Integration Risk Increases Post-Merger Volatility for Acquirers
Study reveals there is a strong run-up in volatility and risk beginning four years before a merger or acquisition and lasting well after the deal has been consummated.
ANN ARBOR, Mich.—Volatility and risk increase significantly in the four years before mergers and acquisitions are announced and persist after they are consummated, say two University of Michigan business professors.
These changes, they say, are caused by industry shocks occurring prior to the commencement of M&A activity and by post-merger fears that the integration process between the two joining companies will be unsuccessful and the resulting single entity will fail to achieve the desired objectives. Such fears appear to outweigh the potential benefits of greater diversification when a single-segment firm merges with a company in another industry.
Sreedhar Bharath and Guojun Wu, assistant professors of finance at Michigan's Ross School of Business, suggest acquirers may be able to mitigate their post-merger integration risk, and the duration time of the volatility associated with it, by spacing out or reducing the number of successive M&As, targeting smaller rather than larger takeover candidates, and financing their deals with cash instead of stock.
These measures, they say, also can work to the benefit of acquiring-firm shareholders, who too often see the value of their stock holdings plummet in the wake of M&A announcements, due to the resulting increases in risk and expected returns for these companies.
Bharath and Wu examined 8,139 acquisitions completed between the fourth quarter 1995 and the third quarter 2002. In the four-year period leading up to a merger, they found significant increases in average total volatility, which includes broader economic (systematic) and firm-specific (idiosyncratic) measures.
The increases are more pronounced in the quarter after the merger than in the pre-merger quarter, and the rising trend in all measures of volatility and risk continues over the next year. Firm-specific volatility persists long after systemic volatility and risk have subsided, but by year four after the merger, all measures have stabilized. During that same time period, the researchers found that industry shocks (cross-sectional averages) rise continually from a level of 5.56 percent four years before a merger to 6.73 percent in the year of the merger.
"Our findings suggest industry shocks mainly affect firm-level volatility," Bharath said. "This is consistent with the view that M&A activity is driven by turbulence at the level of the firm and the industry, not at the level of the economy.”
In the post-merger period, Bharath and Wu found that the integration of the acquirer and target also is related to the pattern of volatility. Their results show that the integration process lasts longer and volatility persists or even increases, when the acquirer makes multiple acquisitions in rapid succession and when the takeover targets are relatively large.
Surprisingly, they found little difference in the volatility patterns of intra- and inter-industry mergers. A change in market volatility, they say, is more likely to have an impact at the systematic rather than firm level.
"Overall, the post-merger volatility pattern confirms the notion that the risk of integration of the acquirer and the target firms eventually is resolved over time," Wu said.
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