and drivers arising in the growing M&A market in the Nordic countries.

According to neoclassic theory, the means of payment should not affect price reactions assuming

that all securities are correctly priced and that all relevant information fully incorporated by the market

participants. In practice, this will not be the case for a variety of reasons. Overall, the bidder’s choice of

for the Nordic countries.

This article is organized as follows. The following section includes a literature review. We

motivate a number of hypotheses regrading M&A-related value creation in section three. The data and

methodology are outlined in section four. We present our results in section five and our conclusion in

section six.

2 LITERATURE REVIEW

The evidence on value creation/destruction in relation to M&As is relatively substantial. Franks

and Harris (1988) found that on average acquisitions in the UK did not generate any significant

abnormal return for bidders. This evidence was also supported by Eckbo and Thorburn (2000) in their

study of Canadian bidding firms. For a sample of 138 acquirers, Mulherin and Boone (2000) found a

found evidence of a significantly positive, yet small, abnormal return of 0.97% when investigating 161

deals in the US in the period from 1963 to 1984. Goergen and Renneboog (2004) found evidence of a

statistically significant announcement effect of 0.7% for bidders when analyzing 228 European deals in

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the period from 1993to 2000. Ultimately, a common and consistent conclusion has not been reached

with regard to the benefits of M&As for the acquirers’ shareholders.

The relationship between the owners of listed firms and top management including the members

of the Board of Directors is characterized as a principal agency relationship. This means that top

management is acting on behalf of the principals and thereby the owners. However, with the

imperfect/inadequate? information available and the separation of ownership and control, agency costs

takeover premiums. Franks and Harris (1988) found that UK targets in the period between 1955

and1985 had a statistically significant average abnormal return of 23.3%.

By analyzing their sample of 138 US acquirers over a 9-year period (1990- 1999), Mulherin and

Boone (2000) found a 20.2% significant cumulated average abnormal return in a short period after

announcement. More recently, Goergen and Renneboog (2004) have documented that target firms in

large intra-European M&A deals experience a 9% surge in stock price in the event window.

It is in line with the principal agency theory that target shareholders benefit from a takeover

announcement since management may seek to optimize its own utility at the expense of the bidder

shareholders. Growth is an important element in the utility function of most CEOs where large

acquisitions may increase the status among peer CEOs. In theory, agency costs can be reduced by

referred to as the “signaling effect” as the company signals to the market that its equity might be

overvalued. Franks and Harris (1988) analyzed 2,500 US and UK-based acquisitions from 1955 to

1985 and made the following discoveries. In both countries, target shareholders were better off in terms

of short-term wealth gains from pure cash offers than from equity offers. For the bidding firm’s

shareholders in the UK, neither cash nor stock bids caused abnormal returns. In the US, the bidding

firms earned significant and positive abnormal returns in cash acquisitions. This effect was negative for

equity acquisitions. In a study of mergers and acquisitions in the US, Servaes (1991) found that both

targets and bidders achieve significantly positive abnormal returns when the transaction is financed

with cash and significantly lower abnormal returns when the transaction is financed with mixed funds.

Doukas et al. (2001) found evidence from the Swedish stock market that all-cash offers generated

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include both mergers and tender offers and classifies companies as valued either high or low using

industry averages of Tobin’s Q. Harford (1999) and Owen and Yawson (2010) control for differences

in required cash holdings by estimating cash reserves in firms. Consistent with the hypothesis, they

found that cash-rich firms are more likely to acquire companies and that these acquisitions are value

decreasing. Delcoure and Hunsader (2006) found that cash flow is only significantly negative for cash

offers in diversifying acquisitions.

(1986) described this as a desirable characteristic of leveraged buy-out candidates.

Merger waves and their typical characteristics are well documented in M&A literature, see e.g.

Alexandridis, Mavrovitis, & Travlos, (2011); Goergen & Renneboog (2004); Golbe & White (1993).

The characteristics of waves often differ. Whereas the third wave in the 1960s was seen as a wave of

conglomerate M&As, the fourth and fifth waves were characterized by divestitures and the focus on

core business. This discrepancy has motivated scholars to investigate whether focused or diversifying

acquisitions create the most value. When comparing diversifying M&As, the findings of Healy et al.

(1992) are relevant. They found that post-merger operating performance measured by cash flow

improvements was enhanced more in case of focused acquisitions, i.e. core acquisitions outperform

non-core. Doukas et al. (2001) studied Swedish acquisitions from 1980 to 1995 and found that

reaction upon announcement. There could be several advantages of performing foreign direct

investments in general and cross-border acquisitions in particular. The motives of cross-border

acquisitions can be to increase/protect one’s market share, increase geographical presence, acquire new

products/services orscale economies (Sudarsanam (2003). Nevertheless, there are also hurdles to

overcome that include differences in political and economic environment and differences in culture,

tradition, taxation and accounting.

Eckbo and Thorburn (2000) found that Canadian domestic bidders outperform US (foreign)

bidders when acquiring targets in Canada. However, in an American sample, Zenner and Hazelkorn

(2004) found that acquirers engaging in cross-border transactions are more successful than those

acquiring domestic targets. They attribute their findings to the possibility of broader geographic

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3 HYPOTHESES

Hypothesis 1.1. Bidder stock return zero upon announcement of acquisition.

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self-interested acquisitions that would otherwise be rejected if the company needed to raise capital

through the market. Alternatively, management may be overconfident rather than self-interested, which

may again result in value-decreasing acquisitions. When firms have extensive cash flows, management

should distribute cash to shareholders unless value-increasing projects are available. The reason is that

money invested in projects with expected returns below the cost of capital will yield a negative net

present value and should rather be invested individually by shareholders. However, as pointed out by

have the ability to outperform the market and that they are therefore able to turn negative NPV projects

into positive ones.

As they point out, executives tend to be especially disposed to overconfidence because of the

“better-than-average” effect. Managers will have engaged in and won multiple contests in order to

achieve their position. It might therefore be natural to believe that their success is only attributed to

skills, when most likely luck has affected the outcome as well. More relevant, the authors found that

investments of overconfident CEOs are significantly more responsive to cash flow. A second factor is

the wish to build an empire because of the personal value and motivation created when controlling a

large corporation. A third factor is the importance of each transaction for the firm combined with the

scrutiny of raising cash in the external market. If a firm is highly leveraged and has low cash flows, it

Hypothesis 3.3: Target cash flow will positively affect target abnormal return.

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3.4 Diversifying vs. focused M&A

When expanding the business through acquisitions, management can typically choose between

performing focused acquisitions where a bidder purchases a firm within the same industry, or perform a

diversifying acquisition where a bidder acquires a company operating in another industry. The core of

the discussion is synergies, which are supposed to rationalize conglomerates.

There are often two main ways to create value with diversifying acquisitions/conglomerates: (1)

hypothesis assumes that managers always act in the best interest of their shareholders. However, based

on the agency theory, they may indeed be maximizing private benefits. By diversifying the revenue

streams of the conglomerate, the variation in the revenue stream will decrease, which again will

decrease the risk of bankruptcy and therefore enable the company to increase leverage to benefit from

the tax shield. Alternatively, the company can transfer losses from one company to another profit-

making company to reduce taxes. Furthermore, the strategy perspective argues that by relocating

managerial talent within the conglomerate, value can be created. Nevertheless, the aforementioned

benefits may be difficult to quantify and thereby test. Although there are many theories supporting

value creation in conglomerates, the evidence is mixed. The most prevalent evidence against

conglomerates is probably the conglomerate discount. Most of the studies in the US on this subject

market as a whole and for the US. Focused acquisitions may increase operational synergies, expand

market shares and enhance the focus on core business, whereas diversifying acquisitions can benefit

from a more efficient internal capital market and potentially a more efficient use of talent. Because

there is limited empirical evidence of an improved internal capital market and because of the well-

known “conglomerate discount,” we expect greater synergies from focused acquisitions.

Specifically, following several findings, see e.g. Delcoure & Hunsader (2006); Doukas et al.,

(2001); Goergen & Renneboog (2004); Healy et al. (1992); Martynova & Renneboog (2006), we

investigate whether diversifying acquisitions are value deteriorating. The majority of these articles

found a negative effect of acquiring non-core companies.

This suggests that core acquisitions increase the focus on core operations, while diversifying

Hypothesis 4.1. Focused acquisitions cause higher bidder returns than diversifying acquisitions.

previous hypothesis, and from research on this specific topic, we hypothesize that targets should gain

the most when being acquired by a related acquirer. The intuition is that a bidder believes higher

synergies can be created from a core acquisition. This, in turn, should result in a higher premium paid

for the target, which leads to the following hypothesis:

Hypothesis 4.2. Focused acquisitions cause higher target returns than diversifying acquisitions.

3.5 Cross-border transactions

The next two hypotheses are based on foreign direct investment theory and findings from M&A

literature. Zenner and Hazelkorn (2004) found that cross-border acquisitions enhance abnormal return

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The Nordic countries differ slightly. While Denmark, Finland, and Sweden are members of the

European Union (EU), Norway and Iceland are part of the EU economic EEA agreement. Finland has

adopted the currency of the EU; the other Nordic countries still use their local currencies. However, the

similarities will not give rise to any locational advantages, such as access to cheaper labor or

production facilities. Furthermore, there are clear differences amongst the Nordic countries, most

prevalent among them their languages, cultures and traditions. This can complicate the integration

to optimize tax systems and exploit favorable exchange rate movements by moving operations into

other countries or by acquiring foreign firms may favor cross border transactions.

On the other hand, by acquiring a company in another geographical area, the bidding firm exposes

itself to another legal system including different taxation and accounting principles, differences in

political and economic environments and a new market for the domestic investors to analyze.

We believe that barriers related to integration will outweigh the potential benefits, leading us to

hypothesis 5.1.:

Hypothesis 5.1. Bidder returns are lower in cross-border acquisitions.

Due to lack of conclusive evidence regarding the target’s price reaction to foreign versus domestic

acquisition plans, and because we expect cross-border acquisitions to affect bidder’s abnormal returns

negatively, we have similar expectations in respect of the target’s abnormal returns. Goergen and

Renneboog (2004) found that premiums are higher for domestic than for foreign acquisitions. We

believe that the market anticipates integration issues to arise in cross-border deals and therefore state

hypothesis 5.2:

Hypothesis 5.2. Target returns are lower in cross-border acquisitions.

3.6 Value vs. growth

In behavioral finance, the performance of value and growth companies has been extensively

investigated. Fama & French (1992) pioneered the studies when they empirically tested the renowned

free cash flows instead of paying out dividends.

On the contrary, value companies are defined to have low market-to-book ratios, and pay out large

dividends rather than reinvesting in new projects. An important implication is the fact that growth

companies have several positive NPV projects available and value companies have few.

Despite the logic that the acquisition of growth firms creates higher abnormal return for bidders,

Rau & Vermaelen (1998) showed that acquisitions of firms with low market-to-book ratios generate a

high abnormal return of 12% for bidding shareholders. They also found that firms with high market-to-

book ratio generate substantial negative abnormal return for bidders. Goergen and Renneboog (2004)

supported this research by finding that a high market-to-book ratio for targets leads to a negative

abnormal return for the bidding firms. Lastly, Zenner and Hazelkorn (2004) provided evidence

suggesting that bidder returns were higher when the target had low projected earnings growth rates.

value companies rather than growth companies. Value companies are in mature industries, so synergy

effects can be easier to collect than for growth companies.

Acquisitions are often the only way mature companies can create growth, as they find it hard to

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Georgen and Renneboog (2004) argue that the market is anxious that acquirers do in fact overpay

for such growth options. Thus, based on the result of the previous research, we form hypothesis 6.1:

about M&A deals. First, we apply five criteria affecting what data to collect from the chosen database

in order to obtain a gross sample. Secondly, we apply five additional criteria that are important for the

1) Both bidder and target have to be publicly listed

2) Both bidder and target have to be listed on one of the Nordic stock exchanges

3) The deal has to be completed

4) The deal must have been announced between 1 January 1995 and 31 December2014

5) The transaction has to be classified as either a merger or an acquisition

Both the bidder and the target have to be listed on one of the Nordic stock exchanges, ensuring

that the sample include only Nordic companies. The focus on Nordic countries is motivated by

customized to match our methodology and requirements. Thus, we had to filter and sort the data

manually. The additional criteria are as follows:

6) The acquisition had to result in the bidding firm owning a majority share of the target

7) Stock prices had to be available for ~200 days prior to the announcement and at least ~10 days

8) The stock price had to be traded at least 2/3 of the days in the ~200 days period prior to

proxy for full control of the company. In order to include the deal, the initial stockholding could not

surpass 49.9% and the final stockholding had to exceed 50%. Thus, we choose not to look at dual class

shares. As we are looking at the market reaction in our event study, we assume that the market reacts

equally when an investor acquires a majority set of A, B or both shares, and we therefore emphasize

that not accounting for dual class share will not affect our data.

Moreover, thin trading occurs if the stocks in the sample are traded infrequently so that the relative

return approaches zero. These illiquid stocks belong to small and more risky companies. The problem

with thin trading is that one will observe less risk in these illiquid and small stocks as their covariance

with the market return is very low. Consequently, their beta will be close to zero indicating low risk,

when it might be the opposite. An inaccurately low beta value will cause expected return to be lower

and thereby provide an incorrectly high abnormal return. There are different ways of adjusting for this.

new type of beta through running OLS beta estimates for securities more thinly traded than the market

index. The model accounts for nonsynchronous trading. Later, Cowan & Sergeant (1996) found that the

previously found correction for nonsynchronous trading provides no significant benefit in coping with