Actividades de enseñanza y aprendizaje Actividades de comprobación
Capítulo 9 Organización del servicio posventa Actividad propuesta 9
Shleifer and Vishny (2003) developed a model of M&As based on the assumption that
managers are rational and the market is less than fully rational. The model explains ‘who
acquires whom, the choice of the medium of payment, the valuation consequences of mergers and merger waves’ (Shleifer and Vishny, 2003: 295). Their study focuses on the limitations of
the neo-classical theory of M&As, which focuses on industry-specific shocks, and the effect of
the method of payment on M&As, which is not clearly interpreted. In addition, reasons why
cash-financed M&As generate long-term positive earnings while stock-financed M&As
generate long-term negative earnings have not been well explained. So as to explore these
reasons, their study presents a simple valuation model of M&As to explain the short- and long-
term gains of the bidder. The model implies that the bidder can produce a positive synergy in
the short term yet few synergies in the long term. Important implications drawn from this model
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Suppose the target firm is 0 and the bidder firm is 1. Stock volumes for firms 0 and 1 are K and
K1, and price per unit is Q and Q1, and Q1 being greater than Q. The price per unit for the
combined equity is S, q is the long-term price. Bidders would pay a price for the target, denoted
P. If synergies exist, P lies between Q and S (i.e. Q<P<S).
1. The combined market value is S (K+K1)-K1Q1-KQ, which is the value of the new combined
firms minus the value of each individual firms involved in an M&A deal.
2. The target value in the short term is (P-Q) K, suggesting that the offer price is over market
value.
3. The bidder value is made up of two parts, one part is the gains the bidders earned as long as
their pay is less than S, the other is the loss of value dilution of the bidder firm’s capital, from
Q1 to S or (S-P) K+(S-Q1) K.
4. Given that there is no long-term profit for the combined firm when acquisitions are funded
with cash since the gains to the target firm is the loss on the bidder firm, the effect on the value
of the target is K (P-q), whereas the value of the bidder is K (q-P).
5. For stock-financed acquisitions, suppose x is the ratio of deal value over combined firm
value or x = PK/S (K+K1). In the long term, this share is xq (K+K1) = q (P/S) K;
6. The net long-term gains to target shareholders in stock-financed acquisitions are q (P/S) K-
qK = qK (P/S-1), where qK is the stand-alone value of target in the long term, whereas for the
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Shleifer and Vishny’s misvaluation model (2003) indicates that bidders are those with a
considerable valuation whereas targets are those with a low valuation. Further, the long-term
effect of cash-financed acquisitions suggests that the target is undervalued whereas the net
long-term effect of a stock deal generates a short-term loss and long-term gains, explaining
why an overvalued bidder tends to use stocks as ‘cheap currency’ to pay for targets. Moreover,
there is a reverse effect between the bidder firm and the target firm, i.e. what the bidder loses
is the target gains. Finally, the model reveals that both the target and the bidder firms could
gain in the short term if there is synergy from the mergers.
Shleifer and Vishny (2003) also reason that M&As are a trade-off game between the bidder
and the target, since they involve a high valuation bidder and a low valuation target based on
the rationale that a low valuation firm may find it hard to create synergy through the acquisition
of a high valuation firm. Their study suggests that a bidder buys a target to create long-term
value whereas the target focuses on short-term gains; hence, targets voluntarily accept
overvalued stocks for a cash-out purpose. All of these imply that bidder managers attempt to
maximise the interest of shareholders through exploring the market’s mispricing in an
inefficient market (Shleifer and Vishny, 2003: 296).
Therefore, Shleifer and Vishny (2003) assume that bidder managers are rational whereas target
managers are irrational as since they accept overvalued stocks. However, this view has been
challenged by Rhodes-Kropf and Vismanthan. (2004) who contend that rational managers
accept overvalued stocks by mistake. According to this study, target managers are misled when
the market valuation is high, and accept overvalued stocks as they overestimate synergies.
Further, Rhodes-Kropf et al. (2005) identified three types of specific valuation errors that drive
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firm-specific deviations from short-run industry pricing (firm-level misvaluation), sector-
factor, short-run deviations from a firm’s long-run mispricing (sector-level misvaluation), and
long-run pricing to book (long-run growth opportunities), the authors found that high MTBV
firms buy low MTBV firms, which is attributed to firm- and sector-level valuation errors. Firms
of low long-run growth opportunities tend to buy firms with high long-run growth opportunities.
Their study suggests a positive correlation between stock-financed acquisitions and market-
wide valuation.
In this connection, Dong et al. (2006) affirm that the misvaluation hypothesis is in favour of
high valuation periods. Analysing a sample of U.S. M&As from 1978 to 2000, the authors
claim that evidence for the misvaluation hypothesis is more relevant for M&As after 1990 than
before, whereas the evidence for the Q hypothesis is more relevant before 1990 than after.
Their findings suggest that the misvaluation hypothesis reconciles the case that the market-
wide valuation is high whereas the Q hypothesis is employed to explain how well-run bidders
explore synergies from poorly-performed targets. In addition, the authors find that more
overvalued bidders prefer to pay for targets with stocks rather than cash, choose mergers rather
than tender offers, and pay higher offer premiums. Their results are consistent with those
predicted by Shleifer and Vishny (2003).
Dong et al. (2006) investigated the effectiveness of the Q hypothesis and the misvaluation
hypothesis in different sample periods but fail to address the concern as to whether bidders
paying with overvalued stocks are being rational. According to Shleifer and Vishny (2003),
bidders who use overvalued stocks as a means of payment for M&As receive negative market
reaction in the short run, leading shareholders to believe that the firm does not generate
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value for the firm, since holding stocks in an overvalued market incur risks for the firm (Jensen,
2005). In this respect, Ang and Cheng (2006) assessed the long-term performance of the bidder
who pays for acquisitions with stocks. Studying a sample of completed stock-financed
acquisitions, the authors find that bidders undertaking M&As with overvalued stocks perform
better than those engaging in M&As but not using overvalued stocks. Their study indicates that
not all M&As are driven by misvaluation, since their data show a small fraction of the stock-
financed acquisitions involve an undervalued bidder, which contrasts with Savour and Lu’s
view (2009) in their assumption that all stock-financed acquisitions are misvaluation-driven.
The misvaluation hypothesis has been challenged by many studies. Firstly, in line with Ang
and Cheng (2006), Fu et al. (2013) suggest that ‘The existence of relative overvaluation
between the bidder and the target is a necessary, but not a sufficient condition for the acquisition to benefit acquirer shareholders’, as their M&A sample shows that two-thirds of
stock-financed acquisitions are motivated by a bidder firm’s overvaluation. They suggest that
bidder shareholders only benefit from overvalued stocks if low premiums are paid to the target
shareholders. Using a sample of 1,319 stock-financed acquisitions between 1985 and 2006, the
authors found that overvalued bidders do not outperform those firms in the control sample,
reflected in significantly worse operating performance and worse stock returns five years
following the M&As. By including corporate governance related proxies, their study reveals
severe agency problems in an overvalued firm, indicating that acquisitions driven by
misevaluation destroy a firm’s value when the firm experiences agency problems.
Further, Eckbo et al. (2016) suggest that ‘overvaluation reduces the all-stock payment
propensity’, which contradicts the idea of the misvaluation hypothesis. Using aggregate mutual
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caused by mutual fund flows pushes up the market valuation but it does not increase the volume
of stock-financed acquisitions. Their study challenges the view that managers use overvalued
stocks to time the market. The authors find that bidders who pay with overvalued stocks for
financing acquisitions tend to be small firms and non-dividend paying firms with low leverage,
indicating that firms that are financially constrained avoid using cash as a means of payment
for financing M&As.
This section has reviewed three broad types of M&A motives. According to these studies
reviewed, there is no single theory that can fully address the M&A motive, since it varies
significantly in any particular sample at any particular time, which calls for up-to-date evidence.
Jensen and Ruback (1983), by reviewing a quantity of M&A research up to the 1980s,
suggesting that the primary M&A motive is synergies, and the small role the human factors
played on M&As weakened prior to 1990. This is also supported by a number of M&A research
works (Bradley et al., 1983; Bradley et al., 1988; Jensen, 1988; Lang et al., 1989; Servaes,
1991), whilst Jensen (1986) indicates the agency problem of free cash flow where managers of
cash-rich firms invest unwisely, and Roll (1986) suggests hubris-infected managers engage in
value-destroying M&A deals. Shleifer and Vishny (2003) suggest that M&As are driven by the
relative valuation of the two firms involved, indicating the role of managers’ timing the market.
Dong et al. (2006), who studied the misvaluation hypothesis and the Q hypothesis in the context
of M&As, noted that synergy-driven acquisitions are more likely to be found prior to 1990
Chapter 2. Literature Review: M&A Process
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