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In industry-wide acquisition waves, firms that buy first buy best, study finds

February 1, 2008

For more information, contact: Benjamin Haimowitz,

When its opening bid for Yahoo recently set Microsoft's stock tumbling, it hardly came as a surprise to market watchers: however unusual this particular deal may be, stock declines are usual for companies that announce their intention to buy another firm.
And why not? After all, according to one educated estimate, about three fourths of corporate acquisitions fail to create wealth for shareholders of the acquirer.
Now, though, a new study involving some 3,200 acquiring firms identifies a group that are striking exceptions to the typical pattern of stock declines. Research in the current issue of the Academy of Management Journal finds that companies that buy early in an industry-wide acquisition wave generally enjoy share-price rises. For those in the very forefront of the wave, the mean increase is more than 4% above what would be expected from the acquiring firm's past stock performance and from overall market trends in the three weeks following the intent-to-purchase announcement.
In contrast, companies that make their move later in an acquisition wave tend to suffer stock-price declines, with losses reaching an average low of about three percent at the two-thirds point of the wave.
The findings are highly pertinent because, research suggests, half or more of corporate acquisitions occur in waves. The new study is one of very few that have focused on industry-wide acquisition waves, when industries move from low levels of corporate buying to a flood of such transactions, both in numbers and value.
"Acquiring firms can benefit from early acquisitions, but often suffer from later acquisitions within an industry acquisition wave," conclude the new study's authors Gerry McNamara and Bernadine Johnson Dykes of Michigan State University and John Haleblian of the University of California, Riverside. The actual economic gain achieved by early movers, they continue, "is particularly impressive because [previous] researchers have concluded that, while target shareholders benefit from acquisitions, acquiring firm shareholders do not."
Adds McNamara: "Our findings suggest that the market rewards executives who perceive opportunities early, scan the environment for targets, and move before others in their industry. Conversely, the market severely punishes followers, those firms that merely imitate the moves of early participants in the wave, who jump on the acquisition bandwagon largely because of pressures created by competitors. Such companies typically lose significant stock value."
In addition to finding a big early-mover advantage, the research identifies several factors that enhance this benefit and that either cushion or exacerbate stock declines experienced by late movers.
One factor is how acquisitions are financed. Those "financed primarily with cash experience only a limited decline in their [stock] performance as the wave progresses," the study finds. "In contrast, when stock is used to finance acquisitions, acquiring firms experience more negative performance consequences as the wave pressures peak." Since the market is inclined to interpret stock-based purchases as a form of hedging, "managers should be cautious in undertaking acquisitions unless they are confident enough in their own information to finance the acquisition with cash," the study notes.
A second factor is what the authors call "market munificence" -- that is, to what extent a company's industry is enjoying a period of growth. Growing markets, the study finds, increase the early-mover advantage for acquirers, while in weaker markets it makes relatively little difference whether a firm moves early or late.
Still another factor is "market dynamism" -- the degree of  "technological uncertainty or discontinuities" in an industry. In more dynamic markets, such as those of high-tech industries, "there is some evidence firms do better acting later, possibly after some of the uncertainty within the market is reduced," the authors write.
Finally, the effect of being an early or late mover is moderated by whether a company is a serial acquirer. Companies that "undertake acquisitions on a regular basis as part of their core business routines" are less likely, the study finds, "to either seize early-mover benefits or suffer from the costs associated with bandwagon pressures." The result: "steadier acquisition performance over the entire wave."
The findings emerge from an analysis of the stock performance of 3,194 companies that purchased other firms during acquisition waves in their industries. Twelve highly diverse industries were chosen on the basis of heightened acquisition activity lasting up to six years during the period 1984-2004 -- semiconductors, trucking, warehouse and storage, wireless communications, telephone communications, radio broadcasting, grocery stores, motor vehicle sales, real estate management, hotels, computer-processing services, and information-retrieval services. For acquisition activity to be considered a wave, there had to be an "acquisition pattern in which the peak year had a greater than 100% increase from the first (or base) year followed by a decline in acquisition activity of greater than 50% from the peak year."
In analyzing stock performance of acquiring companies (all of which gained ownership of most or all the stock or assets of the target firms), the researchers "computed abnormal returns from five trading days before to 15 trading days after the announcement of the acquisition event." Abnormal returns were "calculated as the difference between the observed return for the security and the predicted, or normal, return for the same security," based on two factors -- the performance of acquirers' shares from 14 months to two months before an acquisition announcement and the movement of the market during the 5 trading days before and 15 trading days after the announcement.
While stock market responses to acquisition announcements don't invariably predict whether a merger will ultimately prove a success, the authors note that "a strong positive relationship has been found between abnormal stock returns at merger announcements and post-merger increases in operating cash flows... Thus, existing evidence on event study methodology's predictive validity is consistent with our assumption that abnormal returns are valid indicators of acquisition performance."
The new study, entitled "The Performance Implications of Participating in an Acquisition Wave: Early Mover Advantages, Bandwagon Effects, and the Moderating Influence of Industry Characteristics and Acquirer Tactics," is in the current (February/March) issue of the Academy of Management Journal.  This peer-reviewed publication, now in its 51st year, is published every other month by the academy, which, with more than 17,000 members in 102 countries, is the largest organization in the world devoted to management research and teaching. The academy's other publications are the Academy of Management Review, Academy of Management Perspectives, and Academy of Management Learning and Education.
Media Coverage:
Business Week. To merge or not?. (Monday, March 10, 2008).
Huffington Post. Secrets Revealed: The New York Times and Wall Street Journal Declare "Timing is Everything" in M&A. (Friday, February 29, 2008).
International Herald Tribune. To make a merger work, drive the bandwagon, study says. (Wednesday, February 27, 2008).
KnowledgeCurve. Timing Is Everything. (Wednesday, June 09, 2010). After the Deluge: A Good Time to Buy?. (Monday, May 19, 2008).
The New York Times. Mergers in a Time of Bears. (Tuesday, February 26, 2008).

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