Even Costly Mergers Can Be Good for Some Stockholders
STANFORD GRADUATE SCHOOL OF BUSINESS—It is widely known that after a public merger is announced the stock value of the acquiring company generally drops while that of the target firm goes up. Why, then, do so few buyer-side shareholders attempt to block mergers even in the face of such losses, particularly when millions or billions of dollars are at stake?
In a new study, Michael Ostrovsky, assistant professor of economics, has proposed an explanation. Top shareholders in acquiring companies often simultaneously own a near equal number of shares in target firms, which means that—at the end of the day—they usually break even.
Ostrovsky and Harvard doctoral candidate Gregor Matvos first examined the merger of Bank of America and FleetBoston Financial in 2003. "One week after the announcement of the merger, $10 billion of Bank of America's value—almost 10 percent of the company—was wiped out," says Ostrovsky. That spelled a total loss of more than $2 billion to the ten largest shareholders of the company. In comparing the list of those shareholders against those of Fleet, however, the researchers found that nine out of ten names were identical, among them big companies like Fidelity, Vanguard, and Barclay's.
"The losses to these shareholders resulting from the decrease in B of A's stock value was compensated by the increase in value of their Fleet stock," Ostrovsky says. "This probably explains why they did not oppose the merger."
The authors then looked at whether voting behavior on mergers in the mutual fund industry also was affected by stock cross-holdings. With new SEC rules requiring mutual funds to disclose their voting behavior, a world of data became available to researchers in 2003.
In comparing the voting behavior of institutional stockholders in cases where stock prices dropped as the result of a merger, Matvos and Ostrovsky found that those who owned shares in both purchaser and target companies approved mergers 98 percent of the time. Those who owned shares in the acquiring companies only, however, voted for approval only 79 percent of the time. In contrast, when stock prices did not drop, both groups voted in favor of the merger in approximately 95 percent of cases.
"We think this clearly demonstrates that there's a dramatic difference between how cross-holders and non-cross holders respond to mergers," Ostrovsky says. And no wonder. Across the board, those who only owned stock in acquiring companies lost up to 1.5 percent of the value of their holdings, which, says Ostrovsky, "amounts to a great deal of money when we're talking billions of dollars" in holdings. Those who owned stock in both acquiring and target firms, on the other hand, made a decent net gain of about 2.5 percent.
The numbers were even more striking for those involved in the largest 100 mergers. Acquiring shareholders lost up to 4.5 percent of the value of their holdings. Cross-holders in such instances enjoyed a modest net gain of 1 percent, but clearly their assets in the target firm had mitigated against what could have been a significant loss.
Matvos and Ostrovsky's study goes beyond previous research on mergers. That work generally looked only at aggregate market capitalizations and determined that average returns to acquiring-firm shareholders are negative. "Our work shows that you have to take into account the fact that different stockholders are in different situations," Ostrovsky said. The research sheds light on why some may approve what seem like "bad" mergers, where money is lost, and suggests that, from a policy perspective, the question as to whether a merger is "good" or "bad" is more complex than previously thought.
"Cross-Ownership, Returns, and Voting in Mergers," Gregor Matvos and Michael Ostrovsky, GSB Research Paper No. 1921, January 2006.
"New Evidence and Perspectives on Mergers," Gregor Andrade, Mark Mitchell, and Erik Stafford, Journal of Economic Perspectives, Spring 2001.
"Firm Size and the Gains from Acquisitions," Sara Moeller, Frederik Schlingemann, and Rene Stulz, Journal of Financial Economics, August 2004.
"Corporate Financing Decisions When Investors Take the Path of Least Resistance," Malcolm Baker, Joshua Coval, and Jeremy Stein, Working Paper, Harvard University, 2006.