Literature Review of Short Term Effects on Mergers and Acquisitions

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1.0 Introduction

        Mergers and acquisition decisions are important to the success of firms and their managers. Many firms use this strategy as a way of expanding ownership, increasing capital, and benefitting mutually from the collaboration of the two firm’s operations. This literature review aims at analyzing prior literature of mergers and acquisitions and its effects on the performance of both firms. We will use this information to guide our own research in an attempt to determine the short-term impacts on stock prices during a merger or acquisition on the acquiring firm. The five articles reviewed below are “Why the stock market reacts the way it does to announcements of M&As” by Balog, J. (1975), “Pooling vs. Purchase: The Effects of Accounting for Mergers on Stock Prices” by Hai, H., Kaplan, R. S., and Mandelker, G. (1978), “Executive Compensation Effects of Large Corporate Acquisitions” by Lambert, R. A., and Larcker, D. F. (1987), “Firm size and the gains from acquisitions” by Schlingemann, F. P., and Stulz, R. M. (2004), and “Determinants of Premiums in Acquisition Transactions” by Varaiya, N. P. (1987).

2.0 Review of Previous Studies
2.1 Quantitative-Based Market Measures

        Moeller et al. (2004) created a study to examine the existence of a size effect in acquisition announcement returns. Furthermore, the study examines the gains to shareholders of firms that announce acquisitions, using data from 12,023 acquisitions by public firms from 1980 to 2001. In discussing the size effect, the research defines a small firm to have a capitalization that falls below the 25th percentile of NYSE firms. The article suggests that small firms make small acquisitions with small dollar gains, while large firms make large acquisitions with large losses. It is determined that small firms fare significantly better than large firms when an acquisition announcement is made. Overall, the abnormal return associated with these announcements for small firms exceeds the abnormal return associated for large firms by 2.24%. In addition, when controlling for a wide variety of acquiring-firm and deal characteristics, the size effect still holds true, and there is no evidence it is reversed over time. Large firms offer larger acquisition premiums than small firms and enter acquisitions with negative dollar synergy gains. In terms of shareholder wealth, the average dollar change in the wealth of acquiring-firm shareholders when the announcement was made is negative. From 1980-2001, the sample firms spent roughly $3.4 trillion on acquisitions, and wealth of shareholders fell by $303 billion. In conclusion, the research further investigates some explanations as to why the stock price of firms announcing acquisitions can be negative. They will be discussed further in the next section.