Mergers and acquisitions (Part six)
Scientific predictions of the Hubris Assumptions
The hubris hypothesis is predicated on the central premise (prediction) that the cumulative gain on takeover to share owners of the bidding and target firms is not positive.
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In the absence of any gains on takeovers, the hubris hypothesis suggests for an average increase in the market value of the target company, there should be a corresponding decrease in the bidding company’s value. The increase and decrease in the respective values of the target and bidding firms should more than offset each other, such that the aggregate loss in the takeover could only be traced to the expenses incurred in transaction.
Usually, the target company’s market value is expected to increase, following the announcement of unanticipated bids while the price is expected to decrease to the “original level or below if the first bid is unsuccessful and if no further bids are received” (Roll as cited in Thaler, 1993, p. 441).
The author notes that even though the movement of prices in the market may be ambiguous, the hubris hypothesis could be used to predict market price reactions in acquiring companies, if we could be certain that (a) there was an unanticipated bid and (b) that the only available information on acquiring property is its intentions to combine with the target company:
- The announcement of a bid would lead to a decrease in the market price of the bidding company.
- The market price of the bidding company would increase if it abandons or loses the bid.
- The market price of the bidding company would decrease if it wins the bid.
We will now discuss each of the above predictions in greater detail. Empirical studies conducted by financial experts such as Schipper and Thompson (1983) and Jensen and Ruback (1983) rebut Roll’s (as cited in Thaler, 1993) proposition that the market price reactions of bidding firms could be determined if the bid was not anticipated. Schipper and Thompson (1983) observe it may be difficult for an announced bid to be unanticipated.
Jensen and Ruback (1983) note that the existence of an unanticipated condition will complicate the computation of the transaction’s returns for the acquiring company. The authors conclude that in successful tender offers, the acquiring firms record excess positive returns of four per cent. T
he foregoing contradicts Roll’s (as cited in Thaler, 1993) third prediction that the bidding firm will witness a decrease in market value if it wins the bid. However, Roll (as cited in Thaler, 1993) argues that Jensen and Ruback’s (1983) findings were based on “smaller samples of matching pair” (p. 444), which makes generalisation for all bidding firms difficult.
Generally, the announcement of tender offers is interpreted by market participants to mean the bidder’s financial conditions are better than estimated, that the strong financial condition has culminated in the tender offer. By combining novel information and takeover, the acquiring firm would be able to transform a negative takeover into a positive one. Thus, it is not necessary for the bidding firm to provide additional information on its operations during the bid that is the information on its intentions to acquire the target suffices.
Jensen and Ruback (1983) share this sentiment. They observe that attempts by the acquiring company to provide information on its operations may be very problematic.
If the acquiring firm decides to abandon a previous tender offer, it may be interpreted by some market participants as its inability to raise the requisite funds to purchase the target. Others may attribute it to negative happenings in its internal operations. If the acquiring firm loses the bid to another competitor, it may imply that its economic resources are limited. These possible explanations suggest that available information on takeovers may be contaminated.
When the available information on merger is contaminated, it is quite difficult for financial experts to effectively explain the market price reactions of the acquiring firm, and the market price reactions of the combined companies. It could be argued that the market value of bidding firms could be affected negatively, if analysts are unable to obtain the required information to measure its market price movements.
The negative effect implies a decrease in the bidding firm’s market price. This statement is a contradiction of Roll’s (as cited in Thaler, 1993) second prediction that the market price of the acquiring firm would increase if it abandons or loses the bid. A typical example is the economic loss suffered by Gulf Oil following its withdrawal from Cities Service’s bid.
Roll’s (1986) first prediction states that the market value of the acquiring firm would decrease, following the announcement of a bid. Perhaps, Roll’s (1986) prediction is based on Malatesta’s (1983) statement which affirms; “The immediate impact of merger per se is positive and highly significant for acquired firms but larger in absolute value and negative for acquiring firms” (p. 155).
Malatesta (1983) observes that the performance of the acquiring firm prior to the takeover announcement is positive. Asquith (1983) finds out that significant proportion of takeover gains goes to the share owners of the target firm. The author also observed that the post-takeover announcement effect on the bidding firm is positive, but not significant.
On the contrary, Dodd’s (1980) findings show that on the announcement date, the bidding firm records a significant negative return. Dodd’s (1980) study focused essentially on the announcement date, and not beyond. A similar study conducted by Eger (1983) showed a decrease in value of the acquiring firm’s shares prior to and after the takeover announcement.
Although Schipper and Thompson (1983) found positive price movements for the bidding company, Ruback (1983) observed a slightly negative return for the bidding company after the takeover announcement.
Significant proportion of the existing literature seems to buttress Roll’s (as cited in Thaler, 1993) first prediction. Thus, it is more likely than not, that the bidding firm will witness a sharp decline in its market value after the announcement of a takeover.
The author believes strongly that in the absence of measurable gains from takeovers for bidding firms, the hubris hypothesis provides lucid explanations for the acquiring firm’s decision to finalise the transaction. Roll (1986) also asserts that target companies record perpetual growth in terms of market value only when they combine with bidding firms.