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CORPORATE FINANCE: EVENT STUDY
~{!0~}DOES SIZE MATTER~{!1~}
THE SIZE EFFECT OF ACQUIRING FIRMS ON RETURNS IN AN ACQUISITION
INTRODUCTION
In this paper, we examine the gains to shareholders of public firms that announce acquisitions of public firms from 2000 to 2004. Specifically, we examine if there is a size effect on the abnormal returns for shareholders of acquiring firms.
In the 20th century, there has been five periods of mergers and acquisitions waves in US economic history. These waves are periods of unusually high merger and acquisition activities. The last wave in 1990s was the largest of all due to the dollar value of transactions and the number of deals. There have been many academic researches done on these merger waves, and specifically the 1990s, providing insightful views, phenomenal and empirical data.
S.B. Moeller et al (2003) found that acquisition announcements in the latest merger waves were costly for acquirers~{!/~} shareholders. Acquisition announcements in the 1990s are profitable in the aggregate for acquiring firm shareholders until 1997, but there were huge losses in 1998 through 2001 that wiped out all gains made earlier.
There have been a number of explanations why the stock prices of firms announcing an acquisition can be negative. Roll (1986) hypothesized that managers of bidding firms may suffer from hubris, so they overpay. Travlos (1987) pointed out that firms with poor returns generally pay with equity. Mitchell et al (2004) showed that there is a price pressure effect on the stock price of the bidder for acquisitions paid for with equity due to the activities of arbitrageurs . In addition, the growth opportunities signalling hypothesis formalized that firms make acquisitions when they have exhausted their internal growth opportunities. It is possible that this strategy of growing through acquisitions is no longer sustainable nor creates as much value as before.
Recently, Dong et al. (2002) showed that firms with higher valuations have worse announcement returns. S.B. Moeller et al (2001) supported this stand by showing that small firms gain significantly when they announce acquisitions. In contrast, large firms experience significant shareholder wealth losses when they announce acquisitions of public firms. This disparity suggests the existence of a size effect in acquisition announcement returns. Subsequently, S.B. Moeller et al (2003) followed up with a study that the large losses of acquirers~{!/~} shareholders are the result of a small number of acquisition announcements with extremely large losses. Without the losses of these acquisitions, the wealth of acquirers~{!/~} shareholders would have increased.
In addition, there is a disparity between the target firm being public or private. S.B. Moeller et al (2001) found that on average, shareholders of acquiring companies benefit from acquisitions from 1980 to 2001. However, previous samples restricted to acquisitions of public companies report found that abnormal earnings of shareholders have statistically been insignificant or negative. Andrade et al (2001) reported insignificant negative abnormal returns from 1973 through 1998.
The paper adds to this large body research by examining the gains to acquirers~{!/~} shareholders as we moved into the new century. The paper investigates the trend of losses to acquiring firm shareholders of public companies that has continued in the first five years of the 21st century, from 2000 to 2004; specifically, if the