Bidder's Gain: Evidence from Termination Returns

• Published date: 01 December 2015
• DOI: http://doi.org/10.1111/irfi.12059
• Author: Tilan Tang
• Date: 01 December 2015

Bidder’s Gain: Evidence from

Termination Returns*

TILAN TANG

College of Business and Behavioral Science, Clemson University, Clemson, SC

ABSTRACT

In most cases, bidder’s stock returns around merger announcement convey

more information than the synergy created from the acquisition. To over-

come the interpretation problem, I study the bidder’s return from the per-

spective of deal termination. Using a hand-collected dataset on terminated

merger proposals, I investigate termination returns in deals canceled for

reasons unrelated to the bidder’s stand-alone valuation. I find that bidder’s

gain varies significantly with the type of target acquired. Further evidence

suggests that the liquidity need of private target significantly contributes to

the positive gain to the bidder.

JEL Classification: G14; G32; G34

I. INTRODUCTION

Mergers and acquisitions are economically important events that have attracted

a great deal of attention from financial economists. Despite the importance of

these events, however, our understanding of the effects of takeover on the

bidder is still far from complete.1Part of the problem arises from the fact that

bidder’s stock return at the time of acquisition announcement, although infor-

mative, can be difficult to interpret because the announcement of a bid usually

conveys not only information on the synergy created from the deal, but also

information on the bidder’s stand-alone value.2For example, the decision to

* I would like to express my appreciation to Sudipto Dasgupta (the editor), an anonymous

referee, Charlie Hadlock, Ted Fee, Long Chen, Thomas Bates, Kathleen Fuller,Kien Dinh Cao, and

the participants of the finance seminar at Michigan State University, Clemson University, Uni-

versity of Wyoming, as well as the session participants at the 2009 Financial Management

Association Conference, the 2010 Southern Finance Association Conference, and the 2011

Eastern Finance Association Conference for helpful comments and suggestions. All errors and

omissions are mine.

1 Tremendous variation in bidder announcement returns is recorded in previous studies (see for

example, Jensen and Ruback (1983)).

2 Grinblatt and Titman (2002) state that the stock return at the time of announcement reflects

not just the expected effect of the acquisition on firm profitability, but also information

regarding the stand-alone value of the firm. Furthermore, Hietala et al. (2003) suggest that

announcements contain information about the potential synergies from the combination,

the bidder’s stand-alone value, and possible bidder overpayment.

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International Review of Finance, 15:4, 2015: pp. 457–487

DOI: 10.1111/irfi.12059

© 2015 International Review of Finance Ltd. 2015

undertake a bid may convey to the market that a firm’s internal growth pros-

pects are poor, and the decision to use stock in an acquisition may convey that

the firm’s stock is overvalued.

Several researchers have attempted to overcome these interpretation prob-

lems. Hietala et al. (2003) and Bhagat et al. (2005) use information relating to

competing bids to extract information on the market’s assessment of the value

of the merger to the original bidder. Taking a different approach, Fuller et al.

(2002) use repeated bids by the same acquirer to attempt to remove the

role of bidder-specific characteristics in announcement returns. While these

approaches offer additional insights on bidder gains in merger activity, some

interpretation issues remain. In particular, studies that exploit the presence of

competing bids assume the occurrence of a competing bid to be independent of

the value of the original bidder, whereas studies that consider repeat bidders

cannot adjust for the possibility of time-varying changes in underlying bidder

characteristics.

In this paper, I attempt to examine the bidder’s gain in acquisition activity

from a different perspective by investigating the bidder’s termination returns at

the time that a previously announced acquisition is canceled for exogenous

reasons. To alleviate the interpretation problem, this approach depends criti-

cally on identifying cancellations that have nothing to do with the stand-alone

value of the bidder or the merged entity, that is, cancellations that arise due to

factors such as regulatory intervention, the occurrence of competing bids, or

court rejection.3By utilizing a natural experiment, I begin with a comprehen-

sive sample of canceled deals and select from this set only the transactions for

which I can determine that this exogeneity condition holds. The final sample

includes 272 failed takeover bids occurring between 1990 and 2006.

For the sample as a whole, I find that bidder’s return upon the announce-

ment of deal cancellation is on average insignificantly different from zero.

However, this finding masks considerable variation in the market reaction to

different types of deals. In particular, I find that bidder’s return is significantly

negative (−3.2%) when a deal is canceled and the target is a private firm or a

subsidiary of either a public or private firm. This indicates that the market

believes that these types of deals create value for bidders and that this value is

lost upon recognition that the deal will not be consummated. The fact that

these deals appear to create value for bidders is consistent with prior evidence

that bidders fare well when acquiring relatively illiquid assets (Officer 2007).

When I further compare acquisitions of public firm subsidiaries to acquisitions

of private firm subsidiaries, I find that cancellation returns are relatively smaller

in magnitude (still negative in sign) for acquisitions of public firm subsidiaries

3 While the final sample includes deals failed due to the presence of competing bids, the

assumptions on these events are much weaker than the aforementioned studies that consider

returns at the time of the announcement of the competing bid. In a robustness check I also

examine the sample after excluding all deals canceled because of competing bids and the

results still hold.

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