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By Jarl Kallberg, Ph.D. |
Differences In Public v. Private Acquisitions & Management Retention
This note empirically addresses two basic issues in the area of acquisitions: (i) the relative value of acquiring private versus public targets, and (ii) the benefits of acquiring management. The basic conclusions come from a wide variety of academic research and ongoing research (somewhat preliminary) I am conducting with two colleagues: Iftekhar Hasan at Rensselaer Polytechnic Institute and Crocker Liu at ASU.
Our interest in this topic stems from the fact that, in spite of the extensive theoretical and empirical research on acquisitions, no clear consensus has emerged with respect to its impact on the acquirer’s shareholders. This lack of agreement is surprising, since few areas of corporate finance are as important or have been subject to more analysis.
Achieving success in an acquisition obviously depends on the acquirer’s ability to identify attractive targets. Targets are attractive either because they are under valued by other potential acquirers, because they are inefficiently financed, or because they have greater synergies with a specific acquirer. In addition, information costs and valuation uncertainty vary by target type and are generally higher for acquiring private targets or for acquiring intangible (in particular management) rather than physical assets.
In our study we assume that the possibility of the acquirer having an informational advantage over other potential acquirers will be higher when the target is a private firm or its assets are less tangible. We analyze acquisitions in two separate dimensions: acquisitions of public versus private firms, and acquisitions of a firm’s assets versus acquisitions of a firm’s assets and its management. Previous literature has shown that it should be very difficult to achieve abnormal returns or to have a viable informational advantage when the target is publicly traded. Conversely, acquiring private firms should offer the acquirer more scope to exploit an informational advantage. This potential should be even greater if the target’s assets are more difficult to value, which would be the case if the acquisition involved the retention of the target’s management.
We test our hypothesis by examining 1,538 acquisitions by real estate investment trusts (REITs). These transactions all have a market value in excess of $2 million. The average acquisition size is about $100 million, with public acquisitions being somewhat larger on average. We focus on real estate transactions to avoid industry-specific effects and because real estate is an industry in which each of the four types of acquisitions analyzed is prevalent. In addition, by using the same industry for both target and acquiring firms, we ensure that none of the acquisitions are for diversification purposes.
Related literature
One important fact has emerged from an exhaustive study of literature on restructurings: successful acquisitions are relatively rare events with the acquirer usually suffering negative returns at the time of the acquisition announcement as well as in the long run. Many reasons have been proposed to explain this inability to consistently achieve shareholder gains. These include: market efficiency (through large takeover premiums, markets force acquirers to pay a fair price for the target); hubris (mergers are motivated by factors other than increasing shareholder value); acquirers overestimate their ability to achieve projected synergies or economies of scale; etc.
Researchers have found, generally, that acquisitions have a higher probability of success either when private firms are acquired (depending on how the merger is financed) or when the acquisition involves retaining target management, although the conclusions on the latter are much less consistent. The management literature has addressed the issue of the valuation uncertainty inherent in the acquisition of human-capital-intensive firms. Human capital is naturally more difficult to value than are the physical assets of the firm, and the possibility of employee turnover presents a major risk to the acquirer.
Comparisons between the performance of public and private acquisitions are complicated by the fact that analysts and investors more closely scrutinize public targets. Thus, they may be subject to takeover speculation, which could cause a run-up in the stock price and a higher final takeover premium. In addition, analysts have extensive data available when offering their opinions of the acquisition of a public firm. For private targets, in almost all cases the analyst is forced to rely on management’s information, which makes it highly unlikely that the analyst is able to render a negative opinion on the proposed takeover.
Fuller, Netter, and Stegemoller in a 2002 Journal of Finance article find that the returns to acquisitions of private targets are significantly positive. Returns to acquirers of public targets, in contrast are negative and significant, especially when the transaction is financed by stock. Moeller, Schlingemann, and Stulz in a 2004 Journal of Financial Economics study also find that acquisitions of private firms generate higher returns than public acquisitions.
Our results
Event studies gauge the equity market’s short-term reaction to a corporate event by computing the “abnormal return” around the announcement date. While there are many ways to make this measurement, the basic idea is to evaluate whether or not shareholders view the corporate decision in a positive or negative manner. The table below summarizes our study’s short-term performance results. The data suggest that acquirers of private firms that also acquire the target’s management have the best short-term market reaction.
Short-term returns to acquirers
We also investigated whether our short-run performance results are valid in the longer term. Our metric for long-term performance is the acquirer’s Q ratio (essentially the ratio of the firm’s market value to its replacement value) although our results are robust to different performance specifications. We find that the largest gains in acquirer Q come from acquisitions that involved management retention. The long-term acquirer performance differences between the acquisition of public and private targets are essentially insignificant. Thus the long-term results basically corroborate what we showed in the short term.
Conclusions
The punch lines of this academic literature – the value of retaining target management and the superior performance of private acquisitions - are perhaps not very surprising to practitioners working in this area. It is also unclear as to how much of the traditional thinking about acquisitions will hold in the future since so much of the world of investments has changed forever. However, the basic business ideas that this type of literature is advocating: the value of informational advantage and retaining management versus firing them still represent sound axioms in whatever type of economy emerges in 2009 and beyond.
About the Author
JARL KALLBERG, Ph.D.
Professor of Global Finance, Thunderbird School of Global Management
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