The influence of the method of payment on the long-term firm performance in Dutch M&A

Transcription

1 Bachelor s Thesis Finance The influence of the method of payment on the long-term firm performance in Dutch M&A Author: Koen de Natris ANR: s Date: May 18, 2012 Supervisor: F. Urzúa

2 Table of Contents Introduction 3 Literature overview 4 Motives for M&A 6 M&A failure 8 Methods of payment 9 Theories 11 Empirical evidence 13 Empirical evidence for Europe and the Netherlands 14 Data description 15 Results 22 Conclusion 24 References 25 Appendices 28 2

3 Introduction Cash, shares, or a mixture of both can be the method of payment in mergers and acquisitions (M&A). Many studies have investigated what are the motives to choose for one of these payment forms. Eventually, the main reason for acquiring other firms is creating higher firm performance. In order to do so, every choice in the process of the M&A deal should be aligned to reach this goal. In this study I investigate the relation between the method of payment and the post-merger long-term firm s performance. I use a sample of Dutch M&A deals in which a Dutch acquiring company is involved. As most studies use the merged firm s stock price performance as an indicator of the firm s performance, I use four indicators to measure both operating and financial firm performance. The measurements are done one, two and three years after the completion year of the M&A deal. I chose these certain periods of time because of the nature of the dependent variables. Operating and financial performance will be observable in the first years after the M&A deal has been completed, not in the first months. There is little literature about equal relationships in the area of the Netherlands. Though, for Europe there is slightly more and this literature shows contradicting results. The results I find are in line with the results of Martynova et al. (2006) and indicate that there is no significant relationship between the methods of payment and the long-term firm performance. First I will present a literature overview about M&A in general and the methods of payment, followed by empirical evidence with respect to this topic. Then comes the data description, the results of my study and at last the conclusion. 3

4 Literature overview Mergers and Acquisitions Mergers and Acquisitions is the collective noun for all sort of corporate takeovers. Selling, buying, dividing and combining various firms to create a new entity with more capabilities than the sum of the separate firms involved. The difference between the two terms has been blurred in some literature, but it is important to indicate the differences later on. There are many different shapes in which M&A appear. The characteristics of the involved firms are essential in determining the M&A process. For instance, different methods of business valuation can be used, each giving other outcomes. Such factors make each M&A deal unique and therefore it is a complicated process, proven by the high number of M&A failures (de Man, Duysters. 2003). The number of M&A activities tends to be the greatest in periods of economic growth. In the last half of the 20 th century so called global merger waves appeared that are a result of a complex set of factors. Shleifer and Vishny (1991) found that the demand for conglomerate mergers in the 1960 s are closely related to antitrust laws initiated in the forgoing decade. Also industry-specific deregulations can be influential in urging a merger wave, for example those of the utility industry in 1992 (Jovanovic and Rousseau, 2004). The neoclassical hypothesis argues that merger waves occur as a reaction to certain shocks in their external environment (Martynova and Renneboog, 2008a). The behavioral hypothesis, based on the assumption of misvaluation of target firms, suggests that overvalued stock is used to buy assets of lower-valued firms. In order to cluster the M&A deals in waves, Shleifer and Vishny (2003) state that valuation indicators as price-to-earnings and market-to-stocks must increase at the same time. These firms with stock that is believed to be overvalued then search for target firms with undervalued stock. Depamphilis (2010) explains all sorts of mergers, consolidations, acquisitions and tender offers in his study as follows. From a legal perspective, a merger is a combination of two or more firms in which only one firm survives. The merged firm continues under the original name of the survivor. Typically, shareholders of the target firm first approve with the merger and consequently exchange their shares for shares of the acquiring firm. In a short form merger, the parent firm is primary shareholder in the subsidiary and the merger does not require approval of the parent s shareholders if the parent s ownership exceeds a legal minimum percentage. A statutory merger occurs when the acquiring firm 4

5 assumes the assets and liabilities of the target firm in accordance to the statutes. As the name reveals, a subsidiary merger is a merger in which the target becomes a subsidiary of the parent firm. Though, the target firm can still operate under its own name. A merger of equals is a relatively exclusive situation in which the involved firms are comparable in size, competitive position on the market, profitability, and market capitalization. This mostly happens when companies are closely related by their industry, since this makes it better to compare. The definition of a consolidation is often interchanged with that of a merger, but they are not equal. A statutory consolidation requires two or more companies joining to form a new company and during this formation the involved firms are dissolved. The difference with a merger is that one of the involved firms continues to exist. From an economic perspective mergers can be classified in three different forms. A horizontal merger occurs when firms within the same industry are combined. These mergers have a high potential to create operational synergies. This is also the case for vertical mergers in which companies choose to integrate close related operations in their value chain. Backward integration means integrating operations of the supplier and forward integration means integrating operations of a costumer firm or distributor. By definition an acquisition occurs when one company takes a controlling ownership interest in another firm. This can be a legal subsidiary of another company, as well as certain assets, for instance manufacturing facilities. Though, the acquired firm can continue to exist as a legally owned subsidiary. Depending on the receptiveness of the target s board and management to the idea and shareholders approval of a takeover, the takeover can be friendly or hostile. For gaining control, the acquiring firm must pay a purchase premium in addition to the current stock price. This premium reflects the perceived value of obtaining a controlling interest in the target firm. Most friendly negotiations result in a tender offer which is an offer to buy shares in another firm, using cash, securities of a mix of both. Such offers also appear when firms want to buy back their stock, which is called a self-tender offer. In case the target firm is not seeking for a merger, a tender offer can be done as well. This hostile tender offer is done by circumventing management by offering to buy shares directly from the target s shareholders, but also the public stock exchange makes it possible for the acquirer to buy target s shares. 5

6 Motives for M&A The reasons for M&A may differ and can therefore lead to vertical as well as horizontal integration. Not always cost reduction is the main reason, also an increase in market power or an excellent staff can be the driver of M&A. The most occurring motives for M&A are clarified below according to findings of DePamphilis (2010). Synergy is the added value of combining two or more businesses that perform a result that is larger than the sum of the individual performances. One type is operating synergy that consists of economies of scale and economies of scope. Economies of scale occur when a firm profits from fixed costs reductions per unit as a result of an increased production quantity. These fixed costs are fixed in the sense that they cannot be changed in short period of time. Also on the input side of the firm there are scale advantages, which are reflected in lower input prices of raw materials and bulk discounts. Economies of scope refers to the process in which fixed costs per unit are reduced by adding product lines to eventually divide fixed costs over a higher number of products. Skills and assets that are already firm s property are used to generate more revenue with different products. The fixed costs that are associated with this advantage will be found at the demand-side, for example marketing and distribution costs. Financial synergy refers to a lower cost of capital when combining firms. When the cash flows of the merged firms are uncorrelated, risk can be reduced by diversification which results in lower cost of capital. Combining companies with different amounts of excess cash and demand for cash, can create a valuable firm for taking on investment opportunities. Diversification occurs because of two perspectives. The first one is lowering the cost of capital and the second one is shifting from core product lines into product lines or markets with higher growth prospects. These shifts can be related as well as unrelated to the core products of the firm. Depamphilis (2010) finds that the highest returns are found in the related instead of the unrelated deals. Related firms are more likeable to have cost savings due to operating synergy. Changes in the external environment create M&A opportunities for firms that had not been possible before. Two sorts of changes, proven to be influential, are regulatory and technological changes. In industries subject to significant deregulation M&A has been centered (Mulherin and Boone, 2000). The artificial restrictions in the market that have extinct, stimulate competition. On the other hand, technological development created new opportunities to combine activities and businesses. One of the 6

7 largest technological changes in the last decades was the emergence of internet, which led to numerous M&A activities. Tax considerations are split up in two different parts. Tax benefits, consisting of loss carry forwards and investment tax credits are used to decrease the combined firm s taxable income. In addition to this, the additional tax shelter is created under certain accounting conditions and can also reduce the combined firm s future taxable income. As a more important part of the tax considerations, the taxable nature of the transaction is taken into account. The seller may view a tax-free status of the transaction as a prerequisite to continue the deal. Sometimes target shareholder s capital gains resulting from the transaction are allowed to be deferred. In case the transaction is taxed, compensation is demanded by the sellers in form of a higher purchase price. An increase in market share can in some industries mean a significant increase in market power. When two main market players and competitors decide to go together as one, they can gain such a strong position that they could beat other competitors using price leadership. Often policies on competition limit the ability of such firms to gain too much market power, in order to protect the market and the customers. 7

8 M&A failure The success of M&A deals depends on numerous factors. Not only the financial and legal processes are comprehensive, also the post-merger integration is a complicated process. Literature has come up with three main explanations why some M&A deals fail to meet expectations. Overestimation of synergy and therefore overpaying (Harper and Schneider, 2004), slow pace of post-merger integration (Carey and Ogden, 2004), and flawed strategy are a base of failure in M&A. Now the expected advantages of M&A have passed the review, there are several constraints to enlighten as well. For the bidder, a misvaluation of synergy can result in an overpayment, which is an incorrect price for the target firm. This is a negative point if we consider the theory of market efficiency. Besides that, hidden liabilities appearing after the deal may also hurt acquiring firms. Another market disturbance are firms that gain large market shares resulting in reduced competition and therefore reduced consumer choice in oligopoly markets. Next to economic disadvantages, there are also several disadvantages that concern firms staff. Because of synergy effects, the likelihood to downsize the firm s staff increases. Employees of the target firm can face motivation loss as a result of the corporate restructuring. Furthermore, clashing business cultures and cultural integration with new management can cause remarkable problems. This may lead to decreased employees efficiency or a despondent staff. Finally, Hennart and Reddy (1997) find a negative effect of M&A that involves the entire merged company. The advantages of knowledge exchange may be limited to only a small part of the company because of inefficient communication of this information. Besides that, the acquiring firm pays for all the knowledge of the target, even though it might not be required. Selecting knowledge to acquire is not possible, which causes indigestibility: a company may acquire more knowledge than it can use in a meaningful way. These reasons for M&A failure result from the study of Depamphilis (2010). 8

9 Methods of payment The payment methods in corporate takeovers consist of three basic methods: Cash payments, stock payments and a mixture of both. Martynova and Renneboog (2006) discover that 54% were all-cash, 25% were mixed and 20% were all-equity transactions, considering 1,721 European M&A deals in the time period 1993 until An average mixed payment consisted of 47% in stocks and 53% in cash. In an all-cash deal, the acquirer buys the target s shares or the target s assets with cash. During a period of decreasing interest rates it makes more sense to pay with cash. An advantage of cash payment is a lower probability of EPS dilution for the acquirer. On the other hand it places constraints on the cash flow so that there are not sufficient resources for other investment opportunities. The majority of tender offers use all-cash or a large fraction of cash in the mixture payment. Though cash deals may be relatively costly, bidders are forced to pay higher target premiums that compensate for the tax penalty. Eckbo and Langohr (1989) show that the premiums in all-cash deals are significantly higher than those in all-equity deals. The deal is taxable if target shareholders receive less than fifty percent of the deal in bidder stock. However, the higher premium for all-cash payment did already exist before the introduction on capital gains taxes. Toffanin (2005) finds that the well-know positive market reaction to all-cash bids requires the cash to have been financed either using internal funds (retained earnings) or borrowing. A prior equity issue for financing the all-cash acquisitions earns zero or negative abnormal returns. Cash offers lead to stronger improvements than takeovers involving other methods of payment (Linn and Switzer, 2001; Ghosh, 2001; Moeller and Schlingemann, 2004). A possible explanation is that cash deals are more likely to lead to the replacement of target management, which could result into performance improvement (Denis and Denis, 1995; Ghosh and Ruland, 1998; Parrino and Harris, 1999). Another explanation is that a cash payment is frequently financed with debt (Ghosh and Jain, 2000; Martynova and Renneboog, 2006). Jensen (1986) finds that the debt financing minimizes the scope for free cash flow problems and restricts the availability of corporate funds at the managers disposal. However, there is no empirical evidence to suggest that there is a significant relationship between the method of payment and post-merger operating performance (Healy et al. 1992; Powell and Stark, 2005; Heron and Lie, 2002; Sharma and Ho, 2002). 9

10 An all-stock payment is done by buying the target s stock with the acquirer s stock. In fact, it is a sort of stock exchange between the two companies. The majority of the merger bids are in the form of all-stock. Hansen (1987) predicts that acquirers of relatively large targets pay with equity in order to share the risk of the takeover with the target s shareholders. Although, stock offers are less likely to occur when the bidder has a relatively large total equity size or when the target undervalues the bidder s shares. When the bidder does an undervalued stock offer to the target, it might even get accepted in contrast to an undervalued cash offer. The cause of this is the ex-post value of the stock that is predicted to rise in the future. Stock payments are less likely to be found in taxable offers. For target firms, all-equity announcements on average cause a significant 1% bidder price drop, as an opposite of the nonnegative stock price reaction for private target firms. Moreover, the probability that the initial bidder wins the target is lower for all-stock offers than for cash offers (Betton, Eckbo and Thorburn, 2008). Mixed payments, as a combination of cash and stock carry parts of the advantages of both payment methods. There is no fixed proportion of both payment forms, so every proportion to create a mixed payment is possible. It is a popular method of payment and even during periods with peak market valuations when it is expected that all-stock payments dominate, this is found by Shleifer and Vishny (2003). Eckbo, Giammarino and Heinkel (1990) constructed a rational expectations model of the method of payment in the situation of two-sided information asymmetry and show that the fraction of the deal paid in cash signals the bidder s true value. In the best rational situation, the bidder pays targets shareholders with the correctly priced stock. Faccio and Masulis (2005) find that mixed payments can be explained by the structure of control and the acquirer s debt level. When there is a large shareholder with 20 60% of the capital of the bidding firm, there is a preference for a cash payment. Though, this is also influenced by the debt capacity and the existing leverage. Their final findings suggest that the decision on payment method is influenced by blockholder s desire to maintain the existing corporate governance structure as well. 10

11 Theories Literature gives an extended explanation about the payment methods in M&A. In general sense, this method is determined by tax considerations, the degree of information asymmetry, the degree of misvaluation, the degree of mispricing and corporate control considerations. Also the relative size and growth opportunities are relevant when choosing the method of payment. Asymmetric information The signaling hypothesis that was originated by Myers and Majluf (1984) suggests that the method of payment in M&A contains important information for the market. If the acquiring firm has information concerning its intrinsic value, which is not fully represented in the stock price before the acquisition, the management is placed in the position to finance the acquisition in most beneficial way for its existing shareholders (Travlos, 1987). This means that overvalued acquirers prefer to pay with stock and undervalued acquirers have more incentive to pay with cash. Particularly, cash financing is chosen when the acquirer s stock price is expected to have a favorable value in the future. On the other hand, stock financing is preferred by acquirers when the expected future stock price is assessed as lower. This is how the method of payment reveals information about the acquirer s future performance on the stock market. (Yang, Qu, Kim, 2009) Asymmetric information can be found at the target and the acquirer side at the same time. In the case of two-sided information asymmetry neither the acquirer nor the target knows the real value of other one s shares. The method of payment may cause information revelation about the true values. Next to that it can affect the division of synergy gains as well as the successfulness of the offer. When relatively uninformed target shareholders receive acquirer s bids, they may hedge against the possibility that the bidder s stock is overpriced, which causes a negative market reaction (Myers and Majluf, 1984). Stake of existing shareholders When the M&A deal is paid with shares instead of cash, the acquiring firm will issue stock to the owners of the target firm. The positions of the existing shareholders of the acquiring company will be damaged because their stake in the company dilutes. The fraction of ownership and thus the weight of their voting rights in the firm will diminish. Therefore shareholders do not prefer stock-for-stock as a method of payment. (Pardoel, 2011; Stulz, 1988) 11

12 Some bidder managements select cash over stock in order to avoid diluting their private benefits of control in the merged firm. Since this cash payment might be debt financed it raises the expected bankruptcy costs. Ghosh and Ruland (1998) find that bidder management shareholdings have negative effect on stock financing. These incentives to choose cash as payment form are stronger when there is a relatively concentrated share ownership structure in the bidder firm, such as blockholders. Martynova and Renneboog (2006) find a link between the quality of a country s corporate governance system and the market reaction to stock as payment form for acquisitions in Europe. In countries with greater levels of shareholder rights protection, all-stock offers are more likely to occur. Tax treatments Tax effects are one of the reasons why cash offers often pay higher premiums for target companies (Yang, Qu, Kim. 2009). Target firms tend to prefer cash offers with higher premiums. Also for the bidder, cash offers are advantageous since it is an effective corporate finance strategy to preempt a potential competing bidder. Due to the capital gains tax, shareholders of the target firm demand higher premiums for cash offers. In contrast to this, there is no capital gain tax liability when the deal is paid with equity since there are no immediate capital gains. The taxes on the gains of the shareholders are deferred to the moment they sell their shares (Franks et al., 1988). The higher premiums in cash offers can be seen as compensation for the unfavorable tax treatment. Relative size One of the two aspects that is only relevant for companies with financing constraints is the target size. According to Zhang (2001), the relative size of the two companies in the M&A process is an important determinant of the method of payment. In case the target firm is bigger in size than the acquirer, the acquiring firm needs to obtain additional funding. The likability that the deal is paid with stock instead of cash increases to the degree that the acquirer is larger than the target firm (Faccio and Masulis, 2005). Growth opportunities The second aspect is the existence of investment opportunities. When the bidding firm has a lot of growth and investment opportunities, it will seek to finance the transaction with shares instead of cash. This way the bidder preserves its cash position and is able to finance future investment opportunities necessary for growth (Pardoel, 2011). 12

13 Empirical evidence Literature about the relationship between the method of payment and firm performance mostly considers abnormal stock return as dependent variable. The results of this literature are contradicting. Uddin & Boateng (2009) find that acquisitions paid for with cash generate high bidder returns in contrast to acquisitions paid for with shares or a mix of shares and cash. These findings are generally supported by the majority of the literature about the relation between the method of payment and the postmerger firm performance. For instance, Moeller & Schlingemann (2004) and Schleifer & Vishny (2003) Fuller et al. (2002) and Martynova and Renneboog (2008) find the opposite in their study. Stock payment instead of cash payment leads to higher post-merger firm performance. Next to these two theories there is another theory that denies the existence of a significant relationship between the method of payment and the post-merger firm performance, which is confirmed by Powell and Strark (2005) and Slovin et al. (2005) In this thesis, the merged firm s stock performance is not considered, because the interest is in the relation between the method of payment and the operating and financial performance. In general, the literature on the topic post-merger operating performance is both contradictory and scarce. Whereas some studies find a significant improvement after an M&A deal (Healy et al. 1992), other studies find a significant decline in merged firm s operating performance (Kruse et al., 2002; Yeh and Hoshino, 2001; Clark and Ofek, 1994). Moreover, the majority of the studies concerning this topic find insignificant changes in operating performance, both negative and positive (Ghosh, 2001; Moeller and Schlingemnann, 2004; Sharma and Ho, 2002). Martynova et al. (2006) find that post-merger operating performance significant varies across M&A with different characteristics: hostile versus friendly bids, tender offers versus negotiated deals, and domestic versus cross-border M&A. Despite Gugler et al. (2003) discovered that for continental Europe there is significant decline in post-acquisition sales of the merged firm, the post-acquisition profit increase was found to be insignificant. The method of payment has shown to be not significantly related to post-merger firm s operating performance for European deals in the period (Martynova et al., 2006). This result is in line with previous studies (Healy et al., 1992; Powell and Stark, 2005; Heron and Lie, 2002; Sharma and Ho, 2002). 13

14 Empirical evidence for Europe and the Netherlands When it comes to M&A in relation to the method of payment in the Netherlands, little academic literature is found. Therefore it is difficult to conclude that the latter is also the case in the Netherlands to the same extent as it is in the United States and Europe, where most studies on this topic have been done. What we can conclude from Martynova and Renneboog (2008) is that the division of payment methods in M&A deals in Europe in the period is as follow: cash 62,8%, stock 19,0% and mix 18,2%. When these findings are compared to the percentages of the Netherlands, we can observe the following deviations: cash +25,4%, stock -12,3% and mix -13,1%. Stock payments, as well as mixed payments, seem to be unpopular compared to the European average. On the other hand, the percentage of cash payments is immensely higher. From this sample we can conclude that the division of the Method of Payment in M&A in the Netherlands is different from Europe. Possible reasons for the higher all-cash rate might be a higher number of blockholders or shareholders with a close relationship with the firm. 14

15 Data description The sample of Dutch M&A deals that were completed between 1996 and 2010 is selected from the Zephyr database of the company Bureau van Dijk. Only data about acquiring firms is included in this sample, since this is the focus of this study. The data were structured by the ISIN number, which is an identification code for firms. In addition to these ID codes, data like completion date, deal value, and deal number were collected. The accounting data then were added to the M&A deal data; these were collected from the ORBIS database, also of the company Bureau van Dijk. Again the ISIN number was used as identification code of the company, in order to use this as key variables when merging the two datasets. But since the accounting data were data of all Dutch listed companies, 72% of the data remained unmerged. Together with the 28% merged accounting data, this formed the population for doing T-tests with sample and populations means. The main focus of working with the data was in correctly merging the two datasets by the ISIN numbers and the completion date, which were translated into years because the financial data were indications of the fiscal year end. This process of creating a panel was essential for the study since the results are meaningless when this is done incorrectly. The requirements for the selected firms were that the acquirer was Dutch, so has a Dutch ISIN number. Acquiring companies that were included had to be listed and the deal had to be completed. If the deal took place between January 1997 and December 2010, and the deal was a merger or acquisition, these were included. Moreover, we excluded M&A deals in which a financial institution was involved. This selection resulted in a sample of 394 Dutch M&A deals. To control for omitted variables in the regression model, the control variables were included in the regression analyses. In order to prevent the results being driven by outliers, the control variables were winsorized if possible. To create a small overview of the proportions of payment methods in the Netherlands (NL) and Europe (EU), percentages of different samples of different time periods are shown in Table 1. The sample that is used in this study is NL Sample 1 and can easily be compared to NL Sample 2, which was used for the study of Martynova and Renneboog (2008), just like EU sample 2. NL Sample 1 shows several differences to the other Dutch sample for partly the same period. The proportion of cash payments is lower and therefore the proportions of shares payment and especially mixed payment are higher. Compared to the 15

16 proportions in the United States, Europe gives a better reflection of the proportions in the Netherlands. Although, the European mean proportions of the method of payment in EU sample 1, used in the study of Li et al. (2004) show large deviations for cash and mixed payments compared to NL sample 1. With few exceptions, the tendency that cash payment is the most popular M&A method of payment in the Netherlands is shown in Figure 1. 16

17 Table 1: Number of deals from samples in the Netherlands and Europe NL Sample 1 YEAR METHOD OF PAYMENT Total CASH SHARES MIX Total Period NL Sample 1 57,9% 13,5% 28,7% NL Sample 2 88,2% 5,9% 5,9% EU Sample 1 80,2% 11,3% 8,4% EU Sample 2 62,8% 18,2% 19,0% % 80% 60% 40% 20% 0% NL Sample 1: Method of Payment Cash Shares Mix Figure 1: Percentages of method of payment of NL Sample 1 17

18 Table 2: Summary statistics of control variables, including Z-scores CONTROL VARIABLES Total assets Method Obs Mean Std. Dev. Min Max Z- score Cash ** Shares ** Mix Cash flow over Assets Method Obs Mean Std. Dev. Min Max Z- score Cash Shares ** Mix ** Leverage Method Obs Mean Std. Dev. Min Max Z- score Cash * Shares * Mix * Sales growth Method Obs Mean Std. Dev. Min Max Z- score Cash Shares Mix Value Deal Method Obs Mean Std. Dev. Min Max Z- score Cash Shares Mix *Significant at confidence level of 95% **Significant at confidence level of 99% 18

19 Table 3: Summary statistics of Dependent variables, including Z-scores DEPENDENT VARIABLES EBITDA over Assets Method Obs Mean Std. Dev. Min Max Z- score Cash ** Shares ** Mix EBITDA over Sales Method Obs Mean Std. Dev. Min Max Z- score Cash ** Shares ** Mix ** Return on Capital Employed Method Obs Mean Std. Dev. Min Max Z- score Cash ** Shares * Mix Return on Shareholders' Funds Method Obs Mean Std. Dev. Min Max Z- score Cash ** Shares Mix *Significant at confidence level of 95% **Significant at confidence level of 99% Table 4: Overview of variables used in the regression models Variables Independent Control Dependent METHOD OF PAYMENT DUMMIES TOTAL ASSETS EBITDA / SALES CASH FLOW OVER TOTAL ASSETS EBITDA / ASSETS LEVERAGE RETURN ON CAPITAL EMPLOYED SALES GROWTH RETURN ON SHAREHOLDER FUNDS DEAL VALUE YEAR DUMMIES In this study I used the above variables. In the appendix there is an explanation of the content of the variables, or by with formulae they are calculated. 19

20 The Z-scores of the T-test that have been done indicate the significance of the differences between the means of the variables of the payment methods and of the population mean of that variable. For instance, this means that EBITDA over Assets for firms with cash payments is with 99% confidence significantly higher than the overall mean of EBITDA over Assets of all Dutch listed firms. In most studies, the definition of operating performance is the pre-tax operating cash flow, which is the sum of operating income, depreciation, interest expenses, and taxes (Healy et al., 1992; Ghosh, 2001; Heron and Lie, 2002). According to Martynova et al. (2006) the operating performance is measured by the EBITDA adjusted for the differences in size across firms. These adjustments are done by dividing the EBITDA by total assets and by sales. These values seem to be significantly higher for acquiring firms in M&A deals, compared to the mean value of Dutch listed firms. Firms that pay with a mix of cash and shares are an exception to this, their mean values show no significantly higher mean value for EBITDA over Assets, and show a significantly lower mean value for EBITDA over Sales as follows from Table 3. Two other dependent variables are added to measure merged firm s performance. The return on capital employed (ROCE) and the return on shareholders funds (ROSF). These measures are not a measure of operating performance, but are often a benchmark for stockholders to consider the firm s financial performance. The ROCE is computed by dividing the EBIT by the difference between total assets and current liabilities. The ratio indicates the efficiency and profitability of a company s capital investments. If the ROCE is not higher than the rate at which the firm borrows, it will reduce shareholders earnings. Acquiring firms that pay an M&A deal with cash or shares seem to have a significantly higher mean value of ROCE than the mean of Dutch listed firms. The ROSF is calculated by dividing net profit by the sum of share capital and all reserves. Like the ROCE it measures the efficiency and profitability of a company s capital investments. From the sample becomes clear that acquiring firms that pay M&A deals with cash have a significantly higher ROCE than the mean ROCE of the population. The effects of the method of payment on these dependent variables need to be controlled for other variables that might cause changes in these variables that measure firm performance. Classical control variables, such total assets, leverage, cash flow over assets, sales growth and year dummies are all included in the regression models. I follow the study of Erel et al. (2012) for computing these control variables and add the control variable value deal, in order to control for the size of the deal. However, the deal value of a small number of M&A deals is included in the sample. This causes the number of 20

21 observations in most regressions to decrease to 95 observations, which has decided me to exclude this control variable from the regression, but mention the coefficients as being conditional. This means, if the deal value is included in the regression, then the coefficient would have the following value. The mean of the control variable total assets seems to be significantly higher for acquiring firms that pay with cash, in contrast to those that pay with shares and are significantly lower as follows from Table 2. Again, this is compared to the mean of the total population. Almost a similar contrast is found for cash flow over assets, but then with a significantly higher mean for firms with shares payments en a significantly lower mean for firms with a mixed payment in M&A. Also remarkable are the significantly lower leverage means of all the payment forms. This implies that acquiring firms that are involved in M&A deals are less leveraged than the average leverage level of the population. Since cash payments are often financed with debt, this result is notable. The T-tests done the means of the control variable value deal are slightly different from the other T-tests. Logically, the total population of the deal value only consists of the sum of observations for the three payment forms. 21

22 Results The results of the regressions for all three methods of payment show majorly insignificant results. Moreover, most significant results that were found are the values of control variables. The regression tables can be found in the appendix. The effect of the method of payment on the dependent variable EBITDA over sales is for all three payment methods insignificant. The control variables that were included in the regression model are insignificant as well, except for the fixed effects of cash payment (t-1). The results of the univariate analyses correspond with the multivariate analyses and the R-squared is between 3-5%. This is a very low value of R-squared and therefore the models explain almost none of the changes in EBITDA over sales. The insignificant results show a complete consistency of the negative or positive signs of the variables. In the regression models of the dependent variable EBITDA over assets, two significant coefficient of the method of payment occur. It seems to be that shares payment (t-2) and (t-3) have a significant contradicting influence on EBITDA over assets. Whereas shares payment (t-2) is positively related to the dependent variable, shares payment (t-3) is negatively related. Other significant coefficients in the regression models are all control variables, such as total assets, sales growth and fixed effects. Total assets show for all payment methods and all univariate and multivariate regressions a significantly negative relation with the EBITDA over assets. Also the fixed effects are significant for all methods of payment in both univariate as multivariate regressions. Particularly in the multivariate regressions the coefficient of sales growth is consistently significant and shows a negative relationship with the EBITDA over assets. The R-squared of the regression models that try to explain changes in EBITDA over assets are between 8-10%, which is low. The changes in return on capital employed are scarcely explained by the regression models for all three methods of payment, resulting from R-squared values between 11-19%. Only few control variables seem to be significant, such as cash flow over assets, leverage and sales growth. Again, sales growth is negatively related and cash flow over assets and leverage are positively related to the dependent variable. The signs of the coefficients show consistency between the univariate and multivariate regressions for all control variables. 22

23 Concerning the return on shareholders funds, the regression models of the methods of payment show no significant coefficients, except for shares payment (t-3) and several control variables. The significantly negative coefficient of shares payment (t-3) shows a remarkable inconsistency with the sign of the insignificant coefficients of shares payment (t-1) and (t-2). The R-squared values for the univariate and multivariate regressions are between 9-13%, which is almost indifferent from the R-squared values of all other regression models. However, several control variables have significant coefficients, such as total assets, leverage and fixed effects. All these significant control variables have consistent signs when the univariate and multivariate regressions are compared. To summarize the significant coefficients of the independent variables, there are three cases in which shares payments have a significant influence on the dependent variables in univariate regression models: - Shares payment (t-2) has a positive relationship with EBITDA over assets - Shares payment (t-3) has a negative relationship with EBITDA over assets - Shares payment (t-3) has a negative relationship with ROSF The three significant coefficients of the independent variable shares payment also have contradicting signs depending on the number of years after the M&A deal. This suggests that there is not enough evidence to conclude there is a relationship between the method of payment and merged firm s performance. The results are in line with previous studies (Healy et al., 1992; Powell and Stark, 2005; Heron and Lie, 2002; Sharma and Ho, 2002). 23

24 Conclusion Most research on post-merger firm performance is done in the area of stock price performance. Therefore literature in other areas of post-merger performance is scare and inconsistent as well. As for the topic of the relation between the method of payment and firm performance, most research focuses on the United States, little research focuses on Europe and least research focuses on the Netherlands. In this study, the long-term profitability of 394 Dutch corporate takeovers completed between 1996 and 2010 were investigated, where the complete focus was on the acquiring companies and not the target companies. To measure the post-merger performance of the acquirer, four different measures were employed of which two measured the operating performance and two measured the financial performance. In this study I find there is a lack of evidence to suggest that there is a significant and consistent relationship between the method of payment and post-merger firm performance, both for operating as for financial performance. 24

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28 Appendices Variables used in the regression models Independent variables - Cash Payment Dummy: Value of 1 in case of cash payment, otherwise 0 - Shares Payment Dummy: Value of 1 in case of shares payment, otherwise 0 - Mixed Payment Dummy: Value of 1 in case of mixed payment, otherwise 0 Control Variables - Total assets: Natural logarithm of total assets (Winsorized) - Cash flow/ total assets: Cash flow divided by total assets (Winsorized) - Leverage: Sum of long term debt and current liabilities divided by total assets (Winsorized) - Sales growth: Sales (t) divided by sales (t-1) (Winsorized) - Deal value: Natural logarithm of value deal (Winsorized) - Year dummies: For each year in the period Dependent variables - EBITDA over assets: EBITDA divided by total assets - EBITDA over sales: EBITDA divided by total sales - Return on capital employed: EBIT divided by the difference between total assets and current liabilities - Return on shareholders funds: The sum of net profit after taxation and preference dividend by the sum of share capital and reserves 28