Merger proposals, management discretion and stockholder wealth

Journal

of

Flnanciat

Economics

MERGER

8

(1980) 105 137. 0

North-Holland

Publl\hlng

Cornpan)

PROPOSALS, MANAGEklENT DISCRETION AND STOCKHOLDER WEALTH* Peter DODD

I. Introduction ,A Inci-gcI- IS a transaction in which one corporatic~n (the bid&x) xcures title the outstanding shares or assets of another (the target).’ All state corporate codes require that merger proposals be appro\cd by h<~ldcrs of a majority of the outstanding shares of the target firm. The percentage of favorable votes required to appro\o the merger varies across the different state corporate codes but at least a simple majority (ix.. more than 50 percent) is required and generally it is 66; percent.’ Moreowr. the merger proposal must be approved by the board of directors of the target firm Lvhich then puts the proposal to a stockholder \‘otc. In effect. the board has the power to veto all merger proposals and can refuse to put any proposal to a stockholder vote.’ to

‘Either

the

target

or

the

bidder

can

sohut

the

merger

and

It

combine \GI the merger 10 form a third firm. ‘Msrtmdale Huhhctl (1974) provide dcta~lcd bummarws ot approval of merger proposal5 In the various htate corporate code>. -‘See Smah and Robertson (1977. p. x70).

oh powbte thz

kg31

that

the

,wo

requlrcmcnl\

firm\ tor

106

P. Dodd,

Mergers

and stockholder

wealth

A consequence of the veto power of incumbent management is that merger proposals become discretionary decisions delegated to management by stockholders. Stockholders must vote to approve or reject any merger proposals that management recommend but do not get an opportunity to approve merger proposals that management reject. The response of incumbent target managements to merger proposals provides an opportunity to assess the extent to which they act to maximize the value of stockholder equity. Usually merger proposals involve an offer to purchase the target shares at a price substantially above the pre-proposal maket price and stockholders of acquired firms receive large capital gains in mergers.4 In one sense then, management’s rejection of a merger proposal can be interpreted as a refusal to allow stockholders to sell their shares for more than the market value. However, it is also possible that management can oppose an acquisition proposal while still acting in the stockholder’s interest. Bradley (1979) suggests that management rejection of an acquisition proposal can be interpreted as an attempt to maximize the premium received by target stockholders. Incumbent management is holding out for a higher offer from with the target the bidding firm which most highly values a combinatic, firm. The results of both Bradley and Dodd and Ruback ( j77) indicate that, following rejection of a tender offer, the market price of target shares, on average, does not fall back to its pre-offer level. However, unlike mergers, tender offers do not involve the veto power of incumbent management. In tender offers, the bidder invites target stockholders to tender their shares for a specified amount of cash or securities. The decision to accept or reject the offer is made by each individual stockholder and the success or failure of the offer depends upon the proportion of stockholders tendering their shares. 5 In merger proposals, the target board of directors has the discretion to accept or reject the proposal and stockholders get the opportunity to decide the outcome of the proposal only if management puts it to a vote. The veto power of the incumbent target management has implications for issues beyond that of management/stockholder relations. Economists have been interested in mergers both as investment decisions of bidding firms and as vehicles for changing control of target firms. The relative impact of mergers on stockholders of both acquiring and acquired firms has been a “Halpern (1973) reports that the average premium to acquired stockholders found in SIX studres is 22.7 percent. Mandelker (1974). Ellert (1976) and Langtieg (1978) hnd stockholders of acquired firms earn large, abnormal positive returns from mergers. 51n tender oNers the incumbent managers are formally involved only to the extent that they are also stockholders. However, incumbent target management typically announces its approval or disapproval of the offer and sometimes expends resources trying to prevent the offer from being successful. There is a variety of tactics. These usually involve attempts to have the offer delayed, deferred, or prohibtted by the courts, regulatory agencies or state legislatures. In the absence of such outside Interference. the outcome of the offer is independent of the incumbent management’s attitude.

P. Dodd, Mergers

und stockholders

we&h

107

popular topic of research. In these studies, however. only completed mergers have been considered and merger proposals that are rejected by either the incumbent board of directors or the target stockholders have been ignored. Accurate estimation of the market response to mergers requires use of the date of first public announcement of the proposal. In studies relating mergers to stock prices, Mandelker (1974), Ellert (1976). and Langtieg (1978) all select the ‘effective date of merger’ as the announcement date. This is the date of final approval by target stockholders and Mandleker reports that over 85 percent of the acquired firms in his sample are delisted in that month. Typically a public announcement of negotiations and proposed terms is made well before the date of final approval. It is this earlier date that is of critical importance in studies of market reaction. By the date of final approval of the acquisition, most of the information of the merger has been released. To assess the impact of both accepted and rejected merger proposals on stockholder wealth, a sample of such proposals for New York Stock Exchange (NYSE) listed firms was collected. In the next section the sample of merger proposals is described together with the methodology used in this study to isolate the impact of merger proposals on stockholder wealth. The results of the study are presented in section 3 and are interpreted in section 4. The conclusions of the paper are presented in section 5.

2. Data and methodology 2.1. Data The data used in this study consist of a sample of public announcements of proposals to acquire, by means of merger, NYSE listed firms during the seven years ended December 31, 1977. The sample includes all completed mergers (i.e., where a NYSE firm is delisted) and all proposals that were later cancelled, which are reported in the financial press (including the Wall Street Journal, Moody’s Industrial Manual, and Standard and Poor’s Corporation Records).

By design, the sample consists of acquisition proposals which are initially announced in the form of a merger. The sample does not include merger proposals that were preceded by a tender offer and does not include ‘defensive’ mergers where a target firm finds a merger partner in response to a tender offer by a third firm. There were 151 merger proposals during this time period. Of these, 71 were completed and 80 were cancelled after the initial announcement. The firms are classified as either bidders or targets. For each proposal, the target firm is defined to be the firm whose stockholders would be required to transfer ownership of their shares if the merger is completed. For the 71

completed mergers, 60 of the bidder firms are NYSE listed and of the 80 cancelled merger proposals, 66 of the bidder firms are NYSE listed. Daily stock returns for all these firms are available on the stock price tapes of the Center for Research in Security Prices (CRSP) at the University of Chicago. For all 151 merger proposals, the date of the first public announcement was collected. This date is the day the proposal is first mentioned in the kV’ct/l Street Journc~l. For the completed mergers the date of the public announcement of (A) the final approval of the merger by target stockholders was also collected; and for the cancelled merger proposals (B) the date of public announcement of the termination of negotiations was collected. The summary statistics of the elapsed time in trading days between these announcement dates is presented below.

(A) 71 completed merger proposals (B) 80 cancelled merger proposals

Mean

Range

102 4s

19 to 261 1 to 285

2.2. Mrthodologq

The basic methodology

R,, = A,

+

@,,

of the study involves +

use of the market

model6

f,,

where

=rate of return of security ,j over period r (period t is one day for this discussion), WV?, =rate of return on a value weighted market portfolio over period t, ‘Xi =E(aj,--PiE(R”,), _ =disturbance term of security j at period t, and E(L,) =O. =cov (Rj,, RImr)/var (I?,,). 'jr

The disturbance term. cj,. is interpreted as a measure of the abnormal return to stockholders of firm j for period t. It is an abnormal return in the sense that it represents the deviation of the return on the security from its expected return, given the return earned by the market index during that period. That part of the return to security j represented by /jjB,t is presumed to be caused by market wide or common variables and the disturbance term captures the effects of firm specific variables. When a group of firms experiences the same economic event, such as a merger proposal, the average disturbance of the group is interpreted as capturing the economic impact of that event. ‘See Fama

(1976, pp. 63S132) for a discusslon

of this model.

P. Dodd. hlrrgers

und stockholder

weulrh

109

one event under analysis is the For the sample of merger proposals, announcement of the proposal. The abnormal performance of these firms relative to the date of first public announcement is calculated using the market model (1). Prediction errors for each firm j, PE, are calculated for each day 1 of interest around the date of announcement of the merger proposal, where PE, = Rj, - 3ij - jjR,,

The prediction errors PE, are estimates of the abnormal returns to the stockholders of the firms involved in the proposals. The coefficients dj and fi, are estimated using data from a period outside of (i.e.. not including) the period of interest around the announcement of the merger proposal. For the results presented below. the coefficients are estimated over a maximum of 300 and a minimum of 100 days around the date of announcement, but always excluding the period for which prediction errors are calculated. In all tests, different estimation periods were tried and in no case are the results and conclusions of this paper altered. The market model (1) is applied to all firms in the sample and prediction errors PE, are calculated for each day t relative to the event date (zero). An average prediction error for each day t is calculated as

where N is the number of firms which have prediction errors in day t. These average prediction errors are summed over event time (t = - 50,. ., 0,. .. f 50) to obtain cumulative average prediction errors (CPE ).

3. Results

The average (PE) and cumulative average (CPE) prediction errors of returns to stockholders of firms involved in merger proposals are presented in table 1 and fig. 1 for the 40 days before and after the first public announcement (day zero) of the proposal. The firms are classified as either bidders or targets and the sample of 151 announcements includes both proposals that are later approved (71) and those that are later cancelled (80). The striking aspect of the results is the large positive abnormal return earned by stockholders of the target firms on the day of the announcement of the proposal and the day before. The average prediction error on day 0 is 4.30 percent and on day - 1 is 8.74 percent. To determine whether the

110

Fig

P. Dodd, Mergers

and stockholder

wealth

1a. Percentage daily average and cumulative average prediction errors for 151 target firms for 40 days before and after the first public announcement of a merger proposal.

P. Dodd, Mergers

DRYS RELRTIVE

Fig.

and stockholder

TO FINNCllJNCE&i?

CIF HE%&

weulth

Pf&%L

33.m

u0.m

lb. Percentage daily average and cumulative average prediction errors for 126 bidder firms for 40 days before and after the first public announcement of a merger proposal.

Table

1

Percentage dally average (PE) and cumulatlre average (CPE) prediction errors for 151 furyer and 126 bidder firms for 40 days bcforc and after the first public announcement of a merger proposal. 151 targets Day ___

126 hlddcrs

-_-

._

C’PE ~._~

Day -40 -35 -30 -25

0.44 -0.17 0.06 0.60

0.44 0.96 1.87 3.01

C’PE

- 40 - 35 -30 -25

0.04 0.43 0.26 0.44

0.04 I .22 2.20 2.43

-20 - 19 -IX - 17 - 16 -15 -- 14 -13 -12 -11 -10 - 9 - 8 - 7 - 6 - 5 -4 - 3 - 2 - I 0

0.4x 0.02 0.40 0.39 0.02 0.50 0.4 I 0.17 0.36 -- 0.27 0.34 1.01 0.67 0.51 0.8 1 0.52 0.48 0.59 1.66 8.74 4.30

2.62 2.64 3.04 3.43 3.45 3.95 4.36 4.53 4.89 4.62 4.96 5.97 6.64 7.15 1.96 8.48 8.96 9.55 1 I.21 19.95 23.42

-20 -19 -1X - I7 - 16 -15 - 14 -13 - 12 -11 -IO ~ 9 - 8 ~ 7 - 6 ~ 5 ~~ 4 - 3 ~ 2 ._ 1 0

-0.15 - 0.06 0.28 0.36 0.25 0.3 I 0.22 -0.18 0.20 0.00 0.4 I 0.13 0.12 0.14 0.14 0.43 0.44 0.07 0.09 --0.54 - 0.62

3.1x 3.12 3.40 3.16 4.01 4 32 4.54 4.36 4.56 4.5x 4.97 5.10 5.22 5.36 5.50 5.93 6.37 6.44 6.53 5.99 5.31

1 2 3 4 5 6 I 8 9 IO II 12 13 14 15 16 17 18 19 20

-0.83 -0.13 0.24 -0.17 - 0.09 -0.15 0.2x 0.00 -0.10 -0.19 0.09 ~ 0.48 ~ 0.09 -0.21 0.19 0.46 ~ 0.22 0.30 0.02 0.05

23.42 23.29 23.53 23.36 23.27 23.12 23.40 23.40 23.30 23.1 I 23.20 22.72 22.63 22.42 22.61 23.07 22.85 23.15 23.17 23.22

1 2 3 4 5 6 7 Y 9 I0 I1 12 I3 14 15 16 17 18 19 20

~ 0.23 0.09 0.09 -0.37 - 0.09 0.19 0.08 0.1 I 0.09 0.06 0.10 0.04 - 0.05 -0.12 -0.17 0.17 0.17 -0.13 0.16 -0.19

5.14 5 .2 3 5 32 4.95 4.86 5.05 5.13 5.24 5.33 5.39 5.49 5.53 5.48 5.36 5.19 5.36 5.53 5.40 5.56 5.37

25 30 35 40

-0.01 0.10 - 0.26 0.06

22.41 22.30 21.34 21.43

25 30 35 40

0.09 0.02 -0.21 0.0 I

5.83 5.99 4.99 5.17

“Day Street

____

0 is the day Journal.

the merger

proposal

is reported

in the W’u/l

P. Dodd.

average prediction errors test statistic is calculated:

Mrrgm

md

stockholder

are significantly

113

weulfh

different

from zero, the following

t = PE,Ia,,. where i?!?, is the average

prediction

error for day T, and

with .4PE =

1

PE,,/‘lOO.

The t statistic for the abnormal return to target shares on day 0 is 11.71 and on day - 1 is 23.80. An alternative approach to estimate the significance of these abnormal returns is to standardize each firm’s prediction error by the square root of the forecast variance for that day.’ Across the 151 target firms the abnormal return at day 0 is, on ai’erage. 5.60 standard deviations above zero and for day - 1 it is 10.99. It is important to note that while day 0 is defined as the date of announcement there is reason to believe that the accurate date is in fact day - 1 for some firms in the sample. Day 0 is the date the announcement is published in the WU// Str.ret Jou~r~l. Some of these reported announcements are released to the press during trading hours the day before and it is expected that any information in the announcement is reflected in the market prices of that day (day - 1). Other announcements are released after the close of trading on the day before the publication in the IZ;trl/ .SIWV~Jo~rr~rrl and any information in these announcements is reflected in the market prices of day 0. It follows that the market reaction to the announcement is represented by the 2 day abnormal return at days - 1 and 0. In contrast to the target firms. there is no evidence in table 1 of any average prediction error of similar magnitude for bidder firms around the time of the announcement of the merger proposal. In fact, the evidence indicates a small but significantly negative return to bidding firms. The ‘The prediction error of each firm ,j on each day T. PE,, IS deflated by the qunre forecast variance OX, where

(R,,

-Rm,2ji (R,; 1,=I

R,)’

,

and 0: is the residual variance of firm over 7‘days in the estlmatton

period.

root of 11s

114

P. Dodd,

Mergers

and slockholder

wen/th

abnormal return at day 0 is -0.62 percent which is on average 0.85 standard deviations below zero and which has a t statistic of -2.83. At day - 1 abnormal return is -0.54 percent which is, on average, 0.61 standard deviations below zero and which has a t statistic of -2.46. Over the 81 days around the announcement of the proposal these are the largest (in absolute value) average prediction errors. The results in table 1 are for the total sample of announcements of merger proposals. Of the 151 proposals, 71 are later completed and 80 cancelled. The abnormal returns to stockholders of these firms are presented in tables 2 and 3 and figs. 2 and 3. respectively. Stockholders of target firms in both completed and cancelled merger proposals earn large, positive abnormal returns on the day of first public announcement of the proposal. In table 2 the average prediction error is 3.41 percent at day 0 and 10.00 percent at day - 1 for targets in completed merger proposals. These abnormal returns are 4.44 and 12.75 standard deviations, on average, from zero and have t statistics of 8.56 and 25.10, respectively. For the cancelled proposals the average prediction errors in table 2 are 5.01 percent at day 0 and 7.72 percent at day - 1. These are 6.54 and 9.59 standard deviations above zero with t statistics of 9.64 and 18.45, respectively. In both completed and cancelled merger proposals, the abnormal returns to stockholders of bidding firms are different from those earned by stockholders of target firms. For completed mergers the average prediction error in table 3 is -0.20 at day 0 and -0.89 at day - 1. These are 0.34 and 1.03 standard deviations below zero on average, with t statistics of -0.77 and -3.46. In cancelled merger proposals, the average prediction error is - 1.01 percent at day 0 and -0.23 percent at day - 1, with L statistics of -3.02 and -0.69. Again, the day 0 abnormal return is the absolute largest over the 81 days and is on average 1.31 standard deviations below zero.

3.2. Market

reaction to the announcement

of the outcome of merger proposals

For both subsamples of completed and cancelled merger proposals there are at least two important announcement dates. At the date of first public announcement of the merger proposals, the outcome of the proposal is uncertain and is not resolved until there is an announcement of termination of negotiations or an announcement that the merger has been approved. It is at this second date that all the uncertainty is finally resolved* and this should be reflected in the market reaction to that announcement. The abnormal returns around the date of the announcement of the

‘Even after stockholders have approved the merger there is a possibility that the merger will be challenged by the Federal Trade Commission or Department of Justice. Ellert (1976) discusses these mergers in detail.

Table 2 Daily average (PE) and cumulative average (CPE) prediction errors for 151 target firms in 80 cancelled and 71 completed merger proposals

for

40

days

before

and

after

announcement

of

the

71 completed

80 cancelled Day

CPE

Day

CPE

-40 -35 -30 -25

~ 0.06 0.42 -0.01 0.50

- 0.06 1.05 1.19 2.25

-40 -35 -30 -25

-20 - 19 -18 -17 - 16 -15 -14 ~ 13 - 12 -11 - 10 -9 ~ 8 - 7 ~ 6 - 5 -4 ~ 3 - 2 - 1

0.33 0.1 I 0.16 0.41 0.36 0.11 0.96 -0.22 0.45 -0.40 0.59 1.62 1.13 0.51 0.65 0.44 0.52 0.16 1.83 7.72 5.01

2.39 2.50 2.66 3.07 3.43 3.54 4.50 4.28 4.73 4.33 4.92 6.54 7.67 8.18 8.83 9.27 9.79 9.95 11.78 19.50 24.51

_ 20 - 19 ~ 18 -17

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

-0.79 - 0.48 - 0.48 -0.38 PO.33 -0.35 0.21 0.13 -0.35 -0.52 -0.14 - 1.38 -0.22 0.16 - 0.03 0.5 1 - 0.47 0.11 0.15 - 0.24

23.72 23.24 23.12 22.74 22.41 22.06 22.27 22.40 22.05 21.53 21.39 20.01 19.79 19.95 19.92 20.43 19.96 20.07 20.22 19.98

1 2 3 4 s 6 7 8 9 10 II 12 13 14 15 16 17 18 19 20

0.27 0.65 0.07 0.17 0.08 0.37 -0.15 0.19 0.17 0.35 0.52 0.05 -0.62 0.44 0.41 0.06 0.52 -0.13 0.38

23.14 23.41 24.06 24.13 24.30 24.38 24.75 24.60 24.79 24.96 25.31 25.83 25.88 25.26 25.70 26.11 26.17 26.49 26.56 26.94

25 30 35 40

-0.30 0.25 -0.55 0.18

18.40 17.27 15.24 15.65

25 30 35 40

0.3 1 - 0.07 0.08 - 0.09

26.96 28.00 28.76 27.97

0”

_

“Day 0 is the day srrrrt Journal.

the merger

0.15 0.44 0.56 0.37

0.15 1.41 3.34 2.62

0.64 -0.09 0.67 0.36 -0.37 0.93 - 0.20 0.60 0.26 -0.12 0.06 0.35 0.17 0.51

2.x7 2.78 3.45 3.81 3.44 4.37 4.17 4.77 5.03 4.91 4.97 5.32 5.49 6.00 7.00 7.61 x.05 9.13 10.60 20.60 24.01

I .oo 0.61 0.44

I .0x 1.47 10.00 3.4 I

proposal

- 0.87

is reported

m the Wall

8 d 7

Fig.

I

40.00

2.

-3o.m

-am

OATS RELATIVE

-4o.m

0.00

10.00

I

al.00

TO FINNOUNCEMENT OF MERGER PACIPOSRL

a.00

w.00

Dally average and cumulative accrage predictlvn errors for X0 r~rrgrr firms in c~~r~wr//n/ merger proposals for 40 days before and after announccmcnt of the proposal.

P. Dodd,

Mergers

und stockholdrr

nrulrh

I17

I I I I

/

Fig. 2b. Dally average and cumulative average predlction errors for 71 turgrt firms I” complc~rd merger proposals for 40 days before and after announcement of the proposal.

118

P. Dodd, Mergers

and stockholder

wealth

Fig. 3a. Daily average and cumulative average prediction errors for 66 bidder tirms in cancelled merger proposals for 40 days before and after announcement of the proposal.

P. Dodd,

Fig.

3b.

Mergers

und stockholder

weulth

119

Daily average and cumulative average prediction error5 for 60 bidder firms 111completed merger proposals for 40 days before and after announcement of the proposal.

Table

3

Daily average (B) and cumulative average (CPE) predxtmn for 126 bidder lirms in 66 cancelled and 60 completed proposals for 40 days before and after announcement proposal 66 cancelled

60 completed

errors merger of the

-. FE

(‘PE

2.65

-40 -35 -30 -25

0.33 PO.18 0.04 0.72

0.33 0.78 2.14 3.41

- 0.40 ~ 0.07 0.55 0.52 0.33 0.42 0.42 -0.22 0.46 PO.43 0.59 0.14 0.27 0.30 0.22 0.55 0.52 0.06 0.04 -0.23 ~ 1.01

2.27 2.20 2.75 3.27 3.60 4.02 4.02 4.32 4.78 4.35 4.94 5.08 5.35 5.65 5.87 6.42 6.94 7.00 7.04 6.81 5.80

-20 - 19 - IX - 17 - 16 - 15 - 14 -13 -12 -II - 10 -9 - 8 - 7 .._ 6 - 5 -4 - 3 - 2 - I 0

0.1 1 - 0.05 .- 0.02 0. IX 0.17 0.18 0.1 I -0.14 ~ 0.09 0.48 0.22 0.11 - 0.04 ~ 0.04 0.06 0.30 0.36 0.07 0.14 -0.89 -0.20

4.70 4.15 4.13 4.31 4.48 4.66 4.55 4.41 4.32 4.80 5.02 5.13 5.09 5.05 5.11 5.42 5.77 5.84 5.98 5.09 4.89

1 2 3 4 5 6 7 x 9 10 11 12 13 14 15 I6 17 1X 19 20

-0.21 0.09 0.17 - 0.67 -0.26 -0.1X 0.06 - 0.06 - 0.03 0.06 - 0.07 - 0.01 - 0.03 -0.21 0.07 0.16 0.31 -0.57 0.79 0.06

5.59 5.68 5.85 5.18 4.92 4.74 4.80 4.74 4.71 4.77 4.70 4.69 4.66 4.4s 4.3x 4.54 4.85 4.2X 5.07 5.13

1 2 3 4 5 6 I 8 9 10 11 12 13 14 15 16 17 18 19 20

PO.26 0.20 0.00 - 0.05 0.09 0.59 0.11 0.29 0.21 0.06 0.28 0.10 - 0.07 - 0.03 ~ 0.28 0.18 0.01 0.3s PO.53 -- 0.47

4.63 4.73 4.13 4.68 4.77 5.36 5.47 5.76 5.97 6.03 6.3 1 6.41 6.34 6.3 I 6.03 6.21 6.22 6.57 6.04 5.57

25 30 35 JO

0.22 -0.17 -0.27 0.0x

5.64 5.40 4.05 4.34

25 30 35 40

~ 0.06 0.21 PO.14 - 0.06

6.04 6.64 6.03 6.07

Day

T%

CPE

Day

-40 -35 -30 -25

0.53 -0.17 0.08 0.49

0.53 1.13

20 19 IX -17 -16 -15 ~ 14 -13 - 12 -11 ~ IO -9 - 8 - 7 -6 - 5 -4 - 3 - 2 - 1 0”

1.63

__.-

.‘Day 0 IS the day J0UrlUl.

the merger

is reported

In the

W&l Srrwr

P. Dodd. Merger.\

und .\rockholt/er wulth

121

outcome of the proposals are presented in tables 4 and 5 and figs. 4 and 5. Day 0 for the completed mergers is the date of announcement of the approval of the merger by the target stockholders and for the cancelled proposals it is the date of announcement of the termination of the merger negotiations by either or both boards of directors. The final approval of the merger by stockholders has little impact on the value of the shares of either the target or bidder firms. The average prediction errors for both samples are reported in table 4 and fig. 4. The average prediction error at day 0 is 0.08 percent for targets and -0.33 percent for bidders. At day ~ 1 it is 0.68 percent for targets and -0.06 percent for bidders. Although the prediction error for targets at day - 1 has a t statistic of 2.58, it appears that most of the uncertainty as to the completion of the merger has been resolved before the final stockholder vote. This is not surprising. Of the total of 151 merger proposals, there is no case where stockholders voted to reject the proposal. The rejections that occur are announced ty one or both of the managements during the negotiations before stockholders \ote. If stockholders seldom reject a proposal, the uncertainty as to the outcome is rcsol\ed \\hcn both boards of directors agree or disagree. It is difficult, however. to Isolate this date of appro\ al since a number of examples are found whcrc both boards announce dcfinitii I: agreements to merge. yet later terminate the proposals. Wh11e It is difficult to isolate the timing of the resolution of uncertainty. it is possible to estimate the magnitude of the market reaction to rc\,isions of this uncertainty by cumulating the abnormal returns to target firms in cnmpletcd mergers from the date of first announcement to the date of final appro\ al. Since the period between the first announcement of the proposal and the date of final approval varies across the 71 proposals. no one particular a\eragc prediction error reflects the average market reaction to the resolution of uncertainty. The average cumulative post announcement abnormal return is. however, interpreted as reflecting the market’s reaction to revisions of this uncertainty.” The mean cumulative abnormal return from the date of first announcement of the proposal until final approval by stochholders is 11.20 percent. The market reaction to the announcement of the termination of merger proposals is presented in table 5. The abnormal returns to target stockholders dominate the analysis again. On the day of publication of the termination announcement in the Wtrll Srrcvr Jo~rrrltrl. day 0. stockholders of target firms earn a negative abnormal return of - 4.52 percent and - 4.16 percent “The cumulative abnormal return for firm ; from day + 1 after the first public announcement of the proposal through the day of stockholder approval. day k. IS calculated a~

Thl% procedure allows for the compoundlng

of the abnormal

return5

122

P. Dodd,

Mergers

und stockholder

~,eu/th

Fig. 4a. Daily average and cumulative average prediction errors for 71 tcrrgrr firms in completrd merger proposals for 40 days before and after the announcement of stockholder approval of the proposal.

123

-a.m ‘-w-m OAYS RELRTIVE

-za.m -to.m TO STOCKHOLDER

0.00 1o.m za.m a.00 FlPPRClVFlL Cl+- MERGER PRBPOSQL

Fig. 4b. Daily average and cumulative average prediction errors for 60 completed merger proposals for 40 days before and after the announcement approval of the proposal.

bidder firms in of stockholder

Table

4

Daily avcragc (PE) and cumulative average (CPE) prediction error5 for 60 hddrr firms and 71 rurgcl firms in completed merger proposals for 40 days before and after the announcement of stockholder approval of the proposal 60 bidders

71 tar@\ Day

1%

-40 -35 -30 -25

0.15 0.01 0.17 0.1 I

0.15 -0.17 0.85 2.42

-0.12 0.37 -0.01 -0.12 -0.10 0.25 0.06 -0.40 0.61 0.39 - 0.05 0.30 ~ 0.0x -0.0x 0.04 0.28 -0.37 0.30 0.0x 0.68 0.08

3.06 3.43 3.42 3.30 3.20 3.45 3.51 3.1 I 3.72 4.1 I 4.06 4.36 4.28 4.20 4.24 4.52 4.15 4.45 4.51 5.21 5.29

“Day reported

C’PE

0 is the day the stockholder in the WaH Strert Journal.

0.2 I 0.05 0.07 0.26

0.21 0.23 0.66 I .20

-20 -19 -18 -17 - I6 - I5 - I4 - 13 -12 -II -10 _ 9 - x - 7 - 6 - 5 - 4 .- 3 - 2 - I 0”

-0.10 -0.19 -0.21 -0.50 0. I2 -0.10 - 0.00 0.05 0.04 0.09 0.33 0. I 1 -0.17 -0.31 -0.10 0.00 -0.15 -0.57 - 0. I6 - 0.06 - 0.73

I .56 1.37 1.16 0.66 0.78 0.68 0.6X 0.73 0.77 0.X6 I.19 1.30 I.13 0.82 0.72 0.72 0.57 0.00 0. I6 ~ 0.22 ~ 0.45

I 2 3 4 5 6 7 x 9 I(, II I? 1; 14 15 16 17 I8 I9 20

0.03 0.25 0.3x - 0.25 0. I7 0.27 0.27 -0.26 -0.12 - 0.08 0 34 - 0.17 - 0.20 - 0.06 0. IO 0.23 -0.13 0.01 0.05 0.02

-~0.42 -0.17 0.2 I - 0.04 0.0x 0.35 0.62 0.36 0.24 0.16 0.50 0.33 0.13 0.07 0.17 0.40 0.27 0.28 0.33 0.35

25 30 35 40

0.13 - 0.34 0.14 0.46

0.82 0.53 1.57 2.26

-40 -- 35 - 30 -25

approval

of the merger

IS

returns are on average 6.44 and 5.53 standard onday -1. ‘” These abnormal deviations below zero with t statistics of - 10.39 and -9.56, respectively. For all firms, the terminations are published in the W’lrll Strec’t Jo~rrr~u/ on day 0, but for some firms the announcement of the termination is made to the NYSE before the close of trading on day - 1. Therefore, the earlier interpretation of the two-day abnormal return is relevant here also. In contrast to the target firms, there is evidence of slight positive abnormal returns to stockholders of bidder firms in cancelled mergers. The average prediction error is 0.18 percent at day 0 and 1.06 percent at day - 1. This latter abnormal return is, on average, 1.31 standard deviations from zero and has a t statistic of 3.50.

4. Interpretation 4.1. Merger

of the results

propo.sa/s

und munagcmrnt

discrctiorl

Incumbent target management has a veto power over all merger proposals. It has the discretion to decide whether or not to submit a proposal to a stockholder ljote. Of the 151 merger proposals used in this study. 71 were submitted by management to a stockholder vote and all 71 were approved by stockholders. The remaining 80 proposals were cancelled before stockholders had an opportunity to vote. The sample of rejected merger proposals provides an opportunity to test in this particular decision, is acting in the best whether management, interests of stockholders. Target stockholders earn relatively large capital gains from the premiums offered in proposed mergers. However. the market, on average, interprets the cancellation of proposed mergers as not being in the stockholders’ interests. Table 5 shows that target stockholders earn significantly negative abnormal returns of -8.68 percent at the time of announcement of the termination of merger negotiations. Therefore, target stockholders are hurt by the cancellation of the merger proposal. The evidence in table 5, however, does not confirm that managers are acting to the detriment of stockholders when they reject merger proposals. To draw that conclusion. the market reaction to rejections by target firm managers must be distinguished from the market reaction to terminations by bidder firm managements. For instance the results in table 5 may be fully explained by the market reaction to termination by bidders who find that they initially bid too high for the target firm. To address this issue the ‘“When estimating the reaction to the announcement of the termmatior,. allowance IS made for the earlier positix abnormal returns around the date of the first public announcement. The mean period between the two announcements is 45 days and for 26 firms It IS longer. The coefficients of ai and fl, are estimated from a period 150 days prior to the termination so as not to impound this prior abnormal performance into the estimates.

126

P. Dodd, Mergers

and stockholder

wealth

Fig. 5a. Daily average and cumulative average prediction errors for 80 target firms for 40 days before and after the announcement of the terminationof merger proposals.

P. Dodd, Mergers

and stockholder

Fig. 5b. Daily average and cumulative average before and after the announcement

wealth

127

prediction errors for 66 bidder firms for 40 days of termination of merger proposals

Table5 Daily average (m) and cumulative aceragc (CI’E) predictjon errors for 80 turger and 66 hi&r firms for 40 days before and after the announcement of the trrvlinu!i~ut of merger proposals.

x0

targets

66 bidders

Day

(‘PE

Day

7%

- 40 35 -- 30 ~ 25

0.87 -- 0.4 I ---0.35 ~ 0.03

0.87 m-o.73 ~~ 0.68 - 0.23

-0.3x ~ 0.01 0.3X 0.28 - 0.78 0.09 -0.50 0.14 - 0.10 0.39 0.03 -0.39 -0.26 - O.U2 -0.06 0.12 ~ 0.02 0.08 0.61 I .Oh O.IX

-0.55 ~ 0.56 -0.18 0. IO -0.6X - 0.59 ~- I .09 -0.95 I .05 0.66 - 0.63 --- I .02

<‘PE

-40 -35 - 30 -25

0.26 0.X O.Y7 0.68

0.26 1.36 4.18 6.19

-20 - 1’) -18 -- 17 ~ 16 -15 ~ 14 -13 -12 -11 - IO ~ 9 x

0.22 -- 0.0s 0.1 I 0.32 0.15 -0.28 0.39 0.51 0.79 0.5x 0.33 0.93 0.62 0.0 I

0.14 0.29 0.12 -4.26 -4.52

6.00 5.95 6.06 6.3X 6.53 6.25 6.64 7.15 7.94 x.52 8.85 9.7x IO.40 IO.41 IO.56 10.29 10.15 10.44 10.56 6.40 1.88

; 4 5 6 7 8 Y 10 II 12 13 14 IS 16 17 18 1Y 20

0.57 0.44 - 0.44 -0.15 0.27 0.40 0.68 - 0.60 - 0.04 0.00 -0.27 - 0.30 0.18 ~ 0.34 0.16 0.05 -0.12 -0.50 0.12 0.08

2.45 2.89 2.45 2.30 2.57 2.97 3.6.5 3.05 3.01 3.01 2.74 2.44 2.62 2.28 2.44 2.49 2.37 1.87 I .99 2.07

2 3 4 5 6 7 8 Y IO I1 12 13 14 15 16 17 18 19 20

- 0.36 ~~ 0.19 -0.16 -0.33 0.14 ~ 0.02 -0.23 ~ 0.50 0.25 m~o.57 0.17 0.16 ~ 0.20 ~ 0.20 0.20 ~ 0.02 - 0.40 --0.19 0.36 - 0.09

0.04 0.37 ~ 0.23 0.25 0.48 -~ 0.98 --0.73 - 1.30 - 1.13 -0.97 - 1.17 - 1.37 - 1.17 - 1.19 - 1.59 - 1.78 - 1.42 - 1.51

25 30 35 40

0.27 0.80 ~ 0.29 -0.29

I .96 3.39 3.62 4.36

25 30 35 40

0.05 1.12 -0.37 ~~ 0.08

- 1.01 - 0.95 - 0.49

0.15 ~ 0.27

I ,

“Day reported

0 is the date the termination in the Wull Strwt JournaL

I

of

merger

1.28 1.30 1.36 ~~ I .24 ~ I .26 - I .48 -- 0.57 0.49 0.67

I 0.12

0.3

_

negotiations

1.76

IS

sample of cancelled merger proposals is classified on the basis of whether the target or bidder management terminated the negotiations. From the published announcements of the terminations in the Wull Street Jourr~nl, it appears that 26 of the 80 cancellations are the sole responsibility of target managements. In these cases, the announcements of termination indicate that target management vetoed the proposal. In the remaining 54 proposals, either bidder managements broke off the negotiations. or it is not possible to determine from the announcements which party was responsible for the termination.” It is important to note that the classification of the cancelled mergers is made purely on the basis of the published announcement reported in the Wnll Street Jourrzal. In general these announcements are only brief statements with few details of the negotiations or the cause of the breakdown. Once the merger proposal has been initiated, the two managements engage in a bargaining process. The target management can, as in the 26 cases in this sample, use its power of veto and reject the proposal outright. However, the same effect can be achieved by demanding too high a price from the bidder. This price consists of both the exchange consideration offered to target stockholders and also any side payments to the incumbent management.” If the bidder refuses to pay the incumbent’s price. the negotiations may be terminated at the apparent behest of bidder management or with no statement as to the cause of the breakdown. For the 26 proposals, however, it is evident that incumbent management applied its veto power to the proposal. The market reaction to the announcement of the termination for the two classes of cancelled merger proposals is presented in table 6. The results for 26 proposals cancelled by target managers are presented in column A. and for the other 54 proposals in column B. In contrast to the results for the overall sample of 80 cancelled merger proposals, there is a smaller negative market reaction to terminations by target managements. In column A of table 6 the cumulative average prediction error is 21.13 percent over days - 40 through - 2. The average prediction errors at days - 1 and 0 are - 1.63 percent and - 3.94 percent, with t statistics of -3.75 and -9.06, respectively. This market reaction of -5.57 percent is less than the -8.68 percent reported in table 5 for the total sample of cancelled proposals and the -9.75 percent reported in column B of table 6. For the 26 firms where incumbent managements veto the proposals, however, the negative abnormal returns at the time of announcement of the “Only

9 cases of bidder terminations were found. “Manne (1966) notes that the >eto power of incumbent management encourages side payments. The side payments can be in the form of future consultmg contracts or guaranteed employment after the merger.

Table

6

Percentage daily average (E) and cumulative average (CPE) prediction errors for 40 days before and after the announcement of the termination of merger proposals by (A) target and (B) non-target management. (A) Terminated (N=26)

I%

Day -40 -35 -30 -25

proposals

(B) Terminated (N =54) CPE

-

proposals

Day

IT

CPE

-40 -35 -30 -25

0.27 0.70 1.18 0.79

0.27 0.65 3.37 5.72

0.33 -0.64 ~ 0.29 0.02 0.06 0.1 1 - 0.30 0.57 0.73 0.34 0.14 0.17 0.83 -0.25 0.10 - 0.44 - 0.07 -0.48 - 0.50 - 5.23 -4.52

5.44 4.x0 4.51 4.53 4.59 4.70 4.40 4.97 5.70 6.04 6.18 6.35 7.18 6.93 7.03 6.59 6.52 6.04 5.54 0.31 -4.21

0.22 -0.61 0.52 0.43

0.22 2.87 5.93 7.21

0.00 1.17 0.92 0.94 0.35

-20 -I9 -18 -17 -I6 -15 - 14 -13 -12 -11 - 10 -9 - 8 ~ 7 -6 - 5 -4 _ 3 -2 ~ 1 0

-20 - 19 - 18 -17 - 16 - 15 -14 -13 -12 -11 - 10 -9 - 8 - 7 -6 ~ 5 -4 -3 -2 - 1 0

1.82 0.38 0.89 1.06 0.73 2.50 0.19 0.56 0.25 0.08 -0.27 1.95 1.53 - 1.63 - 3.94

7.15 8.37 9.24 10.18 10.53 9.46 11.28 11.66 12.55 13.61 14.34 16.84 16.03 17.59 17.84 17.92 17.65 19.60 21.13 19.50 15.56

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

0.61 0.53 -0.43 -0.31 0.48 0.34 0.90 -0.62 -0.21 0.09 -0.22 -0.06 0.34 -0.35 - 0.20 -0.04 -0.06 - 0.40 0.10 0.02

16.17 16.70 16.27 15.96 16.44 16.78 17.68 17.06 16.85 16.94 16.12 16.66 17.00 16.65 16.85 16.81 16.75 16.35 16.45 16.47

2 3 4 5 6 7 8 9 10 I1 12 13 14 15 16 17 18 19 20

0.57 0.44 - 0.44 -0.15 0.27 0.40 0.68 - 0.60 -0.04 0.00 - 0.27 -0.30 0.18 -0.34 0.16 0.05 -0.12 -0.50 0.12 0.08

- 3.64 - 3.20 - 3.64 -3.79 ~3.52 -3.12 - 2.44 -3.04 - 3.08 - 3.08 -3.35 - 3.65 - 3.47 - 3.81 - 3.65 - 3.60 -3.72 -4.22 -4.10 -4.02

25 30 35 40

0.43 0.77 -0.20 -0.29

16.29 17.85 18.89 19.91

25 30 35 40

0.27 0.80 -0.29 - 0.29

-4.12 -2.68 -2.45 -1.70

“Day reported

-

1.07

0 is the date the termination in the Wall Street Journal.

I

of merger

negotiations

is

P. Dodd, Mergers

and stockholder

we&h

131

termination do not entirely eliminate the positive abnormal returns earned at the time of first public announcement of the proposal. The cumulative ‘prediction error in column A of table 6 after the termination announcement at day 0 is 15.56 percent. In contrast, the cumulative prediction error at day 0 for the remaining 54 firms in column B is -4.21 percent. This suggests that the overall net effect of the cancelled merger proposals is different for the two classes of terminations. Indeed, the results in table 8 (in the conclusions section) which summarizes all the results in this paper, confirm that for the sample of 26 target terminations, stockholders earn large positive abnormal returns over the duration of the proposals. For each sample firm j, the net abnormal return per proposal is calculated as

where T1 is the day of first public announcement of the merger proposal, and T2 is the day of announcement of termination of the proposal. For the 26 target terminations the average cumulative abnormal return from 10 days before the first public announcement through 10 days after the termination is 10.95 percent. On the other hand, for the 54 non-target terminations the average cumulative abnormal return is 0.18 percent. In summary, when incumbent management vetoes the merger proposal there is a significant drop in the price of the target shares. However, when the positive market reaction to the initial announcement of the merger is incorporated, the net effect of the cancelled merger proposal is to increase, on average, the market value of the target shares by over 10 percent. This is in contrast to cancelled merger proposals which incumbent managements do not veto. In these cases the market value of the target shares returns, on average, to its pre-proposal level. Since mergers and tender offers are alternative mechanisms for acquiring control of target corporations, it is interesting to compare the results of cancelled merger proposals with those of unsuccessful tender offers reported in Dodd and Ruback (1977) and Bradley (1979). All three studies report permanent revaluations in target shares following unsuccessful acquisition attempts. This revaluation is greater than 20 percent in the tender offer samples as compared to the 10 percent plus for the sample of cancelled merger proposals studied here. In tender offers it is difficult to isolate one date when the offer is declared a success or failure, since information on the stockholder response is released gradually after the first announcement. Consequently it is difficult to compare the market reaction to the termination of tender offers to that of termination of merger proposals. However, Dodd and Ruback find that target stockholders in unsuccessful tender offers earn negative abnormal

132

P. Dodd,

Mergers

and srockholder

wu/th

returns of -2.65 percent in the month after first public announcement of the offer. ’ 3 Furthermore, the results in the current study are similar to those for a smaller sample of cancelled merger proposals in 1965 and 1966 reported by Merjos (1966). She concludes: ‘in general, the size of the loss when the merger was abandoned was comparable to the size of the gain made when the merger was first announced’ (p. 17). She did not, however, classify her firms on the basis of responsibility for termination.

When compared with the results of earlier studies the evidence presented here provides comparitiie e\,idenct: of the effects of mergers on stockholder wealth. Mandelker (1974). Ellert (1976) and Langtieg (197X) ha\e all presented evidence that stockholders of acquired firms earn abnormal positive returns over the seven months before the merger. In each of these studies the event date (month 0) is selected as the ‘effective date of merger’. This is the month of final approval by stockholders, and Mandelker reports that over 85 percent of the acquired firms in his sample are delisted in that month. Selection of the date of approval of the merger as the event date confounds the results of Mandelker. Ellert and Langtieg. If the mergers in their samples are initiated by an announcement of pending negotiations or offer terms, the pre-merger gains could reflect the market reaction to the earlier release of this information. The persistent average abnormal returns over the seben months suggest that across their samples the time lapse between the earlier announcement and subsequent merger is distributed over seven months. Alternatively. these pre-merger positive abnormal returns could indicate that the acquired firms experienced persistent good performance prior to the merger. lJ With the evidence of Mandelker, Ellert and Langtieg it is not possible to reject this alternative hypothesis. With the results of the current study. however, it is possible to determine whether or not the pre-merger gains to acquired stockholders reported in the earlier studies are induced by the selection of a later event date. Table 7 presents the abnormal returns to stockholders of target firms in completed “Most usually

tender resolved

‘“Mandelker mformatwn

oKers within

rcmaln this

(1974. regardmg

p. the

abnormal

returns

for

abnormal

returns

around

similar

to those

outstanding

320)

noted

mergers,

stockholders

in column

for

30 days

and

the

uncertainty

as to

the

outcome

15

period.

the

and of

that that the

announcement

B of table

7.

his

results

‘another acquired date

could

possible lirms’. for

reflect

the

hypothew Asqulth

completed

(1979) mergers

earlier

is that

release

mergers

also

analyres

and

reports

of

follow daily results

Table

7

Dally average (m) and cumulative average (CPE) prediction errors for 71 target firms in completed mergers for 250 days before (A) stockholder approval and (B) announcement of the merger proposal. (A) Day 0

-___ CPE ______

Day -250 -245 - 240 -235 - 230 -225 ~ 220 -215 -210 - 205 -200 - 195 -- 190 - 185 -180 ~~17s ~- 170 -- 165 - 160 ~ 155 -150 - 145 ~ 140 -135 -130 - I25 -120 -- 115 ~ 110 - 105 -100 -- 95 - 90 ~ 85 - 80 ~ 75 - 70 - 65 - 60 - 55 ~ 50 ~ 45 40 - 35 - 30 - 25 - 20 - 15 - 10 5 ~ 0

-0.32 -0.23 0.02 0.06 - 0.42 0.09 0.15 0.19 0 14 -0.27 - 0.42 PO.63 0.37 0.19 0.03 - 0.06 0.5X 0.06 -0.16 0.29 -0.32 PO.08 -0.09 -0.31 0.14 0.25 -0.30 ~~0.32 0.12 0.59 0.31 0.43 - 0.05 0.8 1 0.22 0.57 0.36 0.05 0.04 -0.17 0.02 0.71 0.39 0.25 0.03 -0.01 -0.32 0.15 -0.14 0.24 0.09

- 0.32 -0.51 PO.27 1.10 0.62 0.62 0.68 1.27 2.62 2.19 2.26 1.97 3.00 3.37 3.62 4.23 5.22 5.97 5.79 5.85 5.64 5.64 5.38 5.17 5.87 7.61 6.89 7.80 9.40 10.45 11.61 13.11 13.47 15.52 16.19 17.05 19.60 21.24 22.60 22.69 22.14 23.85 25.55 25.09 ?l.ox 25.90 ‘0 h3 7fl.X4 27.38 2X 14 20.2.5

(B) Day 0

Day ~ _

250 245 240 235 ~ 230 _ 225 -- 220 -215 -210 - 205 ~ 200 - 19s - 190 -1X5 - 180 175 -170 ~ 16.5 - 160 - 15s - 150 - 14s - 140 ~~135 ~ 130 - I25 -- 120 -115 110 -105 -100 - 95 - 90 - 85 - 80 - 75 - 70 ~ 65 ~ 60 -~ 55 50 ~ 45 40 -. 35 ~ 30 ~ 25 ~ 20 - 15 - 10 ._ 5 0

__~__

- 0.40 -0.27 0.1 I 0.09 -0.11 0.29 0.06 0.37 - 0.26 0.28 0.13 0.07 0.01 0.10 - 0.30 -- 0.02 -0 IX -0.13 -- 0.06 0.05 -- 0.08 -0.33 0.3 1 0.04 - 0.42 0.59 0.06 0.18 -0.63 --0.16 -0.15 PO.01 PO.12 - 0.07 - 0.20 0.01 0.06 -0.20 - 0.15 0.20 0.1 1 0.12 0.23 0.48 0.63 0.2x 0.58 I.14 0.01 0.53 3.30

(‘PE

- 0.40 ~ I .28

0.14 0.28 1.46 2.18 0.93 0.68 0.58 0.34 0.41 I .60 1.31 I .93 1.X4 2.09 1.09 I .I2 0.77 0.62 0.X4 7 ‘3 _.__ 2.72 2.60 2.67 2.78 2.74 2.82 1.27 2.90 2.35 3.27 2.62 2.29 2.26 2.44 1.79 2.42 2.05 2.80 7 51 2.02 I .40 2 .3 5 3.48 2.79 2.74 4.18 4.53 7.18 24.13

-

134

P. Dodd, Mergers

and stockholder

wealth

merger proposals (i.e., acquired firms). In part A of table 7 the results are presented for the 250 trading days (approximately one year) prior to the date of announcement of stockholder approval of the merger. Day 0 is the effective date of merger as used by Mandelker, Ellert and Langtieg. In part B of table 7 the results are presented for the 250 trading days prior to the announcement of the proposal. Here, day 0 is the day the announcement of the merger proposal is first published in the Wall Street Journal. When day 0 is selected as the date of approval of the merger, the premerger gains reported in the earlier studies are replicated. Of the 29.95 percent total abnormal return to acquired stockholders over the 250 days prior to the approval of the merger, 22.74 percent is earned before day -50. When day 0 is selected as the date of first publication of the merger proposals, only 2.57 percent abnormal return is earned before day -50. Of the 24.13 percent total abnormal return over the 250 days, 19.60 percent is earned from day - 10 through day 0, inclusive. It is apparent that target stockholders earn relatively large positive abnormal returns around the time of merger proposals. These abnormal returns are a direct result of the merger proposal and do not reflect any premerger good performance by these firms. The veto power of incumbent management in mergers encourages discussions between the firms prior to the public announcement. lManne (1966) concludes that this veto power results in side payments to the incumbents and one form of side payment is access to valuable information. In both table 7 (completed merger proposals) and table 1 (all targets) there is evidence of positive abnormal returns over the days immediately preceding announcement of the merger proposal. In table 1 target stockholders earn 6.59 percent returns from day - 10 through day -2, inclusive. This evidence is consistent with reports in the financial press documenting heavy trading volume and relatively large price appreciations in the days before the first public announcement of merger proposals, e.g., see the Wall Street Jourrtal, September 11, 1978, p. 20, where heavy trading was reported in Amax, Inc. shares before the public disclosure that Standard Oil of California had delivered its merger proposal to Amax. The results in this study are consistent with the hypothesis that there is some leakage of the information prior to the public announcement.

4.2.2. Bidder firms Any gains from mergers accrue to stockholders of the target to those of the bidder firms. For stockholders of bidding evidence of small, but significant negative abnormal returns at first public announcement of the merger proposals (see tables negative performance is further emphasized in table 8. The

firms and not firms there is the date of the 1 and 3). This average cumu-

P. Dodd, Mergvrs and stockholdrr wrulrh

135

lative abnormal return from 10 days before the first announcement through 10 days after target stockholder approval for completed mergers is -7.22 percent. For cancelled proposals through 10 days after the termination, the average cumulative abnormal performance is - 5.5 percent. Furthermore, negative returns are found for both target and non-target terminations. The results for bidding firms are interesting when compared to the evidence of earlier studies. Mandelker (1974) finds that stockholders of acquiring firms earn normal returns around the time of mergers. On the other hand, Langtieg (197X) finds evidence of negative abnormal returns over the 6 months before and the 12 months after the merger date. Mandelker’s sample includes 241 mergers between 1941 and 1962 while Langtieg’s includes 149 mergers prior to 1970. The results in this present study are for a similarly designed sample but for a different period and there is no overlapping data. The negative abnormal returns to stockholders of bidding firms is puzzling. It is an obvious area for future research. 5. Conclusions State corporate codes require that the incumbent board of directors approve any merger proposal before putting it to a stockholder vote. Since these codes give the management of a target firm veto power over all merger proposals, managements response to specific proposals provides an opportunity to assess whether the acceptreject decision is made in the best interests of stockholders. In this study the daily abnormal returns to stockholders of bidder and target firms in both completed and cancelled merger proposals for NYSE firms are reported. The main results are summarized in table 8. Stockholders of target firms earn large positive abnormal returns from the announcement of merger proposals, irrespective of the outcome of the proposal. In both completed and cancelled merger proposals, target stockholders on average, earn approximately 13 percent abnormal return at the time the offer is initially announced. There is significant market reaction to the revisions of uncertainty of the outcome of the proposals after the first announcement. For those merger proposals that are completed, target stockholders earn positive abnormal returns after the initial announcement of negotiations. Over the duration of the merger proposals (defined as 10 days before the first announcement, through 10 days after approval by target stockholders) these stockholders earn abnormal returns of 33.96 percent, on average. For merger proposals that are subsequently cancelled, stockholders of target firms earn, on average, significant negative abnormal returns on the date of the announcement of the termination of negotiations. Over the duration of the proposal (defined as 10 days before the first announcement through 10 days after the termination) these stockholders earn abnormal

13.41 (I0

- 1.09”.

71

60

returns

Table

33.96”,,

- 7.22”,,

0.76 *,,

- 0.29 :/,,

8

66 19 47

80 26 54

Sample size

proposals

termmattons

- 1.23 ‘If,, - 0.04 o0 - 1.70”,,

12.73 9, 1 1.18 “,<, 13.43 I::,

merger

3.68 ‘/; 10.95 ‘i: 0.18% - 5.50:/” - 3.12 7; - 6.47 I”,

- 8.68 “I<, - 5.57 0,0 -9.75 4, 1.24”,, 0.86 II<> 1.38”,

Average cumulative abnormal returns from first public announcement through terminatton of merger proposalsb

proposals

Average abnormal returns around date of announcement of termmation of merger proposals”

and cancelled

Average abnormal returns around first public announcement of merger proposals”

merger

firms tn completed

Cancelled

of target and bidder

Average cumulattve abnormal returns from first pubhc announcement through date of stockholders approval of merger proposalsh

to stockholders

Average abnormal returns around date of stockholder approyal of merger proposals”

abnormal

“Sum of average predtction errors at day - 1 and 0. 0mulated from 10 days before first public announcement through 10 days after approval or termmation. ‘(A)=all targets (target firms) and all bidders (budder firms); (B)= target termmattons: (C)=other than target

Target firms’ (A) (B) (C) Budder firms’ (Al (B) (C) _

Sample size

merger proposals

of percentage

Average abnormal returns around first public announcement of merger proposals”

Completed

Summary

P. Dodd. Mergers

and srockholder

wmlth

137

when the sample of cancelled merger returns of 3.68 percent. However, proposals is classified on the basis of whether or not the target firm’s the market reaction is different. management terminate the negotiations, Where the merger proposal is vetoed by incumbent management, target stockholders earn, on average, 10.95 percent over the duration of the proposal and this represents a permanent revaluation of the target shares. In the remaining cancelled proposals it is not clear from the termination announcement that the incumbent managements have used their veto power ~~ either bidder firm managements retract their offers or no reason for the terminations are given. Stockholders of target firms in these cases earn only 0.18 percent over the duration of the proposal, i.e., after an initial gain of 13.43 percent at the time of first announcement of the merger proposal, the stock price returns to its pre-proposal level. For stockholders of bidder firms. in both completed and cancelled merger proposals, there is evidence of negative abnormal returns of -7.12 percent and -5.50 percent, respectively, over the duration of the proposals.

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