In industry-wide acquisition waves, firms that buy first buy best, study finds
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Broad Expert Link: McNamara finds that firms that buy first buy best
Researchers and managers know that, as with the just announced proposed merger of Delta and Northwest Airlines, the stock price of the acquiring firm usually declines in response to merger and acquisition announcements. Yet, firms continue to undertake mergers and acquisitions, with over 10,000 acquisitions in the United States in 2007.
In an effort to better understand which acquiring firms gain and which lose when undertaking acquisitions, Professor Gerry McNamara examined the performance implications of participating in acquisition waves in a recent article in the Academy of Management Journal. This study identifies a group of firms that are striking exceptions to the typical pattern of stock market declines. Professor McNamara and his colleagues find that companies that buy very early in an industry-wide acquisition wave generally enjoy share price rises. For those at the forefront of the wave, the mean increase is more than 4% above what would be expected from the acquiring firm’s past stock performance and from overall market trends in the three weeks following the intent-to-purchase announcement. In contrast, companies that make their move late in an acquisition wave tend to suffer stock-price declines, with losses reaching an average low of about three percent at the two-thirds point of the wave.
Professor McNamara states that the findings “suggest that the market rewards executives who perceive opportunities early, scan the environment for targets, and move before others in their industry. Conversely, the market severely punishes followers, those firms that merely imitate the moves of early participants in the wave, who jump on the acquisition bandwagon largely because of the pressures created by competitors. Such companies typically lose significant stock value.”
In addition to finding an early-mover advantage, several factors were identified that reduced or increased stock declines experienced by the late movers. For example, the study found that firms that use stock to finance acquisitions suffer more than firms that pay cash for acquisitions during the height of the wave. Since the market is inclined to interpret stock-based purchases as a form of hedging, “managers should be cautious in undertaking acquisitions unless they are confident enough in their own information to finance the acquisition with cash,” the study notes.
The study also finds acquisition performance during the wave was influenced by industry conditions. Growing markets increase the early-mover advantage for acquirers, while in weaker markets it makes relatively little difference whether a firm moves early or late. Still another factor is “market dynamism” – the degree of “technological uncertainty or discontinuities” in an industry. In more dynamic markets, such as those in high-tech industries, “there is some evidence that firms do better acting later, possibly after some of the uncertainty within the market is reduced,” the authors write.
The findings emerge from a study of more than 3000 companies that purchased other firms during acquisition waves in their industries. Twelve highly diverse industries were chosen on the basis of heightened acquisition activity lasting up to six years during the period from 1984 to 2004. These industries included semiconductors, trucking, warehouse and storage, wireless communications, telephone communications, radio broadcasting, grocery stores, motor vehicle sales, real estate management, hotels, computer-processing services, and information-retrieval services. For an acquisition to be considered a wave, there had to be “an acquisition pattern in which the peak year had a greater than 100% increase from the first (or base) year followed by a decline in acquisition activity of greater than 50% from the peak year.”
Source: McNamara, G., Haleblian, J., & Dykes, B. 2008. Performance implications of participating in an acquisition wave: Early mover advantages, bandwagon effects, and the moderating influence of industry characteristics and acquirer tactics. Academy of Management Journal. 51: 113-130.