Stock returns in mergers and acquisitions

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Strategic Management Journal, Vol. 13, 67-84 (1992)

FACTORS INFLUENCING WEALTH CREATION FROM
MERGERS AND ACQUISITIONS: A META-ANALYSIS
DEEPAK K. DATTA and GEORGE E. PINCHES

School of Business, University of Kansas, Lawrence, Kansas, U.S.A.

V. K. NARAYANAN
Graduate School of Management, Rutgers-The
Newark, New Jersey, U.S.A.

State University of New Jersey,

This study analyzes the empirical literature concerning the influence of various factors on
shareholder wealth creation in mergers and acquisitions using a multivariate framework.
Overall, results indicate that while the target firm’s shareholders gain significantly from
mergers and acquisitions, those of the bidding firm do not. Findings also indicate that the
use of stock financing has a signijicant impact on the wealth of both the target and bidding
firms’ shareholders. The presence of multiple bidders and the type of acquisition inpuence
the bidders’ return, while regulatory changes and tender offers influence the targets’ returns.
The paper also provides a comparison of our findings with that of previous narrative reviews
and discusses their implications from the viewpoint of managers and researchers.

regression analysis using observations from 41
studies. The results indicate that a select set of
factors explain a substantial proportion of the
wealth gains to both bidding and target firm
shareholders. By ‘bidding’firm we mean the firm
initiating the acquisition transaction; the object
of their interest is the ‘target’ firm.

The paper is structured as follows. First, we
provide an overview of the literature on wealth
creation in mergers and acquisitions, discussing
five key factors which have been hypothesized
to influence shareholder wealth. Next we describe
the method employed in this study, the studies
used in our analysis and the way the variables
are coded from the studies. Third, we present
the results of the regression analysis assessing
the influence of various factors on shareholder
gains. Finally, in the concluding section, we
discuss the findings and compare them with those
identified in two prior narrative reviews of the
literature. We also raise important theoretical
questions and issues for future research, and
Key words: wealth creation,mergers and acquisitions, discuss their implications for both practice and
research in strategic management.
meta-analysis

The performance implications of mergers and
acquisitions have been of considerable interest
to researchers over the last couple of decades.
Recent studies have focused on the market
performance of individual mergers and acquisitions both in the area of strategic management
(e.g. Barney, 1988; Chatterjee, 1986; Lubatkin,
1983, 1987; Shelton, 1988; Singh and Montgomery, 1987) and in financial economics (Jarrell,
Brickley and Netter, 1988 and Jensen and
Ruback, 1983 provide narrative reviews of this
literature). In this paper we provide a metaanalytic synthesis of the findings of studies on
wealth creation or the market peformance of

mergers and acquisitions where ‘market performance’ or shareholder wealth gains refers to
the stock market appraisal of specific merger
transactions. Unlike traditional literature reviews
we employ a multivariate framework and

014~2095/9uo10067-18$09.00
0 19!Z by John Wiley & Sons, Ltd.

Received 27 July 1990
Revised 15 July 1991

68

D . K . Datta, V . K . Narayanan and G. E. Pinches

THEORETICAL OVERVIEW
Measuring wealth creation
Research on wealth creation from mergers and
acquisitions, both in strategic management and
financial economics has been primarily undertaken using the event study methodology (see
Brown and Warner, 1980; 1985 for a detailed
description of the market and other models used
in such methodology). This approach is based on
the proposition that in an efficient market the
immediate wealth effect reflects the capital
market’s overall unbiased assessment of the
present value of the future benefits of the merger
or acquisition. This focus on present value
incorporates both:

of the empirical estimates examined in this study
indicate that while the average shareholder gains
for target firms in the month of the merger
announcement is about 22 percent, gains to
bidding firms in the same period are less than
one-half of one percent. To provide an indication
of the magnitude of wealth creation and variability
therein we have plotted on a month-to-month
basis the means and variation (mean & one
standard deviation) of the prediction errors (the
indicator of weath gains) for both bidders and
targets during and around the month of the
announcement of the merger or acquisition
(Figure 1).2 Note that only in month zero (the
month of the announcement) is there any
indication of substantial wealth increases, and
then only for targets. Figure 1 also highlights that

1. The actual flow of cash or securities incurred
by the bidder during the transaction; and
2. The expected incremental cash inflow generated during the integration phase by combining
the operations of the target and bidder (the
expectation being formed by an unbiased
assessment of all available information).

The merger transaction itself may span several
weeks. The negotiations may be started before
any public announcement, and the acquisition is
consummated some time after the initial public

announcement (if it is consummated at all).
Although negotiations may be conducted in strict
-6t
-6 -5 -4 -3 -2 -1 0 1 2 3 4 5 6
secrecy, often there is speculation, news begins
Month
to leak, and/or the market begins to anticipate
the acquisition. However, the market’s expectations are almost fully formed by the announcement date of the merger or acquisition with
wealth effects being insignificant around the
consummation date (Asquith, 1983; Dodd, 1980).
As a consequence, studies examining the wealth
creation in mergers and acquisitions have typically
---- Man
f one standud Dcviltirn
employed relatively short event periods surrounding the announcement date. This is consistent Figure 1. Mean and standard deviation of prediction
with both the efficient market hypothesis as well errors for bidders and targets around the announcement
month (t = 0).
as available empirical evidence.

-

-

Factors influencing wealth creation
Evidence from previous narrative reviews indicates that the wealth created in mergers and
acquisitions accrues almost exclusively to the
target firms’ shareholders (Jarrell, Brickley and
Netter, 1988; Jensen and Ruback, 1983). Analysis

I Traditionally, the term ‘abnormal returns’ (ARs) or

‘cumulative abnormal returns’ (CARS) has been prevalent in
the literature to connote the wealth effects of an event.
However, more recently, this has been redefined as ‘prediction
errors’ (PEs) or ‘cumulative prediction errors’ (CPEs) to be
more congruent with what is actually measured.
The data for Figure 1 came from previous studies using
monthly data which reported wealth effects in and around
the announcement month.

Wealth Creation from Mergers and Acquisitions
there is considerable cross-sectional variability in
the wealth effects for both bidders and targets.
This cross-sectional variability has been obscured
in previous narrative reviews.
What contributes to this variation in wealth
creation as measured in the observations across
various studies? While the question has been
addressed in both the strategic management and
the financial economics literature, the two have
adopted somewhat different frames of reference
in identifying the sources of shareholder wealth
in mergers and acquisitions. The ‘market for
corporate control’ perspective, where mergers
and acquisitions have been viewed as contests
between competing management teams for the
control of corporate entities, is common among
financial economists. The proponents of this
perspective argue that the total economic value
created in a merger or acquisition, and its

partitioning between the bidding and target
firms’ shareholders is determined by market
characteristics, including its competitiveness (e.g.
number of bidders and regulatory changes affecting the market). On the other hand, strategic
management researchers, while sometimes adopting the financial economists’ methodological
tools, have typically emphasized factors which
are management controlled. For example, based
on the existing literature on diversification
strategies, they have argued that the type of
merger (i.e. whether it involves the acquisition
of related or unrelated business units) is an
important determinant of performance. Other
factors, such as the bidders’ approach (i.e. merger
or tender offer) and the mode of financing, while
also being management controlled, have been
examined primarily in the finance literature from
a market for corporate control perspective.
A review of the theoretical and empirical
literature on shareholder wealth creation in
mergers and acquisitions identifies a number of
factors which may explain differences in wealth
creation. Primary among these are regulatory
changes, the number of bidders, the bidder’s
approach (i.e. merger vs. tender offer), the mode
of financing (i.e. cash vs. stock), and the type
of merger or acquisition (i.e. conglomerate vs.
non-conglomerate). This study is limited to these
five factors-factors that have been examined in
a sufficient number of previous studies so their
impact (or, lack thereof) can be systematically

assessed. It should be emphasized that additional

69

factors may also impact wealth creation, however,
they have not been examined with sufficient
frequency in previous research to be considered
in this empirical analysis and ~ynthesis.~
Regulatory changes
Changes in the environment over time, including
regulatory changes, play a key role in influencing
the selection of a firm’s strategy and also
determining the consequencesof various strategic
decisions. In the case of mergers and acquisitions
Jarrell and Bradley (1980) and Schipper and
Thompson (1983), among others, point to two
important regulatory changes, namely, the 1968
Williams Amendment and the 1969 Tax Reform
Act. Two specific mechanisms have been postulated in relation to their impact on wealth
creation. First, the 1968 Williams Amendment
required bidding firms to provide targets adequate
time (10 trading days) to evaluate tender offers,
thereby allowing additional bidders to enter the
process and increasing the competitivenessof the
market for corporate control. This, in turn, can
be expected to increase the bid price, benefiting
the target firms’ shareholders at the expense of
the bidding firms’ shareholders. Second, the 1969
tax reform disallowed the interest deduction on
convertible bonds issued to finance a merger and

also taxed negotiable bonds given to the seller as
installment payments. Since both these regulatory
changes imposed additional costs on the bidder,
the returns to the bidding firms’ shareholders
should be lower in the post-1969 period; the
opposite being true for targets.
Number of bidders
The extent to which the market for corporate
control is competitive is ultimately an empirical
question. However, in a situation where there
are a number of bidders, there is an increase in
the level of competitiveness resulting in a negative
impact on the stockholder gains of bidding firms.
On the other hand, target firms are likely to
benefit when there are multiple bids. At the
extreme, the rivalry among bidding firms might
even result in the price of the target being bid
Only factors where we had a minimum of five observations
were included in this study. The number of observations on
each of the factors are available from the authors.

70

D. K . Datta, V. K . Narayanan and G. E. Pinches

up until the takeover is a zero net present value
(or. at times, even a negative) investment for
bidders. This argument is the essence of Barney’s
(1988) theoretical analysis and Roll’s (1986)

‘hubris’ hypothesis. Ruback’s (1982) case study
of the DuPont-Conoco merger also illustrates
that restricting the number of bidders (in this
case the court ordered withdrawal of Mobil from
the bidding process) can have an impact on
stockholder gains.
BidderS approach
The approach used by the bidding firm (i.e.
merger or tender offer) has figured fairly prominently in the empirical literature on mergers and
acquisitions (e.g. Bradley, 1980; Huang and
Walking, 1987; Kummer and Hoffmeister, 1978;
Kusewitt, 1985). Mergers, by definition, are
negotiated directly with the target firm’s management andor the board of directors and approved
by them before going to a shareholder vote. On
the other hand, in tender offers, which may be
friendly or unfriendly, the offer is made directly
to the target firm shareholders. It is then up to
the shareholders (and not the management) to
decide whether or not to tender their shares to
the bidding firm.
There are at least two reasons why the target
firms’ shareholders are likely to benefit more in
tender offers. First, the announcement of a
tender offer can alert other firms to the intent
of the bidding firm, thereby attracting other
bidders and initiating a competitive (auctiontype) process for the target firm. This increased
competition should result in higher bid premiums
being paid by the bidding firm, benefiting the
target firm at the expense of the bidder. Second,
as Bradley, Desai and Kim (1988) suggest,

mergers permit payment of a ‘control premium’
diectly to target firm’s management in the form
of favorable post-acquisition contracts. In tender
offers such premiums go directly to the target
firms’ shareholders, who thereby stand to benefit
more from the transaction. In either case, tender
offers allow targets to benefit at the expense of
bidders.

(or some combination of the two). While the
choice depends on how the transaction is negotiated, the mode of payment can influence
shareholder wealth creation in a variety of ways.
First, the mode of payment affects the speed,
and, with it, the cost of the transaction. In stock
offers, the bidding firm must obtain the approval
of the Securities and Exchange Commission
(SEC) before target shareholders can exchange
their shares. This process tends to increase the
competitiveness of the acquisition market and
benefits targets at the expense of the bidders.
Second, financial theory (e.g. Myers and Majluf,
1984) sugg6sts that the issuance of stock is viewed
negatively by the capital markets. DeAngelo,
DeAngelo and Rice (1984) provide empirical
evidence with respect to stock issues that is in
line with the theoretical position of Myers and
Majluf. Alternatively, a common stock offer may
also lead to wealth transfer from stockholders to
bondholders, implying a fall in stock prices (e.g.
Eger, 1983; Travlos, 1987). Third, unlike stock

offers, cash transactions impose an immediate
tax liability on the shareholders of the target
firm, who, obviously, seek compensation in the
form of higher premiums (e.g. Franks, Harris
and Mayer, 1988; Hayn, 1989). The above
arguments suggest that both bidders and targets
are likely to be better off in cash-financed rather
than in stock-financed transactions.
Type of acquisition

The type of acquisition as a factor in wealth
creation has been of concern to researchers in
strategic management given their interest in
linking wealth effects of mergers and acquisitions
to the diversification literature. Thus, it has been
argued that synergistic benefits through a transfer
of core skills between the bidding and target
firms in related acquisitions should result in
greater wealth creation than in unrelated or
conglomerate transactions (Salter and Weinhold,
1979). In extending Salter and Weinhold’s work,
Lubatkin (1983,1987) and Singh and Montgomery
(1987) hypothesized three additional mechanisms:
merger-related economies of scale, economies of
scope, and market power economies, all of
which help enhance the total value of related
Mode of payment
acquisitions. However, others have hypothesized
In making an acquisition, the bidding or acquiring there are factors which favor conglomerate
firm can choose either cash and stock financing acquisitions: cheaper access to capital (Steiner,

Wealth Creation from Mergers and Acquisitions
1975); improved income stability, lower bankruptcy probabilities and increased market value
of debt of the combined firm (Higgins and
Schall, 1975; Leontiades, 1986; Lewellen, 1971).
Recently, the relatedness argument has also been
extended to targets: in related acquisitions, the
targets should gain more since such acquisitions
result in greater overall value and most of the
gains in these transactions accrue to the target
firms’ shareholders. Singh and Montgomery
(1987) provide some empirical support for this
hypothesis. On the whole, this literature views
related acquisitions more favorably than conglomerate acquisitions in terms of shareholder wealth
creation for both bidders and targets.
In summary, a review of the theoretical and
empirical research suggests a number of factors
which influence shareholder wealth creation in
mergers and acquisitions. Table 1summarizes the
nature of the influence and also the hypothesized
direction for these five factors. It is important to
note that previous studies have investigated the
influence of these factors on shareholder wealth
creation within a univariate framework, i.e. one
factor at a time. The central thrust of this study
is to assess the significance of various factors
simultaneously in a multivariate framework, one
that allows the impact of individual factors to be
examined after partialling out the effects of

others.

METHOD
In this study, we utilize a meta-analytic procedure
to estimate the significance of the hypothesized
independent variables on merger returns for both
bidders and targets. Meta-analytic procedures
have been extensively used in areas such as
organization theory (e.g. Gooding and Wagner,
1985), marketing (e.g. Assmus, Farley and
Lehman, 1984), and more recently in strategic
management (Datta and Narayanan, 1989). The
procedure is useful for synthesizing an existing
body of evidence and is particularly appropriate
when there is a substantial body of empirical
evidence already available.
In a meta-analysis, empirical studies of a
phenomenon are viewed as a natural unplanned
experiment. Since it is often difficult to account
for all relevant factors within a single study, a
number of studies are necessary to shed light on

71

various aspects of a phenomenon. ‘me studies
naturally differ along a number of dimensions;
hence, the evidence from them is not directly
comparable without controlling for interstudy
differences. Study observations are viewed as
estimates in a multi-factor analysis of variance,

with the experimental factors corresponding to
the interstudy and/or intercase differences. This
allows us to exploit the empirical evidence
available from previous merger and acquisition
studies to draw statistically meaningful conclusions. In contrast, narrative reviews adopt ad
hoc procedures to cumulate their findings.
In this study we adopt a form of meta-analytic
procedure called replication analysis (Farley,
Lehman and Ryan, 1981).We array the estimates
of merger gains (i.e. prediction errors) from
previous empirical studies as observations in
a multi-factor natural experiment, with the
experimental factors corresponding to the factors
hypothesized to influence wealth creation. Thus
the factor levels for each estimate are identified,
and the estimate of wealth created (the prediction
error) is the dependent variable. Using multiple
regression analysis the impact of each factor on
the dependent variable is assessed.
As in any meta-analytic review, we are forced
to identify the factor levels based on the data
available in the existing studies. For some factors
the data precludes finer refinements of factor
levels. For example, although the ‘mode of
payment’ may vary from ‘all cash’ to ‘all stock’
along a continuum, we could identify only two
levels for analysis: cash or stock. The factor level
‘mixed mode of payment’ was not generally
represented in the studies. This is common in
meta-analysis, since individual studies are driven

less by a planned program and more by the
specific researchers’ concerns; consequently, the
studies form an unplanned experiment.
Key methodological issues to be resolved in a
meta-analysis are: sample selection, operationalization of dependent and independent
variables, and analytic procedures for drawing
conclusions.
Sample

The sample consisted of studies identified through
a comprehensive search of articles that have
examined the issue of shareholder wealth creation
in mergers and acquisitions using the event study

Mechanisms

Stimulates the market for corporate
1. Regulatory
changes in 1968 & control and increases the cost of
1%9
transactions.
Stimulates the market for corporate
2. Number of
bidders
control
3. Type of
Tender offers stimulate the market for
transaction
corporate control and lead to an

(tender offer vs.
auction type process
merger)
Mergers provide less stimulation in the
market for corporate control
4. Mode of payment Use of cash reduces time required to
(cash vs. stock)
complete transaction and gains, if any,
are not shared after the transaction
with target shareholders
Use of stock viewed negatively by the
capital market; may result in wealth
transfer to bondholders
5. Type of
Economies and transfer of core skills
acquisition
in related (i.e. non-conglomerate)
(conglomerate vs. mergers, vs. cheaper capital, lower
non-conglomerate) bankruptcy probability and increased
market value of debt in unrelated
mergers

Factor

Bidders

Stimulates the market for corporate
control
Tender offers stimulate the market for
corporate control and lead to an

auction type process
Mergers provide less stimulation in the
market for corporate control
Cash transactions require additional
premium to compensate for immediate
tax consequences
Use of stock viewed negatively by the
capital market; may result in wealth
transfer to bondholders
Value, if any, of relatedness primarily
captured by targets

Negative

Negative
Positive or
uncertain

Positive

Positive

Negative

Stimulates the market for corporate
control

Mechanisms

Targets

Negative

Direction of
influence

Table 1. Mechanisms and direction of influence of factors on shareholder wealth creation

Positive or
uncertain

Negative

Positive

Negative

Positive

Positive

Positive

Direction of
influence

a

n

3

Wealth Creation from Mergers and Acquisitions
methodology. Using the market model, or other
similar models, researchers have tried to assess
whether mergers and acquisitions result in
increases in shareholder wealth. The search was
initiated by a systematic examination of articles
appearing in major journals over the past 15
years.4 Next, additional studies published in
books or other journals were identified from the
references provided in these articles. For the
purpose of analysis we used four screens in
selecting studies. First, the study had to be based
on either daily or monthly returns. Second, we
confined our analysis to studies on acquisitions
in the United States so as not to confound the
value gains due to country specific factors and
cross-national differences. Third, we omitted a
small number of studies which focused on unique
or very specific industries (e.g. REITs and
banking). Finally, only those studies which
reported wealth effects based on the announcement (and not the outcome or consummation)
date of the merger or acquisition were considered.
In our analysis, we examined a total of 41
studies with a total of 409 usable observations
(i.e. estimates of wealth creation) for both bidders
and targets, each over four event period^.^ The
Appendix provides a list of the studies used along

with the number of usable observations contained
in each study.) The 41 studies have drawn their
samples from 16 different sources, and have used
different time periods (dating as far back as 1948)
and widely different screens or sampling criteria.6
Although the population of acquisitions from
which the studies have drawn their ‘samples is
finite, the sampling criteria are so different that
observations are treated as being independent of
one another. Similarly, while multiple observations from the same study have been used,
they represent wealth estimates from samples
unrelated to each other.’ However, as with any
The list of 41 journals examined is available from the
authors.
We have 75 observations for bidders and 79 for targets for
the main analysis, and 32, 51 and 31 for bidders and 40, 62
and 39 for targets for the event periods (-10,-2), (-1,O)
and (1.6) respectively. Together they constitute a sample of
409 usable observations.
* Less than 25 percent (10 out of 41) of the studies used
FTC large merger series. The list of sources, time periods
and sampling criteria on a study-by-study basis is available
from the authors.
For example, Asquith (1983) provides prediction errors
around the announcement date for bidders and targets for
both ‘completed’ and ‘not completed‘ mergers. Therefore,

73

meta-analytic study, the data used suffers from

a ‘publication bias,’ due to the use of studies
that have passed a reviewing process.
Dependent variable: wealth effects
Wealth creation in mergers and acquisitions has
typically been estimated using the technique
commonly referred to as an ‘event study.’ The
procedure entails analyzingcommon stock returns
of a firm that is hypothesized to have been
affected by a particular ‘information event’ (in
this case the announcement of the merger or
acquisition).*The return for any period is defined
as the change in the value of the stock plus any
dividends (if appropriate) as a percentage of the
stock price at the beginning of the period. In the
absence of new information which impacts the
price (and returns) for the stock, the difference
between the actual and expected (i.e. ‘normal’)
returns will, over a large number of firms, be
approximately zero. However, when unusual new
information is present, the actual returns might
exceed or be less than expected giving rise to
positive or negative prediction errors, respect i ~ e l y .In
~ an efficient capital market these
prediction errors represent the investment communities’ unbiased expectation of the present
value of the long-run benefits of the event. Thus,
they capture both immediate and anticipated
longer term impacts of the merger. Of course,
as additional information about the merger and
its success or failure becomes known, it is
assimilated by the market and the value of the

firm may be further affected.
In this study we operationalize shareholder
wealth creation as the prediction errors (PEs) at
four usable and independent observations (two for bidders
and two for targets) are available from this study.
Virtually all studies use the date on which the announcement
was first reported in the Wall Srreer Journal as ‘the
announcement day,’ or day ‘0.’
Most of the studies employed the market model to estimate
the expected return. Under the market model the expected
return is estimated via
Expected return = a

+ p (return on the market)

where, Q and p are estimated on a security-by-security basis
over some relevant time period (often 100 to 200 trading
days before the announcement) and the return on the market
is based on a CRSP (Center for Research in Security Prices)
index. In the studies which reported PEs via a graph we
estimated the returns.

74

D. K . Datta, V. K . Narayanan and G. E. Pinches

and around the transaction announcement date.
Our analysis focused on wealth creation separately for both bidders (or acquiring firms) and
targets. For studies using daily return data this

involved examining the gains in the (- 10,lO)
period. In other words, the total prediction error
over the 21-day period beginning 10 days before
the announcement date, and continuing for
10 days after the announcement date was
examined. lo For studies which utilized monthly
data, we used the prediction error during month
zero (i.e. the month of the announcement).
Secondary analysis involved employing only daily
data and using the prediction errors in the (-10,
-2), (-1,O) and (1,6) time periods representing
pre-announcement, announcement and postannouncement periods relative to the specific
date the merger or acquisition was announced.
Variables: factors influencing wealth creation
From the available studies, we coded the factor
levels for the five independent variables identified
in the literature review. Four were identified
directly: number of bids (single vs. multiple),
bidder’s approach (merger vs. tender offer), type
of financing (cash vs. stock), and type of
acquisition (conglomerate vs. non-conglomerate).
The number of studies and/or cases available did
not permit us to code multiple bidder cases in
finer detail nor to consider mixed .modes of
financing (i.e. cash and stock). Similarly, studies
did not permit us to code the type of acquisition
using more complex classifications such as the
FTC scheme, or Salter and Weinhold’s (1979)
typology.
For the fifth variable, namely, regulatory

change, direct identification of factor levels was
not possible. However, the empirical work of
Asquith, Bruner and Mullins (1983), Jarrell and
Bradley (1980), and Schipper and Thompson
(1983) suggest the regulatory changes in 1968
and 1969 (Williams Amendment and the Tax
Reform Act) had a significant impact on wealth
’OTwenty-one trading dates is approximately equal to 1
month. The window was allowed to vary for the (-10,lO)
window, depending on the data available in a study. The
beginning day could vary between -20 and -5 and the
ending day between 5 and 20, providing there are a minimum
of 16 observations in the interval. Statistical tests (available
from the authors) indicate this variation does not effect the
results.

effects in mergers and acquisitions. The year of
the transaction was used as a proxy for regulatory
change and studies were classified based on
whether the mergers and acquisitions in the study
pertained to the 1969 and after period, or not.
Control variables: methodological artifacts
Since studies differed along methodological
dimensions, we also controlled for four methodological artifacts: the source of the merger sample,
type of sample employed, the kind of data
employed, and the outcome of the proposed
merger or acquisition.
The first control variable relates to whether or
not the study sample was drawn from the FTC
data base (the FTC merger series was last

published in 1981, covering mergers through
1979). Since the FTC only listed mergers in the
manufacturing sector that are valued in excess
of $10 million, samples selected from the FTC
data base are biased in favor of larger mergers.
Second, the criteria used in selecting the sample
has also differed across studies. Some studies
have used only ‘clean’ samples (i.e. excluding
mergers where the announcement occurred along
with other significant firm-specific announcements). On the other hand, in studies which did
not systematically consider the possibility of other
announcements (e.g. earnings releases, dividend
announcements, capital expenditures, etc.), the
samples are contaminated. We distinguish
between ‘clean’ and ‘contaminated’ samples.
Third, as previously mentioned, studies have
differed on the kind of data used in assessing
wealth effects. Some studies, especially the earlier
ones, used monthly return data while the more
recent studies have predominantly used daily
return data. We distinguish between whether
returns data is daily or monthly. Finally, we
control for ‘outcome’, i.e. whether the transactions were completed or not completed. ‘Completed’ acquisitions are those which were eventually consummated while ‘not completed’ relates
to those which were not. Theoretically, there is
no reason to suspect that the market can
anticipate the outcome at the time of the
announcement; however, we included this factor
to enable us to meaningfully compare our
conclusions with previous narrative reviews.
The above variables, namely, the source of

merger sample (FTC or other), type of sample

Wealth Creation from Mergers and Acquisitions

75

(contaminated or clean), kind of data (daily
or monthly) and outcome (completed or not
completed), were included to control for potential
variability across studies in estimates of wealth
gains arising from methodological artifacts rather
than substantive factors.

the effects of the other independent and control
variables. This is a form of multi-factor analysis
of variance with the interaction terms suppressed;
the regression intecept is the main effect and
each zerolone variable adds to or subtracts from
the main effect.

Analysis

RESULTS

To assess the impact of the five independent
factors on the wealth effects in mergers and
acquisitions, we employed a multiple regression
approach using dummy variables. The following
regression model was estimated:

PEW = f(TIME, MBID, TEND, MERG, CASH,
STOCK, CONG, NCONG, FT'C, CONTAM,
DAILY, OUTCOME)
where:
PEW

= Prediction error for event period
W

= Time period of merger (1 = 1969
and after, 0 = Pre-1969)
= Number of bidders (1 = Multiple
MBID
bidders, 0 = Otherwise)
= Tender offer (1 = Tender offer,
TEND
0 = Otherwise)
= Merger (1 = Merger, 0 =
MERG
Otherwise)
= Cash-financed transaction (1 =
CASH
Cash, 0 = Otherwise)
= Stock-financed transaction (1 =
STOCK
Stock, 0 = Otherwise)
= Unrelated or conglomerate mergCONG
ers (1 = Conglomerate, 0 =
Otherwise)
= Related or non-conglomerate

NCONG
mergers (1 = Non-conglomerate, 0
= Otherwise)
= Sample drawn from FTC data
FTC
base (1 = FTC, 0 = Other sources)
CONTAM = Type of sample (1 = Contaminated, 0 = Non-contaminated)
= Kind of data (1 = Daily, 0 =
DAILY
Monthly)
OUTCOME = Outcome of merger (1 = Not
completed, 0 = Completed)

TIME

Our primary focus was on shareholder wealth
creation for bidders and targets as assessed by
examining the PEs in the combined (-10,lO)
time period (for daily data) and month zero (for
monthly data). Based on 75 observations for
bidders and 79 for targets, the mean PEs were
0.388 percent for bidders and 21.814 percent for
targets with standard deviations of 2.105 and
7.256, respectively (see Table 2).Thus, bidders
had, on average, a gain of less than half of one
percent when the merger was announced, while
target firms' shareholders experienced over a 20
percent increase in value. The overall results for
targets are consistent with those arrived at by
Table 2. Regression analysis of factors influencing

wealth creation as measured by prediction errors
Bidders Targets

-Mean prediction errors
Standard deviation

Regression analysis"
Factor
TIME (1 = 1969 and after)
-0.547 4.913'
MBID (1 = multiple bidders)
-1.133+ 3.176
-0.310
8.060"'
TEND (1 = tender offer)
MERG (1 = merger)
-0.001 -1.300
CASH (1 = cash-financed)
0.909 3.159
STOCK (1 = stock-financed)
-2.738"L5.606'
CONG (1 = conglomerate)
-0.950 -1.866
NCONG (1 = non-conglomerate) 1.789' 2.488
FTC (1 = sample drawn from FIT) 0.024 -0.443
CONTAM (1 = contaminated)
1.121t 1.539
DAILY (1 = daily data)
-0.786 2.546
OUTCOME (1 = not completed) -0.980 0.285

Intercept
0.565 14.743"
R2
0.509 0.470
Adjusted RZ
0.414 0.373
F
5.350" 4.873"'
N
75
79
~

This procedure allows us to test the impact of
each independent variable after controlling for

0.388 21.814"'
2.105 7.256

~~

*

~

Values shown are unstandardized coefficients. + p < 0.10,
p c 0.05, *' p < 0.01, p < 0.001

---

76

D . K . Datta, V. K . Narayanan and G. E. Pinches

Jarrell et af. (1988) and Jensen and Ruback
(1983); however, our results for bidders are, on
net, more pessimistic than theirs. In addition, an
examination of the standard deviations indicates
there is considerable variability in the prediction
errors across studies, a fact that is obscured in
the previous reviews. Multiple regression analysis
was employed to assess the extent to which the
five independent and four control factors explain
the variability in the bidder and target gains.

(i.e. conglomerate vs. non-conglomerate), was
not significantly related to wealth creation for
targets. None of the control variables, i.e. the
source of the sample (FTC), type of sample
(CONTAM), kind of data (DAILY) or outcome
of the transaction (OUTCOME) contributed
significantly to the variation in estimates of
shareholder wealth effects for targets.
Secondary analysis

Secondary analysis was undertaken to obtain a
better understanding of the influence of the
Table 2 also presents the results of the multiple hypothesized factors on wealth creation in the preregression analyses. As shown, the set of indepen- announcement (- 10,-2), announcement (- 1,O)
dent variables explained a significant amount of and post-announcement (1,6) periods.'2 Table 3

variation in the PEs for both bidders and provides the means and standard deviations of
targets (with adjusted R2 being 0.414 and 0.373, the prediction errors for each of these periods
respectively"). One factor, namely, the mode of for both bidding and target firms. For bidders
payment (STOCK) was significantly related to the mean PE for the 2-day announcement period
changes in shareholder wealth for both bidders was 0.167 percent compared to a mean of PE of
and targets. Its direction of influence is consistent 0.388 percent (from Table 2) for the combined
with the theoretical predictions identified in sample using both monthly and daily data.
Table 1. This finding substantiates that both Similarly, for targets, the mean PE for the 2-day
bidders and targets are worse off in stock announcement period was 14.596 percent vs.
21.814 percent for the combined daily and
transactions.
In addition, the number of bids (MBID) monthly sample. This is consistent with Jarrell et
and the type of acquisition (NCONG) were al's (1988) results which indicate that as the time
significantly related to changes in shareholder period for estimating returns is extended over
wealth for bidders. Multiple bids had a negative more than the 2-day period (-l,O), the estimates
effect on the wealth of bidding firms, while non- are higher.
conglomerate mergers provided higher returns
We also estimated separate regression estimates
for bidders. All these results were consistent with for the 2-day announcement period (-l,O), as
the theoretical arguments presented earlier. Only well as pre-announcement (- 10,-2), and postone control variable was significant in the case announcement (1,6) periods. In the regression
of bidders: the use of contaminated data provided model the type of data (DAILY) control variable
a higher estimate of returns than where no other was not used since only daily data were relevant.
firm-specific announcements occurred around the Also, because of insufficient data, we could not
announcement of the merger or acquisition.
estimate the effects of MBID in these regressions.
As hypothesized, the target firm's shareholders The results of these secondary analyses are also
registered higher gains in transactions that took presented in Table 3.
place during or after 1969 (as indicated by
A detailed examination of Table 3 points to
TIME). Also, as hypothesized, target firm four important findings. First, for both bidders

shareholders experienced substantial wealth gains and targets, stock transactions depressed the
when tender offers were employed. The other key gains significantly around the announcement
independent variable, namely, type of acquisition date, a result that is consistent with that of the
Multiple regression analyses

The possible existence of multicollinearitywas assessed by
computing the tolerance (i.e. 14:) for each independent
variable, where R f is the variance in an independent variable
which is explained by the other independent variables. Results
available from the authors indicate multicollinearity is not a
problem.

l2 The pre-announcement and post-announcement periods
were allowed to vary. The beginning day of the (-10,-2)
period could vary between -18 and -5 and the ending day
in the (1,6) period between 5 and 18. Statistical tests available
from the authors indicate this variation does not effect the
results.

Wealth Creation from Mergers and Acquisitions

77

Table 3. Regression analysis of factors influencing wealth creation as measured by prediction
errors: Pre-announcement, announcement and post-announcement periods
Targets

Bidders
(-10,-2)

Mean PE
Std. Dev.

(-1J)

0.600"
1.106

(1,6)

(-10,-2)

(-170)

(196)

0.167
1.589

-0.538"'
0.900

6.606"'
2.558

14.596"'
6.337

0.075

0.334
0.052
-0.437
-2.676"'
0.539
-0.249
0.287
0.285
-0.778

-0.501
-0.773+
0.329
-0.247
-1.006
-0.923
-0.662
1.149
0.774
-0.232

0.947
0.713
-0.441
2.414+
-1.341
-5.103"'
-0.204
1.553'
0.885

1.406

5.133"
5.088"
-3.238'
4.943+
-6.999'
-1.796
-0.271
-1.619
-7.814"'
5.229'

2.013
6.101"
-0.762
4.610t
1.979
4.330+
7.166"
-3.22Pt
0.190
-3.232

0.227
0.403

-0.755
0.433
0.149

1.526
31

4.934"
0.679
0.569
6.141"'

16.436"'
0.617
0.542
8.219""
62

0.141
0.464
0.272
2.421 *
39

2.823' * *
4.037

5

Regression analysis"
Factor
-0.415
TIME
TEND

0.450
MERG
0.780t
CASH
-0.408
STOCK
-0.551
CONG
-2.583"
NCONG
-1.444
FTC
1.316
CONTAM
1.732"
OUTCOME 0.460

Intercept

-0.765

R=
0.708
Adjusted R2 0.569
F
5.093"
N
32
A

0.254
*

2.702'
51

40

Values shown are unstandardized regression coefficients. p C 0.10, * p < 0.05,

primary analyses. Second, the explanatory power
of the regression for bidders pertaining to the 2day (-1,O) period fell off substantially (adjusted
R2 of 0.254) from the full model (adjusted R2 of
0.414) reported in Table 2). Third, the lower
explanatory power of the regressions for both
bidders and targets (adjusted R2 of 0.149 and
0.272, respectively) in the post-announcement (1,
6) period indicates the lack of systematic factors
impacting wealth creation after the announcement
date of a merger or acquisition. Finally, the
relative impact of various independent variables
differ markedly over the three periods for both
bidders and targets. This suggests researchers
must be careful in interpreting their findings
since the different periods employed or emphasized may significantly impact the results and
interpretations.

DISCUSSION

**

p < 0.01, '*+ p

< 0.001

impact of a number of factors. The multi-factor
model employed explained a substantial portion
of the variance in wealth gains reported by
previous studies. The findings of our analyses
provide robust evidence that shareholders gains
are lower in stock-financed transactions for both
bidders and targets. Further, multiple bidders
and conglomerate acquisitions have a negative
impact on the wealth of the bidding firm
shareholders. On the other hand, targets benefit
more in tender offers than mergers, and regulatory changes in 1968 and 1969 benefitted target
shareholders.
Our discussion is arranged in three sections:
(1) a comparison of our results with previous
reviews, (2) the implications of our findings for
practitioners and, (3) a discussion of some of the
larger theoretical issues raised by our conclusions.
A comparison of reviews

In Table 4, we have compared our meta-analytic
This study was based on the hypothesis that results with the conclusions provided in the two
shareholder wealth creation in mergers and previous narrative reviews by Jarrell et al. (1988)
acquisitions is influenced by the simultaneous and Jensen and Ruback (1983). As indicated in

Some univariate r-tests

Selective

1. Announcement period,

Sample selection

Explanatory factors
considered

Explanatory power of
factors

b. Targets

Central findings
a. Bidders

Primarily narrative

General thrust
Statistical tests

declined over time
2. Recent bidders show no gains

1. Returns to bidders have

1. Tender offers
2. Time
3. Sources of gains, defensive
tactics and related issues

Selective

Primarily narrative
Some univariate t-tests

Jarrell, Brickley & Netter

Cannot provide

Cannot provide

1. In completed transactions, gains 1. Targets of completed tender
are higher in tender offers than
offers gain
in mergers
2. Returns have increased in the
2. Targets do not lose in either
1970s and 80s over the 1960s
mergers or tender offers which
are not completed

1. Bidders in completed tender
offers gain
2. Bidders in mergers and bidders
in tender offers which are not

completed do not lose
3. Bidders lose in not completed
mergers

sometimes through completion
date
2. Mergers and tender offers
3. Completed vs. not completed
4. Sources of gains, antitrust,
defensive tactics and related
issues

Jensen & Ruback

Criterion

Table 4. A comparison of merger and acquisition reviews

Can provide: R2, Adjusted R2,
F

1. Bidders don't gain, whether
completed or not
2. Bidders lose in multiple bid
situations and in stockfinanced transactions
3. Bidders gain in nonconglomerate acquisitions
1. Targets gain
2. Returns have increased over
time
3. The gains are more in tender

offers than in mergers
4. Targets lose in stock-financed
transactions

1. Regulatory changes (1969 and
after)
2. Number of bidders
3. Type of transaction (mergers
vs. tender offer)
4. Mode of payment (cash vs.
stock)
5 . Type of acquisition (nonconglomerate vs.
conglomerate)
6. Control variables; source of
sample, contaminated sample,
daily data, and completed vs.
not completed

Comprehensive

Meta-analytic
Multiple regression: Tests of
significance controlling for other
factors

The present study

9

3

P

Wealth Creation from Mergers and Acquisitions
the table, our study is based on a comprehensive
sample of studies, unlike the selective samples
utilized in previous reviews. Further, the set of
factors considered in this study are much more
comprehensive and the use of multiple regression
analysis enabled us to isolate the relative explanatory power of these factors. Taken together, they
testify to the benefits of meta-analytic synthesis
over narrative reviews.
More importantly, some of the conclusions in
this study are significantly different from those
in previous reviews. First, compared to Jensen
and Ruback (1983), our results provide a much
more pessimistic picture of bidder gains from
mergers and acquisitions. Second, Jensen and
Ruback (1983) did not isolate the effects of the
time frames over which returns are estimated.
Our study shows the influence of a narrow 2-day
(- 1,0) announcement period vs. a wider (month
zero) period on the bidder’s gains. Third,
although Jarrell el al. (1988) reported declining
returns to bidders in the 1970s and 1980s (relative
to the 1960s), we found that the decline over
time is not statistically significant. Fourth, while
Jensen and Ruback (1983) found that bidders
gain in completed mergers and lose in not

completed transactions, our results suggest the
distinction between completed and not completed
mergers is of no consequence. Since information
about the eventual outcome at the time of
announcement is speculative, our results are
more consistent with theory and the efficient
market hypothesis.
The extent of convergence among the three
reviews is greater for targets. First, a merger or
acquisition results in significant gains for targets.
Second, when compared to mergers, targets
achieve larger gains in tender offers. Third, our
findings that gains to targets were higher in the
1970s and 1980s compared to the 1960s is
consistent with the observation of Jarrell et al.
(1988).
In addition to the above, our findings emphasize
the importance of the mode of payment (i.e.
cash vs. stock) in mergers and acquisitions. Our
results indicate that both bidders and targets lose
in stock-financed transactions; this is consistent
with both financial theory (e.g. Myers and Majluf,
1984; Krasker, 1986) and empirical evidence (e.g.
Asquith and Mullins, 1986; Masulis and Korwar,
1986). Of all the factors considered, mode
of payment emerges as the most significant

79

explanatory factor in the wealth gains for both

bidders and targets. Additionally, while both of
the previous reviews provide elaboration on
the importance of the competitiveness of the
acquisition market (i.e. number of bidders), our
results suggest this factor is significant only from
the perspective of the bidding firm’s shareholders.
Finally, our results provide modest evidence of
the positive effect of non-conglomerate mergers
on the bidders’ wealth. This finding is consistent
with recent theoretical arguments in the strategic
management literature.
Practical implications
What do our findings imply for practitioners?
First, the results strongly suggest that it is the
targets who benefit in acquisitions: therefore,
from a shareholder wealth creation standpoint it
is better to be a seller than a buyer. More
importantly, our findings highlight that managers
considering acquisitions should be sensitive to
the many factors that are related to wealth
creation. These include regulatory changes in the
macroenvironment, the competitiveness of the
market for corporate control, tactics employed
by the bidder (tender offer or merger), the mode
of financing, and the type of acquisition, all of
which jointly influence the wealth gains to
shareholders. More specifically, target firm managers can maximize gains for their stockholders
by avoiding stock-financed transactions or being
acquired by a bidding firm in an unrelated
industry. Moreover, tender offers should be

preferred over mergers, whenever possible.
From the bidders’ perspective, the findings
suggest they should prefer non-conglomerate over
conglomerate acquisitions. In related acquisitions
they stand to benefit from economies available
through resource sharing and the transferring of
distinctive competencies between bidding and
target firms. Related acquisitions also allow
managers to minimize the risks associated with
acquiring a business in an industry of which they
may have only limited knowledge. Moreover,
bidders, like targets, should avoid stock-financed
transactions. By doing so, managers can send
positive signals to the capital markets. In addition,
use of cash helps speed up the transaction, which,
in turn, might reduce the cost of making the
acquisition. Finally, the findings suggest that
bidding firms should avoid getting involved in

80

D. K . Datta, V. K . Narayanan and G . E. Pinches

acquisitions where multiple bidders are
involved-the increased competitiveness, in such
cases, tends to drive up premiums and lowers
potential gains to bidding firms’ shareholders.
The mode of financing seems to be a particularly important factor for both bidders and
targets. Historically, investment decisions and

financing decisions have been treated as if they
were independent; however, there is emerging
theoretical recognition that these decisions are
often interdependent (Myers and Majluf, 1984;
Ravid, 1988). In acquisitions, which represent
‘investment’ decisions for bidders, our results
indicate the strong influence the mode of payment
has on shareholder wealth gains. This has a larger
implication when one considers that most strategic
decisions are investment decisions (i. e. they
describe the pattern of resource allocation needed
to enhance shareholder wealth) and, hence,
cannot be divorced from the decision about how
to finance them. In turn, this highlights the need
for closer integration between strategic planning
and the financial function of raising funds for an
organization.
Larger theoretical questions
The synthesis of ex ante event studies presented
in this paper provides robust evidence that, on
average, shareholders of bidding or acquiring
firms do not realize significant returns from
mergers and acquisitions. This conclusion is
remarkably consistent with the available evidence
on post-acquisition performance. For example,
Porter (1987), based on an analysis of acquisitions
made by 33 Fortune-500 firms, concludes that
acquisitions have been largely unsuccessful, when
one considers that over half were subsequently
divested. Also, a recent study on post-acquisition

integration by Ravenscraft and Scherer (1989)
concludes that, on average, acquiring firms have
not been able to maintain the pre-merger levels
of profitability of the targets. Finally, in perhaps
the only study that measured performance in
terms of both the actual cost and realized benefits,
Alberts and Varaiya (1989) conclude that postacquisition gains to most bidding firms were not
adequate to cover the premiums paid to acquire
the targets.
The insignificant gains to bidders revealed in
event studies and the pessimistic picture of postacquisition performance of targets leads one to

wonder why firms are interested in acquiring
other firms. Paradoxically, the number of mergers
and acquisitions in the U.S.have remained at
very high levels, with more than 3,400 acquisitions, valued in excess of $230 billion, having
been consummated in 1989 (Mergers and Acquisitions, 1990). A recent study by Walter and
Barney (1990) on management objectives in
mergers and acquisitions identified such objectives to be primarily economic; however, our
findings suggests little economic justification
for mergers from the bidding shareholders’
standpoint. How can we explain the apparent
anomaly that, even in the absence of economic
justification, managers continue to invest time
and their companies’ resources in making acquisitions? This remains an extremely important
issue that needs further rigorous analysis, given
the state of our knowledge about mergers and
acquisitions.
The significant gains to targets in conjunction
with the insignificant gains to bidders have led

some to suggest that, when gains to targets and
bidders are combined, acquisitions are wealth
creating. From a macroeconomic viewpoint one
can argue (as many have done) that acquisitions
channel resources from less to more productive
sectors of the economy. However, this argument
presumes that bidders have incentives to be a
participant in such transactions. We find such
incentives for bidders, at least economic incentives, to be minimal. In other words, we believe
that without an economic rationale for the
bidder’s behavior, macroeconomic claims about
the economic benefits of mergers and acquisitions
suffer from inadequate reasoning.
In the absence of a compelling economic
justification for the continuing high levels of
merger activity, we may need to look at other
factors to explain acquisition behavior. These
include the incentive compensation of managers,
lack of monitoring by board of directors, or as
Caves (1989) has suggested, further examination
of why managers apparently continue to make
estimation errors in valuing targets. Alternatively,
as institutional theorists (e.g. Scott, 1987) suggest,
the acquisition acts of bidders may be modeled
as processes of imitation: a manager does what
other managers do. Most of these are behavioral
and sociological factors which tend to elude the
elegance of economic models. However, given
that they represent potentially important con-

Wealth Creation from Mergers and Acquisitions
tenders in any explanation of the continuing high
level of merger activity, future research should
be directed toward understanding their influence.
There is, obviously, a need for more satisfactory
explanations of why bidders actually undertake
acquisitions.

ACKNOWLEDGEMENTS
Extensive research help provided by Chin Chin
Soh is gratefully acknowledged. The authors also
thank two anonymous reviewers and numerous
individuals who provided comments on an earlier
draft of the paper.

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D . K . Datta, V . K . Narayanan and G. E. Pinches

84

APPENDIX: STUDIES AND NUMBER OF CASES ANALYZED PER STUDY; BY EVENT PERIOD
~

Study
Asquith (1983)
Asquith & Kim (1982)
Asquith, Bruner & Mullins (1983)
Bradley (1980)
Bradley, Desai & Kim (1983)
Bradley, Desai & Kim (1988)
Bruner (1988)
Chatterjee (1986)
Chung & Weston (1982)
Dennis & McConnell (1986)
Dodd (1980)
Dodd & Ruback (1977)
Ekkbo (1983)
Eckbo (1985)
EEkbo & Wier (1985)
Eger (1983)
Franks & Harris (1989)
Franks, Hams & Mayer (1988)
Gupta & Misra (1988)

Gupta & Misra (1989)
Hayn (1989)
Huang & Walking (1987)
Jarrell (1985)
Jarrell & Poulsen (1989)
Keown & Pinkerton (1981)
Kummer & Hoffmeister (1978)
Lewellen, Loderer & Rosenfeld (1985)
Magenheim & Mueller (1988)
Malatesta (1983)
Ruback (1983)
Ruback (1988)
Scalon, Trifts & Pettway (1989)
Singh & Montgomery (1987)
Smiley & Stewart (1985)
Travlos (1987)
Varaiya (1986)
Varaiya & Ferris (1987)
Wansley, Lane & Yang (1983a)
Wansley, Lane & Yang (1983b)
Wansley, Lane & Yang (1987)
Wier (1983)

Bidders
Daily

Monthly
0

-10,