The impact of merger outcome, bid order, payment method and managerial resistance on stock returns...

THE IMPACT OF MERGER OUTCOME,

BID ORDER, PAYMENT METHOD, AND

MANAGERIAL RESISTANCE ON STOCK

RETURNS TO BIDDERS IN

MULTIPLE-BIDDER MERGER CONTESTS

ZAHID IQBAL and SHEKAR SHETTY

ABSTRACT

Prior studies find that stock returns to bidders depend on merger outcome, bid order, payment method, and

managerial resistance. Using a sample of bidders in multiple-bidder merger contests, we find that these

variables are associated with one another. Significant associations between these variables imply that their

effects on bidders’ stock returns should be examined jointly. Our regression results indicate that only bid

order explains bidders’ stock returns in multiple bidder contests. This is true even after controlling for

merger outcome, payment method, and managerial resistance.

1. INTRODUCTION

Prior studies on corporate takeovers examine the impacts of merger outcome, (successful

vs. unsuccessful attempts), bid order (first vs. later bids), payment method (cash vs. stock

Direct all correspondence to: Zahid Iqbal, Department of Business Administration, School of Business, Texas Southern University, Houston, TX 77004; Shekar Shetty, School of Business, University of South Dakota, Vermillion, SD 57069-2390.

International Review of Economics and Finance, 4(l): 57-67 Copyright 0 1995 by JAI Press Inc.

ISSN: 1059-0560 All rights of reproduction in any form reserved.

57

ZAHID IQBAL and SHEKAR SHETTY

offers), and managerial resistance (target resisted vs. target unresisted bids) on the abnor-

mal stock returns to bidders. These studies generally observe the following: successful bidders outperform unsuccessful bidders, first bidders earn higher abnormal returns than late bidders, cash offers earn higher abnormal returns than stock offers, and unresisted bidders earn more than resisted bidders. While most studies examine the effects of these four variables separately, their joint effects on bidders’ stock returns are not known.’ A joint exam-

ination is required if the variables are associated with one another. The purpose of our research is to examine the joint effects of merger outcome, bid order,

payment method, and managerial resistance on the abnormal stock returns to bidders. In

order to examine the joint effects of these four variables, our study required a sample of bidders in multiple bidding contests only. This requirement enabled us to code the bidders based on merger outcome, bid order, payment method, and managerial resistance in our regression analysis. Our regression analyses indicate that bid order is the only significant determinant of stock returns to bidders in multiple bidder merger contests.

The next section discusses the predictable hypotheses on the effects of merger outcome, bid order, payment method, and managerial resistance on stock returns to bidders.

II. PREDICTABLE HYPOTHESIS

A. Merger Outcome

The question of how takeover gains to the shareholders are created is still debatable. The

“increased efficiency” argument proposes that corporate acquisitions are attempts by bidders to gain control of target resources and implement value-maximizing strategies. The value-maximizing strategies involve economies of scale, improved production techniques, increased market power, and so forth. Financial synergies such as reduction of variability in income streams and utilization of unused debt capacity may also result from acquisitions. The “redistribution” theory, on the other hand, argues that shareholder gains are

simply redistributions resulting from losses to others such as bondholders and employees. In their survey article, Jarrell, Brickley, and Netter (1988) conclude that the takeover gains are net synergistic gains and not simply wealth distributions.

The extent to which shareholders capture takeover gains are measured by abnormal stock returns that result from the acquisitions. Prior empirical findings suggest that target shareholders capture a majority of the acquisition gains, while bidders earn little, if any, returns. The stock returns to bidders depend, however, on the outcome of their bids. Empirical findings show that successful bidders earn higher abnormal returns than unsuccessful bidders2 Dodd and Ruback (1977) and Bradley (1980) observe positive abnormal returns for successful bidders and negative abnormal returns for unsuccessful bidders. Asquith (1983) finds that successful bidders earn insignificant abnormal returns, while unsuccessful bidders earn negative abnormal returns. In their studies of multiple-bidder contests, Bradley, Desai, and Kim (1983, 1988) observe that bidders earn normal returns if the bids are successful and earn negative abnormal returns if their bids are unsuccessful. Bradley, Desai, and Kim (1988), therefore, conclude that once a firm finds itself in a bidding war, it is bet- ter to win than lose. By failing to acquire the target resources in a bidding contest, the

Multiple-Bidder Merger Contests 59

unsuccessful bidder puts itself in a competitive disadvantage vis-a-vis the successful bidder.

B. Bid Order

The findings by Bradley, Desai, and Kim (1988) indicate that first-bidder acquirers earn positive abnormal returns and late-bidder acquirers earn negative abnormal returns at the announcement of tender offers. They conclude that late-bidder acquirers or white knights pay too much for their targets. In other words, they attribute the difference in stock returns between first bidders and late bidders to the takeover premiums offered to the targets. First bidders earn positive stock returns because they initiate the takeover process by offering a low premium which can make the offer a positive net present value project. The process continues as new (late) bidders enter the contest and bid up the offer price. Ruback (1983) argues that bidding firms can act irrationally by bidding too much for the target firms. The higher takeover premium offered by late-bidder acquirers apparently makes the takeover

attempt a negative net present value project.

C. Payment Method

The effect of payment method on bidder stock returns can be explained by a “signalling” hypothesis and a “tax-effect” hypothesis. The signalling hypothesis, proposed by DeAn- gelo, DeAngelo, and Rice (1984), suggests that the method of payment chosen by the bidder management represents its assessment of the true intrinsic value of the bidding firm. Under asymmetric information, a cash offer is made if the bidding firm is considered to be undervalued, whereas, a stock offer reflects the opposite. Consequently, a cash offer is expected to have a positive effect on bidder stock returns, while a stock offer will have a negative effect. The tax-effect hypothesis, on the other hand, proposes that bidders pay higher premium in cash offers than in stock offers. This is mainly because of the preferen-

tial tax treatment of stock offers over cash offers. Since cash offers are immediately taxable and stock offers are tax deferred, target shareholders demand higher premiums in cash offers than in stock offers. Therefore, bidders pay higher premiums in cash offers to com-

pensate the target shareholders for the unfavorable tax treatment. Because of the overpayment, the tax-effect hypothesis proposes that bidders would earn smaller returns in cash transactions than in stock transactions.

Of these two hypotheses proposed for the method of payment, empirical evidence lends support to the signalling hypothesis. Travlos (1987), Wansley, Lane, and Yang (1987), and Asquith, Bruner, and Mullins (1983) detect higher abnormal returns to bidding firms in cash transactions than in stock transactions.

D. Managerial Resistance

Resistance by the target management can be viewed as a form of competition to control the target firm. A resisted offer can mean that the target management intends to retain con-

60 ZAHID IQBAL and SHEKAR SHETTY

trol of the target resources. Therefore, managerial resistance is an undesirable obstacle that the bidder has to overcome to acquire target resources. According to Jarrell and Poulsen

(1989), resistance by the target management means additional costs to the bidders. These

costs may result from litigations and delays. The bidders may even pay higher premiums to

acquire the target resources. Managerial resistance can also affect the success of the acqui-

sition offer. Hoffmeister and Dyl(198 1) and Walkling (1985) find that opposition by target management impedes the success of tender offers.

The adverse effect of managerial resistance on bidder stock returns is evident in the study

by Jarrell and Poulsen (1989). Their findings indicate that bidders earn lower abnormal stock returns in resisted tender offers than in unresisted tender offers.

In light of the preceding discussion, the predictable hypotheses are stated as follows:

1. Abnormal stock returns to the bidders are higher in successful offers than in unsuc-

cessful offers. 2. Abnormal stock returns to the bidders are higher in first bids than in late bids. 3. Abnormal stock returns to the bidders are higher in cash offers than in stock offers. 4. Abnormal stock returns to the bidders are higher in unresisted offers than in

resisted offers.

III. SAMPLE DESCRIPTION

An initial sample of 119 merger contests with multiple bidders are collected from the Wall

Street Journal Index. The sample period spans 1976 to 1991. There are 248 bidders in this initial sample. Of the 248 firms, 190 are deleted for the following reasons:

1. Daily stock returns for 88 firms are not available on the CRSP tape for the period of investigation.

2. Information about payment method are not reported for 67 firms.3 3. We remove 35 firms because they have mixed form of payment. Only cash and

stock transactions are used in our study.

In the final sample of 58 bidders, there are 36 successful and 22 unsuccessful bidders; 22 are first bidders and 36 are late bidders. The late bidders enter a merger contest after the first bidders initiate it. The contest continues until all but the successful bidders withdraw

from the contest. There are 40 cash and 18 stock transactions. 16 merger proposals are resisted by target management and, thus 42 are unresisted. Information regarding managerial resistance comes from the articles in the Wall Street Journal. Typical phrases indicating

resistance are “spumed the offer,” “rejected the bid” etc. Table 1 provides chi-square tests of pair-wise associations between merger outcome, bid

order, payment method, and managerial resistance. Panel A indicates that most first bidders are unsuccessful and most late bidders are successful. All chi-square values are significant in Panel A. Panel B presents the findings on the association between merger outcome and

payment method. The chi-square test indicates that cash offers are mostly successful offers. Panel C shows that resisted offers are mostly unsuccessful and unresisted offer are mostly


Table 1. Chi-Square Tests of Association Between Merger Outcome, Bid Order, Payment Method, and Managerial Resistance for the Sample of 58 Bidders.

Panel A: Merger Outcome vs. Bid Oiler

First Late Total Chi-square

Successful

Unsuccessful

Total

Chi-square

Successful

Unsuccessful

Total

Chi-square

Successful

Unsuccessful

Total

Chi-square

6 30 36

16 6 22

22.00 36.00

4.56* 16.00**

Panel B: Merger outcome vs. payment method

Cash Stock Total

29 I 36

11 11 22

40 18

8.10** 0.89

Panel C: Merger outcome vs. managerial resistance

Resisted Unresisted Total

4 32 36

12 10 22

16 42

4.00* 11.52**

Panel D: Bid order vs. payment method

Cash Stock Total

16.00**

4.56*

Chi-square

13.44**

0.00

Chi-square

21.78**

0.18

Chi-square

First 15 I 22

Late 25 11 36

Total 40 18

Chi-square 2.50 0.89

Panel E: Bid order vs. managerial resistance


First 14 8 22

Late 2 34 36

Total 16 42

Chi-square 9.00** 16.10**

Panel F: Payment method vs. managerial resistance


Cash 11 29 40

Stock 5 13 18

Total 16 42

Chi-square 2.25 6.10*

Notes: *Significant at the five percent level. ‘*Significant at the one percent level.

2.91

5.44*

Chi-square

1.64

28.44**

Chi-square

8.10**

3.56

successful. This finding is consistent with the results of Hoffmeister and Dyl (198 1) and Walkling (1985) that managerial resistance can play an important role in the success of a takeover attempt. Panel D reports that late bids are mostly associated with cash offers.


Panel E indicates that target management resists first bids more frequently than later bids.

The late bids are mostly friendly. Finally, the chi-square tests in Panel F suggest that major-

ity of the cash offers are unresisted. The evidence presented in Table 1 suggests that the impact of the above-mentioned

determinants of bidder stock returns must be examined jointly. Significant associations

between them suggest that each must be examined by controlling for the others.

IV. METHODOLOGY

We employ event study methodology to measure abnormal stock returns to the bidders.

The prediction error (PE’J for Firmj on Day t is given by:

where Rjl is the return for Security j for Day t, R,,,* is the return on the CRSP equally

weighted index on Day t, and aj and “j are the estimated values of the market model param-

eters. A 1 go-day estimation period (trading day t = -200 through trading Day t = -2 1, with

t = 0 defined as the day of the merger announcement in the Wall Street Journal) is used to

estimate the market model parameters. For a sample of N firms, the cumulative average

prediction errors (CPE) from t = Tl to t = 72 is computed in the following way:

Following Mikkelson and Partch (1988), the statistical significance of CPET,,~ is given

by the following Z statistic:

(3)

where Sjr is the square root of the adjusted residual variance from the market model. The difference in CPEs between two portfolios (Portfolio 1 and Portfolio 2) is given by

the following Z statistic:

(4)

To measure the impact of merger outcome, bid order, payment method, and managerial

resistance on bidder stock returns, we use the following cross-sectional regression:

cpEj.TI T2 1 , = &, + p, MOj + &BOj + &PMj + &MRj + ej (5)

Multiple-Bidder Merger Ccntests 63

where

CPEj;n,n = cumulative average prediction error for Firmj from t=Tl to t=T2. MOj = dummy variable for the merger outcome. MOj=l for successful offers, 0

for unsuccessful offers. BOj = a dummy variable for the bid order. BOj=l for first bids, 0 for later bids. PMj = a dummy variable for the payment method. PMj=l for cash offers, 0 for

stock offers. MRj = a dummy variable for the managerial resistance. MRj=l for unresisted

offers, 0 for resisted offers. J$(O,..,4) = model parameters.

ej = model error term.

The signs of the model parameters should be interpreted in the following way. A positive l3, indicates that successful bidders earn higher abnormal stock returns than unsuccessful bidders; a positive 8, indicates that first bidders earn higher abnormal stock returns than late bidders; a positive B3 indicates that cash bids earn higher abnormal stock returnsthan stock bids; and a positive 84 indicates that unresisted bidders earn higher abnormal stock returns than resisted bidders.

v. EMPIRICAL FINDINGS

A. Abnormal Stock Returns

Table 2 presents the CPEs for the 58 bidders classified by merger outcome, bid order, payment method, and managerial resistance. The CPEs reported are for the periods, t = -1

tot=+landt=-lOtot=+5. The findings by the merger outcome indicate that the successful bidders exhibit a CPE of

-2.5 percent (Z-value = -4.70) from t = -1 to t = +I. Contrary to our predictable hypothesis, the difference in the CPEs of -1.8 percent (Z-value = -1.97) indicates that successful bidders earn less returns than unsuccessful bidders. In the interval t = -10 to t = +5, both successful and unsuccessful bidders suffer a significant wealth loss. The CPEs are -2.7 percent (Z-value = -2.15) for the successful bidders and -3.9 percent (Z-value = -2.49) for the unsuccessful bidders. The results are consistent with those of Dodd (1980) who finds that bidders generally earn negative stock returns.

Our results for the first and late bidders confirm those of Bradley, Desai, and Kim (1988). The first bidders earn normal stock returns, while the late bidders earn -2.9 percent (Z-value=-5.43) from t=-1 to t=+l and -3.5 percent (Z-value = -3.00) from t = -10 to t = +5. The difference in the CPEs indicates that the first bidders outperform the late bidders by 3.0 percent (Z-value = 3.53) from t = -1 to t = +l. These findings on bid order are consistent with the argument offered by Bradley, Desai, and Kim (1988) that the late bidders may offer too much for their targets.

The results on stock returns by the method of payment indicate that from t = -1 to t = + 1, the bidders suffer wealth loss in both cash and stock transactions. The CPEs are -1.2 percent (Z-value = -2.60) and -3.2 percent (Z-value = -4.07) for the cash and stock


Table 2. Cumulative Prediction Errors (CPE) for Selected Classifications of 58 Bidders from 1976 through 1991. t = 0 is the Day of the Merger Announcement.

Classification by Variables CPE-I,+I Z-value Cf’~%o,+, Z-value

Merger Outcome

Successful (N=36) -0.025 -4.70** 4.027 -2.15*

Unsuccessful (N=22) -0.007 -1.17 -0.039 -2.49*

Difference -0.018 -1.97* 0.012 0.64

Bid Order

First (N=22) 0.001 0.24 -0.025 -1.39

Late (N=36) -0.029 -5.43** -0.035 -3.00**

Difference 0.030 3.53** 0.010 1.10

Payment Method

Cash (N=40) -0.012 -2.60** a.024 -1.88

Stock (N=18) -0.032 -4.07** -0.047 -2.99**

Difference 0.020 1.93 0.023 1.44

Managerial Resistance

Unresisted (N=42) -0.018 -4.31** -0.033 -2.88**

Resisted (N=16) -0.017 -1.45 -0.028 -1.47

Difference -0.001 -1.03 -0.005 -0.26 _

Notes: *Significant at the five percent level. *‘Significant at the one percent level

transactions, respectively. From t = -10 to t = +5, cash transactions earn normal return, while stock transactions earn a CPE of -4.7 percent (Z-value = -2.99).

Finally, the findings on stock returns by managerial resistance indicate that unresisted bidders lose -1.8 percent (Z-value = -4.3 l), while resisted bidders earn normal returns from t = -1 to t = + 1. Similar results are also observed for the t = -10 to t = +5 interval. The unresisted bidders earn -3.3 percent (Z-value = -2.88), while the resisted bidders earn normal return. This contrast the results of Jarrell and Poulsen (1989) who find that bidders earn lower stock returns if the bid is resisted. The negative stock returns to unresisted bidders in our study may be because most unresisted bidders are late bidders in our sample.4

Overall, the findings on only bid order in Table 2 are consistent with our predictable hypothesis that the stock returns to first bidders are significantly higher than the stock returns to late bidders. However, little is known from these findings about the relative significance of merger outcome, bid order, payment method, and managerial resistance in explaining stock returns to bidders. The following subsection presents regression results that explain how these variables affect bidder stock returns.

B. Regression Results

Table 3 reports regression results for equation (5). Regression A utilizes the CPEs from t = -1 to t = +l as the dependent variable. Regression A reveals that of all four variables, only bid order is significant in explaining bidder stock returns. The first bidders earn 4.1 percent (t-statistic = 2.04) more return than the late bidders after controlling for merger outcome, bid order, and managerial resistance. We do not expect 131 to be significant because


Table 3. Regression Results. Model A uses CPEs from t=-1 to t=+l as the Dependent Variable. Model B uses CPEs from t = -10 to t=+5 as the Dependent Variable. Sample Size is 58 for both Models. The t-statistics are in parentneses.

Intercept* SuccessJ%l First Cash Unresisted

Regression JO Bl a J3 J4 F

A -0.066 -0.019 0.041 0.027 0.018 2.5 1 (-1.01) (2.04)** (1.67) (1.78)

B -0.061 0.019 0.02 1 0.016 -0.001 0.59

(0.79) (0.80) (0.79) (-0.03)

Notes: * The intercept term, 6, represents observations where the merger is unsuccessful, the bid is late, the method of payment is stock, and the merger proposal is resisted. **Significant at the five percent level.

the merger outcome is unknown in the announcement period. However, insignificantBS

andJ4 contrast the findings by Travlos (1987) and Jarrell and Poulsen (1989), respectively. Regression B reports the regression results for the CPEs from t = -10 to t = +5. None of

the coefficients are significant for this regression. The overall regression results in Table 3 reveal that bid order is the single most important

determinant of bidders’ stock returns in multiple bidder merger contests. Contrary to the

findings of prior research, our regression results show that merger outcome, payment

method, and managerial resistance do not explain bidder stock returns.

VI. SUMMARY AND CONCLUSION

This paper examines the associations between merger outcome, bid order, payment

method, and managerial resistance and their joint impacts on bidder stock returns in multi-

ple-bidder merger contests. Our evidence indicates that there are significant associations

between most of the determinants of bidder stock returns. We find that the target manage-

ment offers resistance mostly to first bids and that the resisted bids are mostly unsuccess-

ful. Late bidders are mostly unresisted and successful. We also find that most cash offers

are successful, but resisted. Stock offers, on the other hand, are unresisted. Our stock return results on bid order are consistent with our predictable hypothesis. We

find that the stock returns to first bidders are significantly higher than the late bidders. The regression results also indicate that bid order is the only variable that explains bidder

stock returns. This is true after controlling for the effects of merger outcome, payment

method, and managerial resistance. Contrary to the findings of prior studies, merger out-

come, payment method, and managerial resistance have little explanatory power.

NOTES

1. Jarrell and Poulsen (1989) examine relative size of targets and bidders, resistance

by the target management, and decades (time variable) to explain bidder stock returns.


Their analyses, however, do not focus on method of payment, bid order, and takeover out-

come; these variables can have significant influence on the stock returns to bidders. 2. Since the outcome of the proposed bid is uncertain at the day of the announcement,

abnormal returns by the outcome are generally examined over a longer interval. In most

cases, an interval from the announcement day through the outcome day is used. 3. The method of payment for the mergers is identified from various sources such as

the Wall Street Journal, the Standard and Poor’s Stock Report, and the Moody’s Industrial

Manual.

4. We compute the CPEs for the eight unresisted first bidders in our sample. The unre-

sisted first bidders earn normal returns of 1.7 percent (Z-value=0.60) from t=-1 to t=+l

and -2.6 percent (Z-value =-0.54) from t = -10 to t = +5. This indicates that only the

unresisted late bidders suffer wealth loss.

REFERENCES

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Economics, II, 51-83.

Asquith, P., Bruner, R. F., & Mullins, D. W. (1983). The gains to bidding firms from

merger. Journal of Financial Economics, II), 121-140. Bradley, M. (1980). Interfirm tender offers and the market for corporate Control. Journal

of Business, 53, 345-376.

Bradley, M., Desai, A., & Kim, E. H. (1983). The rationale behind inter-firm tender offers:

Information or synergy. Journal of Financial Economics, 11, 183-206. . (1988). Synergistic gains from corporate acquisitions and their division between

the stockholders of target and acquiring firms. Journal of Financial Economics, 21,

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DeAngelo, H., DeAngelo, L., & Rice, E. M. (1984). Going private: minority freezeouts

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Dodd, P. (1980). Merger proposals, management discretion and stockholder wealth.

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Dodd, P., & Ruback, R. (1977). Tender offers and shareholder returns: An empirical

analysis. Journal of Financial Economics, 5, 35 l-373. Hoffmeister, J. R., & Dyl, E. A. (1981). Predicting outcomes of cash tender offers.

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The empirical evidence since 1980. Journal of Economic Perspectives, 2,49-68. Jarrell, G. A., & Poulsen, A. B. (1989). The returns to acquiring firms in tender offers:

Evidence from three decades. Financial Management, 18, 12- 19. Mikkelson, W. H., & Partch, M. M. (1988). Withdrawn security offerings. Journal of

Financial and Quantitative Analysis, 23, 119- 134. Ruback, R. S. (1983). Assessing competition in the market for corporate acquisitions.

Journal of Financial Economics, 11, 141-153. Travlos, N. G. (1987). Corporate takeover bids, methods of payment, and bidding firms’

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Walkling, R. A. (1985). Predicting tender offer success: A logistic analysis. Journal of Financial and Quantitative Analysis, 20,461-478.

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