The Dynamics of Merger and Acquisition Activity in Stock Market Movements


Updated: 11 Mar 2024

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Financial economics has conducted a great deal of study on mergers and acquisitions. Even however, it is still unclear what factors influence returns to shareholders in control transfers or how takeover timing and conditions relate to one another, despite the literature’s significant progress. The time of the takeover is determined exogenously in the great majority of takeover models, and it is not influenced by the conditions that were negotiated. The current study creates an equilibrium framework for jointly deciding on takeover terms and timing when there is competition and incomplete information. The ramifications for shareholder returns in acquisition transactions are then calculated using this methodology.

The paper’s concept is predicated on two essential components. The first draws a comparison between exchange options and takeover prospects. This comparison acknowledges that takeover agreements usually provide transaction parties the choice to swap one asset—the original firm’s shares—for another—cash or shares in the new company. This first component is sufficient to provide consequences about the terms and timing of takeovers, as the article demonstrates.

The investor information set is the subject of the model’s second essential component. Outside investors are not fully informed about the model’s underlying parameters, although participating enterprises are fully informed. Investors can, however, revise their assumptions based on participating businesses’ actions. This process of learning suggests that outside investors are able to predict the terms and timing of the takeover to some degree. Because of this, the share of the takeover surplus that may be captured by public information is reflected in the stock market values of participating corporations. This process also suggests that a greater portion of the takeover excess is included into the stock market valuations of participating corporations as the takeover becomes more likely, which causes a pre-bid surge in stock prices. The study also shows that, in equilibrium, there is still some uncertainty up to the takeover announcement. As a result, the model produces unusual returns for investors in the wake of acquisition news. There are two phases involved in deriving the results presented in the study. The first stage is to solve an option exercise game involving target shareholders and bidders to find the equilibrium restructuring plan. The implications of the equilibrium for anomalous returns around takeover news are outlined in the second phase. The model produces several novel predictions as well as implications that are in line with the actual data that is already accessible. Specifically, the model predicts that: (1) abnormal returns to target shareholders should be greater than returns to bidding shareholders; (2) abnormal returns to bidding shareholders may be negative in the event of competition for the target’s acquisition; (3) the likelihood of negative abnormal returns rises with the dispersion of beliefs regarding the synergy created by the takeover; (4) abnormal returns to stockholders rise with the volatility of stock returns and fall with the correlation between the returns of merging firms; (5) the sensitivity to the return characteristics of merging firms is greater for abnormal returns to target shareholders; and (6) competition accelerates the acquisition process and lowers returns to bidding shareholders.

Since takeovers generate wealth in the near term, one significant prediction of the model is that total returns to investors should be positive. In this regard, our model deviates from Roll’s (1986) hubris hypothesis, which states that since purchases only result in a wealth transfer between bidding and target investors, acquisition announcements should have a zero combined anomalous return. It also deviates from Jensen’s (1986) free cash flow theory, which states that total returns need to be negative. Crucially, our approach also enables us to link the features of stock returns and the dispersion of analysts’ expectations to shareholder returns. These further forecasts are exclusive to our model. So what are the steps to do fundamental analysis? Any security, stock, derivative, bond, or firm may be the subject of it.

This paper’s analysis is connected to other studies in the literature. The first person to examine takeovers as exchange possibilities was Margrabe (1978). In his concept, time is exogenous and the takeover is a zero-sum game. In addition, Shleifer and Vishny (2003) take into account an exogenous time zero-sum game (in the long term). The potential excess linked to the takeover is not included in the stock market values of participating corporations by outside investors in their framework.

The influence of mergers and acquisitions (M&A) on stock prices can be substantial. An announcement of a merger or acquisition may prompt stock market participants to modify their holdings. Depending on the terms of the agreement, the stock values of the participating firms may increase or decrease. Since the acquiring business pays more for the target shares in order to get the approval of the shareholders, the acquisition typically results in an increase in the stock price of the target company. Because of the premium paid, the selling company’s stock price rises as a result, attracting additional possible investors. Acquisitions and mergers are significant commercial transactions that may have a lasting impact on the stock market as well as the firms involved. Companies are drawn to M&A by the attraction of growth opportunities and synergies, but regulatory obstacles and integration issues need to be properly managed. Stock market investors keep a careful eye on these developments, expecting short-term price fluctuations as well as long-term effects on the combined company’s financial performance and standing in the market. Businesses and investors alike must continue to comprehend the complexities and implications of M&A as it continues to influence the corporate environment.

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Priya Kumari

Priya Kumari

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