The impact of Mergers and Acquisitions on Corporate Financial Performance in India
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Transcript of The impact of Mergers and Acquisitions on Corporate Financial Performance in India
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5/27/2018 The impact of Mergers and Acquisitions on Corporate Financial Performanc...
http:///reader/full/the-impact-of-mergers-and-acquisitions-on-corporate-financial
IJRMBSS I ISSN No. : 2319-6998 I Vol. 1 I Issue 2 I July. 2013------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ Indian Journal of Research in Management, Business and Social Sciences (IJRMBSS) 13
The impact of Mergers and Acquisitions onCorporate Financial Performance in India
Dr. K. B. Singh 1
Abstract- Mergers & Acquisitions (M&A), as a corporate
restructuring activity in India has exhibited explosive growth
in recent years and has become an important corporate
strategy in the financial and economic environment all over
the world. Since 1991, Indian industries have been
increasingly exposed to both domestic and international
competition. The Indian economy has undergone a major
transformation and structural change following the economicreforms, size and competence have become the focus of
business enterprises in India. Hence, in recent times,
companies have started restructuring their operations
around their core business activities through (M&A). M&A
is a tool used by companies for the purpose of expanding
their operations often aiming at an increase of their long
term profitability (Seth, 1990). Even though M&A have been
an important element of corporate strategy all over the globe
for several decades, research on M&As has not been able to
provide conclusive evidence on whether they enhance
efficiency or destroy wealth. Therefore M&A related issues
have drawn considerable interest from practitioners and
academicians across the globe. Researchers (Yook, 2004;
Dickerson, Gibson, & Tsakalotos, 1997; Paulter, 2003;
Cochran & Wood, 1984) have documented that there are twomain streams in the existing post-acquisition performance
literature. One is the stock market approach which uses stock
market valuation to determine post-acquisition performance
(Paulter, 2003; King, Dalton, Daily, & Covin, 2004), and the
other is the accounting data approach which directly focuses on
a companys profitability through accounting and cash flow
ratios (Healy, Palepu, & Ruback, 1992; Ghosh 2001). Our
study uses long-term pre- and post-merger financial data to
assess firm operating performance. According to Bromiley
(1986), in many cases, accounting performance measures are
better than market-based measures because they are used more
frequently by managers to make strategic decisions. A sample
of 20 pair of public listed companies which have undergone
M&A during 2005 were taken for analysis. We use averages
of the financial ratios data of three years prior to (Pre-merger)and three year subsequent to the merger (Post-merger). These
ratios were compared and tested for any statistical significant
difference, using paired t test. The study found that there
was a long-term improvement in financial performance of
merging companies. Thus we conclude that mergers and
acquisitions is an effective methods of corporate
restructuring, and should become an integral part of the
long-term business strategy of corporates in India.
Key words: Mergers and acquisitions; M&A; takeovers;corporate fi nancial perf ormance; I ndia.
I. INTRODUCTION
Over the last two decades, Mergers and Acquisitions
(M&A)-related issues have drawn considerable interest from
practitioners and academicians. As a result, scores of
empirical studies have documented various aspects of M&A
activity, including trends in such M&A activities,
characteristics of the transactions, and corresponding gainsor losses to shareholders. While the majority of the existing
empirical evidences focus on the stock returns surrounding
the announcement dates, a smaller body of research has
examined the long-run post-acquisition stock returns and
operating performance.
In Indian industry, the pace for mergers and acquisitions
activity picked up in response to various economic reforms
introduced by the Government of India since 1991, in its
move towards liberalization and globalization. The Indian
economy has undergone a major transformation and
structural change following the economic reforms, and size
and competence" have become the focus of business
enterprises in India. Indian companies realised the need togrow and expand in businesses that they understood well, to
face growing competition; several leading corporates have
undertaken restructuring exercises to sell off non-core
businesses, and to create stronger presence in their core areas
of business interest. Mergers and acquisitions emerged as
one of the most effective methods of such corporate
restructuring, and became an integral part of the long-term
business strategy of corporates in India.
A survey among Indian corporate managers in 2006 by
Grant Thornton found that Mergers & Acquisitions are a
significant form of business strategy today for Indian
Corporates. The three main objectives behind any M&A
transaction, for corporates today were found to be: Improving Revenues and Profitability
Faster growth in scale and quicker time to market
Acquisition of new technology or competence
Table 1: Objectives of Indian Corporates for M&As
Objective behind the M&A
Transaction
Responses (in
%)
o improve revenue & Profitability
Faster growth in scale and quicker
ime to market
cquisition of new technology or
competence
o eliminate competition & increase
33%
28%
22%
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5/27/2018 The impact of Mergers and Acquisitions on Corporate Financial Performanc...
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IJRMBSS I ISSN No. : 2319-6998 I Vol. 1 I Issue 2 I July. 2013------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ Indian Journal of Research in Management, Business and Social Sciences (IJRMBSS) 14
market share
Tax shields & Investment savings
11%
3%Source: Grant Thornton (India), The M&A and Private
Equity Scenario, 2006
This paper examines the long-term operating performance of
Indian acquiring firms. Most of the prior studies focus on
the industrial developed nation such as US and UK
acquisition markets, where most of the M&A deals take
place. Indian M&A market is also considerably large and
vibrant; hence the present study focuses on the Indian
market.
II. OBJECTIVES
1.To analyzes the profitability of merged companies by
comparing key financial ratios during pre and postmerging year.
2.To analyze the change in financial leverage due to M&A.
III. RESEARCH METHODOLOGY
Sample -List of companies involved in mergers during the
year 2005 were compiled from Capitaline and Prowess
database and the same was cross-checked from the websites
of BSE and NSE (for names of name changes and delisted
companies). To such a list, the screening criteria were
applied to arrive at the final sample. These criteria were -
merger cases, where at least two years of data were not
available for pre-merger period and at least four years data
for post-merger period, were removed from the study
sample. Also companies where the target or acquirer were aforeign listed company was omitted and those acquirers
which went for multiple mergers were also removed. The
final sample size for the study was 20 public listed
companies from a total of 58 companies which have
undergone M&A during the period of the study.
We have taken sample firms of the year 2005, as the long-
term financial performance is tested for 3 years post mergers
and abnormal economic time period of recession starting
year 2008 is avoided.
Research Hypotheses: To test the objectives mentioned
above, the following hypotheses were formulated:
(i) H0: Mergers in India have no impact on the operating
performance of acquiring firms.
H1: Mergers in India have impact on the operating
performance of acquiring firms.
(ii) H0: Mergers in India have no impact on financial
leverage of acquiring firms.
H2:Mergers in India have impact on financial leverage of
acquiring firms.
We have adopted the methodology of comparing pre- and
post-merger performances of acquiring companies, using the
following financial ratios:
Operating Profit Margin (Profit Before Depreciation,
Interest and Tax/Net Sales)
Gross Profit Margin (Profit before Interest and Tax/Net
Sales) Net Profit Margin (Profit after Tax/Net Sales)
Return on Networth (Profit after Tax/Networth)
Return on Capital Employed (Profit before Interest and
Tax (PBIT)/Capital Employed)
Debt-equity Ratio (Book value of Debt/Book value of
Equity)
The pre-merger (for three years prior to merger) and post-
merger (for three years after the merger) averages of the
above financial ratios were compared and tested for
differences, using paired `t' test for two samples. The
observations of each pair of firms in the sample are not
independent, since the acquiring firm retains its identitybefore and after merger. Therefore, paired `t' test was
considered appropriate to measure merger induced operating
performance changes. Year of completion of merger,
denoted as year 0, has been excluded from estimation. The
pre-merger calculation has been done for both the acquired
and the acquirer for the period (-3 to -1) years and it is the
sum of their operating ratios for each year. Post the merger,
the operating ratios for the combined firm were taken for
(+1 to +3) years.
IV. LITERATURE REVIEW
There is a substantial body of literature that examines the
performance of M&A deals both for the acquiring firms and
target firms. There are generally three approaches followedin the literature for examining the performance of M&A
transactions. The most common approach is the
investigation of gains and losses to shareholders around the
deal announcement date. Evidence shows that target
shareholders generally earn significantly positive abnormal
returns (AR) but the acquirers' shareholders earn, on an
average, a zero abnormal return at the acquisition's
announcement, but considerable variation exists in these
results (Andrade et al., 2001; Fulleret al.,2002; and Bruner,
2002).
Most of these long-term studies conclude that the acquiring
firms experience significant negative abnormal returns over
one to three years after the merger (Agrawal et al., 1992;Gregory, 1997; Agrawal and Jaffe, 2000; and Andrade et al.,
2001).
Most of the US based studies either report an improvement
in operating performance (Linn and Switzer, 2001; and
Heron and Lie, 2002), or an unchanged performance
(Moeller and Schlingemann, 2005). Results from the studies
on other markets are also inconsistent. Sharma and Ho
(2002) find insignificant changes in acquirers' post-
acquisition operating performance for Australian firms.
Asian studies also present inconsistent results (Sharma and
Ho, 2002; and Rahman and Limmack, 2004). Rahman and
Limmak (2004) show that operating performance improves
significantly for Malaysian acquirer.
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IJRMBSS I ISSN No. : 2319-6998 I Vol. 1 I Issue 2 I July. 2013------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ Indian Journal of Research in Management, Business and Social Sciences (IJRMBSS) 15
V. RESULTS AND INTERPRETATION
Table 2: Mean pre-merger and post-merger ratios formerging firms
Financial
Ratios
Pre-
merger
(3 yrs
before)
mean
Post-
merger
(3 yrs
after)
mean
t-stat
(paired)
P-value
(2-
tailed)
Operating
profit margin
Gross Profit
Margin
Net Profit
Margin
Return onNet worth
Return on
Capital
Employed
Debt-Equity
Ratio
21.385
19.447
15.455
21.247
20.24
1.685
23.225
17.658
18.584
24.541
21.65
2.422
1.211
1.023
2.115
2.682
3.457
2.314
0.231*
0.514**
0.034*
0.018*
0.076*
0.009*
Source:Authors calculation from Prowess.
*Significant at 5% significance level
**Not significant at 5% significance level
The comparison of the pre-merger and post-merger
operating performance ratios for the entire sample set of
mergers showed that there was an increase in the meanoperating profit margin (21.385% to 23.225%), but the
decline was not statistically significant (t-statistic value of
1.211). Similarly there was an increase in net profit margin
(15.455% to 18.584%), return on Net worth (21.247% to
24.541%) and return on capital employed (20.24% to
21.65%) and these increase are statistically significant (t-
statistic values of 2.115, 2.682 and 3.457 respectively).
However gross profit margin (19.447% to 17.658%)
declined the decline was not statistically significant in the
post-merger period (t-statistic values of 1.023). There was a
marginal but statistically significant increase in leverage
after the merger (1.685 vs. 2.422), confirmed by the high t-
value of 2.314.The results suggest that operating financial performance of
all mergers in the sample from Indian industry had increased
following mergers, as there was a increase in both the
profitability ratios and returns on net worth and invested
capital. The results are comparable to those obtained by
Ramakrishanan (2007) who found that most mergers during
1995-2005 in India have resulted in improving operational
efficiencies. The results above also agree with the results of
research studies in USA and Europe on operating
performance of acquiring firms - that the operating
performance of acquiring firms had either stagnated or
declined after mergers.
Based on the results of the analysis, the alternate hypothesisH1: Mergers in I ndia have impact on the operating
perf ormance of acquir ing fi rms isaccepted, since mergers
were found to positively impact the performance in terms ofboth profitability and returns on investment.
However, the analysis of debt-equity ratios suggest that
during post merger period leverage has increased and this
increase has been statistically significant. Therefore the
alternate hypothesis H2: Mergers in I ndia have impact on
fi nancial leverage of acqui ri ng fi rms is accepted.
VI. CONCLUSION
An analysis of pre- and post-merger operating
performance ratios for the entire sample set of mergers
shows that while there was significant increase in the mean
operating profit margin, net profit margin ratios, return on
net worth and return on capital employed after the merger.
These results corroborate with some of the general research
results on post-merger operating performance in other
countries, which suggested that the operating performance
increases after mergers, for acquiring firms.
VII. REFERENCES
[1]. Agrawal A, Jaffe J F and Mandelker G N (1992),"The Post-Merger Performance of Acquiring Firms: A
Reexamination of an Anomaly", Journal of Finance,
Vol. 47, No. 4, pp. 1605-1621.
[2]. Agrawal A and Jaffe J F (2000), "The Post-MergerPerformance Puzzle", Advances in Mergers and
Acquisitions, Vol. 1, pp. 7-41.
[3]. Andrade G, Mitchell M and Erik Stafford E(2001),"New Evidence and Perspectives on Mergers",Journal
of Economic Perspectives, Vol. 15, No. 2, pp. 103-120.
[4]. Bruner R F (2002), "Does M&A Pay? A Survey ofEvidence for the Decision-Maker",Journal of Applied
Finance, Vol. 12, No. 1,pp. 48-68.
[5]. Fuller K, Netter J and Stegemoller M(2002), "WhatDo Returns to Acquiring Firms Tell Us? Evidence
from Firms that Make Many Acquisitions", Journal of
Finance, Vol. 57, No. 4, pp. 1763-1793.
[6]. Ghosh A(2001), "Does Operating Performance ReallyImprove Following Corporate Acquisitions?", Journal
of Corporate Finance, Vol. 7, pp. 151-178.[7]. Ghosh A and Jain P J (2000), Financial Leverage
Changes Associated with Corporate Mergers", Journal
of Corporate Finance,Vol. 6, pp. 377-402.
[8]. Healy P M, Palepu K G and Ruback R S (1992),"Does Corporate Performance Improve After
Mergers?", Journal of Financial Economics, Vol. 31,
pp. 135-175.
[9]. Heron R and Lie E (2002), "Operating Performanceand the Method of Payment in Takeovers", Journal of
Financial and Quantitative Analysis, Vol. 37, No. 1,
pp. 137-155.
[10].Linn S C and McConnell J J (1983), "An EmpiricalInvestigation of the Impact of `Antitakeover'
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IJRMBSS I ISSN No. : 2319-6998 I Vol. 1 I Issue 2 I July. 2013------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ Indian Journal of Research in Management, Business and Social Sciences (IJRMBSS) 16
Amendments on Common Stock Prices", Journal of
Financial Economics,Vol. 11, pp. 361-399.[11].Linn S C and Switzer J A (2001), "Are Cash
Acquisitions Associated with Better Post-acquisition
Operating Performance than Stock Acquisitions?",
Journal of Banking and Finance, Vol. 25, pp. 1113-
1138.
[12].Moeller S B and Schlingemann F P(2005), "GlobalDiversification and Bidder Gains: A Comparison
Between Cross-Border and Domestic Acquisitions",
Journal of Banking and Finance, Vol. 29, pp. 533-564.
[13].Rahman A R and Limmack R J (2004), "CorporateAcquisitions and the Operating Performance of
Malaysian Companies", Journal of Business, Finance
and Accounting, Vol. 31, Nos. 3/4, pp. 359-400.
[14].Sharma D S and Ho J (2002), "The Impact ofAcquisitions on Operating Performance: Some
Australian Evidence", Journal of Business, Finance
and Accounting,Vol. 29, No. 1, pp. 155-200.
________________________
1 Dr. K. B. Singh , Assistant Professor, Dept. of
Management, Birla Institute of Technology, Mesra (Noida
Campus). [email protected]