Asian Lessons in the Payment of Premia, and the Performance of Mergers

The level of the premium paid is a function of the expected synergies that the deal will create, and it is designed to ‘lubricate’ the deal. It would, for example, be both rational and efficient for the acquiring manager, forecasting post-acquisition synergies of €100 million, to pay a premium of €10 million to the target firm, up front. In this way, the payment of a premium can be seen as a positive, value-inducing acquisition tool. 

Unfortunately, little in the world of mergers and acquisitions is as simple as it might first appear. And a significant body of research suggests that the level of the premium paid is negatively related to post-acquisition merger performance. In a study of 12,840 large, public deals, completed in the period Jan 1st, 1990 and Dec 31st 2010, for example, we show that a 1% increase in the premium paid implies a decrease of 0.8-1.2% in performance (McCarthy, 2011).

So where does it all go wrong? Clearly, there logic behind the suggestion that a premium is necessary, to encourage the target firm to sell; because why would the owners of a firm agree to sell a successful firm, at market prices? Combining sources, we suggest that there are at least three problems with premiums, that combine to create a negative performance impact. 

First, the evidence suggests that the managers of acquiring firms are too optimistic in their forecasts, and too willing to over-pay as a result. Writing in the Journal of Financial Economics, Houston et al. (2001), for example, show that firms tend to realise about 60% of their cost-cutting forecasts, but only 7% of the estimated growth forecasts. Because 86% of mergers announced  between 2000 and 2010 were expansionary in nature (McCarthy, 2011), the implication here is that most managers will have realised far less than they forecast. The manager who forecasts post-acquisition synergies of €100 million, and pays a premium of €10 million in order to ensure that this deal is concluded, might realise a net loss of €3 million. 

Secondly, it is suggested that managers are too generous, and that they’ve become more generous over time. Martynova & Renneboog (2008), writing in the Journal of Banking and Finance, report that in the 1960s, the average premium was 18-19% of the target firms’s market value, but that this had risen to 35% in the 1980, and to 45% in the 1990s. A premium of 45% in the 1990s will ensure that deals get done, but mergers are often zero sum games, with razor thin gains, a 45% premium puts the acquiring firm at a significant disadvantage. 

Finally, there is a suggestion that the payment of premiums is a cultural artefact. To test this, we built a sample of 12,840 large, public deals, completed in the period Jan 1st, 1990 and Dec 31st 2010, which disclosed the necessary information. In the sample we identify 2,696 acquisitions by European acquirers, 1,215 acquisitions by Asian-Pacific acquirers, and 8,929 by North American acquirers, and calculate both the 1-Day Premium and 4-Week Premium. A 1-Day Premium is the sum paid on the day of the merger announcement, in excess of the target firm market value on the previous day, and the 4-Week Premium is the sum paid on the day of the merger announcement, in excess of the target firm’s average market value over the previous four weeks. Table 1 reports the average premiums paid per region, and demonstrates that ‘generous’ premiums are very much a Western — European and American — phenomenon. Plotting the premiums paid in each region over time, Figure 1 shows that North American typically paid a premium of 15-20%, Europeans of 10-15%, and Asian firms in the range of 5%. 

 

 

 

The unwillingness of Asian acquirers to pay anything above what is necessary to ensure that the deal gets done has been linked to finding that Asian acquirers are increasingly doing better deals. Our results suggest that the median North American deal, concluded in the period 2003-2008, added 0.001% to the value of the acquiring firm, while the median European deal destroyed 0.001% of the market value. The median Asian acquirer, by contrast, added 3%, and the mean acquirer added 11% to the market value of the acquiring firm (McCarthy, 2011). 

Western acquirers have long looked to Asia as a source of targets. In terms of premiums, and financing strategies, Western managers, it seems, would also be wise to look to Asia.

 

Killian McCarthy is assistant professor bij de University of Groningen en verzorgt voor MenA.nl een maandelijkse blog. Hij behaalde zijn PhD in economics of corporate strategy in 2011 voor zijn onderzoek over overnameprestaties. in dit onderzoek evalueerde Killian de prestatie van 35,000+ deals in Europe, Noord-Amerika en Azië in de periode 1990-2010.  

References: 

• Gaughan PA. 2008. Mergers, Acquisitions and Corporate Restructurings. John Wiley and Sons
• Houston JF, James CM, Ryngaert MD. (2001) Where Do Merger Gains Come From? Bank Mergers from the Perspective of Insiders and Outsiders, Journal of Financial Economics 60: 285-331
• Martynova, Marina & Renneboog, Luc, 2008. A Century of corporate take-overs: what have we learned and where do we stand?", Journal of Banking and Finance, Elsevier, vol. 32(10), pages 2148-2177, October.
• McCarthy, K.J., (2011), Understanding success and failure in mergers and acquisitions : questing for the Holy Grail of economics, finance, and strategic management, University of Groningen, Faculty of Economics and Business