Motives, Default Risk and Valuation Errors in Corporate Takeovers

Abstract

Motivated by the plethora of theories in explaining the conflicting evidence on the acquiring firms’ profitability after a merger, this thesis examines how market conditions affect the most prominent takeover motives and the acquirers’ abnormal returns and analyse changes in acquiring firms’ default risk around the announcement on four different types of diversification. In the takeover process, information asymmetry holds a very central role, along with other firm and deal variables which release new information in the market and alter investors’ views. Further, market conditions around the announcements significantly affect not only the takeover activity but also investors’ beliefs and optimism which will eventually drive the acquirers’ stock prices.
We first investigate the main takeover motives by analysing the wealth creation of the acquiring, the target firm and their combined gains. Firms react to both internal and external conditions by restructuring their business and takeovers are the fastest strategy to do so. Consequently, we re-examine takeover motives by incorporating the potential influence of market conditions (i.e. market misvaluation and merger waves). The results indicate that value increasing acquisitions are driven by both synergy and hubris, while value decreasing acquisitions by managerialism, after controlling for the hostility of the deal and extreme market valuations. We then turn our attention to the diversification benefits of mergers; although recent evidence suggests that mergers increase default risk for the acquiring firms, we find that due to the less uncertainty around horizontal mergers, acquirers can actually enjoy the risk-reducing diversification benefits of this related type of merger. Finally, we investigate how firm, market and industry valuation errors affect acquires performance in the UK market, after we control for multiple deals, method of payment and target type. Results suggest that although firm and deal characteristics help investors to revalue the potentials of an acquisition, investors are more likely to base their views on the state of the market/industry or the value of the firm and this will in turn drive the acquiring firms’ abnormal returns.