Why do bidders do badly out of mergers? Some UK evidence

This paper began with the hubris hypothesis in attempting to examine why bidders do badly. It was argued that, as a merger bid was not a common-value auction, the winner's curse (a component of the hubris hypothesis) did not apply. Further, the inference, that the bidder who offered the largest premium was the one that won, was incorrect. This result has interesting implications for pre-emptive bidding, challenging the view that a significantly high valuation (and the appropriate medium of exchange) could deter the competition (Fishman, 1988 and 1989). The paper introduced a version of bargaining power, represented by a firm's eagerness to merge, as a factor in determining the merger terms and, therefore, the division of synergy. A modification of this hypothesis, deriving from observation of the market for corporate control, was the existence of a premium determined by the market and demanded irrespective of the amount of synergy expected. The empirical study was primarily concerned with examining these issues. The hypothesis of a direct relationship between bid success and the share of synergy being offered to the target stock holders (the winner's curse hypothesis) was rejected. Thus, even though it is the principal explanation for why bidders overpay, the winner's curse can neither be supported on theoretical nor empirical grounds. It was also argued that the empirical evidence provided by Varaiya (1988) and Varaiya and Ferris (1987) had a number of interpretations and was consistent with the bargaining approach here. There was also little supporting evidence that a firm's eagerness to merge influenced the generosity of the merger terms. Regression evidence did not support the existence of a relationship between the amount of synergy offered to the bidder stock holders and the target's eagerness to merge, as represented by profitability and growth expectations and whether or not the bid was hostile or contested. The empirical evidence tended to support the modified hypothesis: the notion of a premium being demanded by the market irrespective of synergy. These two hypotheses take on greater importance if the stock holder wealth-maximization hypothesis is relaxed and the managerial objectives hypothesis is assumed. However, acceptance of the managerial motives hypothesis could not be upheld in the comparison of stock only and cash bids. Here it is hypothesised that the latter contain an additional premium to compensate stock holders for the adverse tax effects and the bidder stock holders lost out because the loss is not fully offset by the higher amount of perceived synergy in such bids. Whilst the results here do not support an alternative hypothesis, they are unclear because of an inconsistency across successful and unsuccessful bids. Overall, (i) the acceptance of the managerial motives hypothesis, (ii) the rejection of the winner's curse and (iii) the rejection of the hypothesis that the eagerness to merge affects the generosity of the merger terms, combine to support the notion of eagerness to merge being reflected in the determination of a premium largely irrespective of the amount of synergistic benefits. Further, the empirical study suggests that these characterise managerial decision making, both in terms of whether or not a bid is made and ,if so, the generosity of the terms offered.