Are M&A Premiums Too High? Analysis of a Quadratic Relationship between Premiums and Returns

Abstract

Introduction Since the 1990s, the banking industry in a majority of developed countries has experienced a consolidation process where mergers and acquisitions (MA Cybo-Ottone and Murgia, 2000; Beitel et al., 2004). The success of an MA Grullon et al., 1997; Mueller and Sirower, 2003; Moeller et al., 2005). The existing literature assumes that premium has a positive influence on the abnormal returns obtained by the stockholders of the target organization. There is no consensus, however, regarding the relationship between premiums and bidders' returns due to the existence of two hypotheses. On one hand, it is possible that merger premiums may proxy for the synergies between a bidder and its target, thus promoting a positive relationship between premium and return (Bradley et al., 1983; Antoniou et al., 2007). On the other hand, high premiums may proxy for overpayments in mergers, thereby increasing the likelihood of a value-destroying deal which should lead to a negative relationship between the premium and return (Varaiya and Ferris, 1987; Sirower, 1997; Schwert, 2003). Moreover, prior studies, both in the industrial and financial sectors, have assumed a linear relationship between premiums and acquirers' returns. It is possible that this relationship depends on the magnitude of the premium. The premium initially would have a positive influence on abnormal returns of the bidder, thus supporting the synergy hypothesis. If the premium were too high, the effect would be negative, as formulated in the overpayment hypothesis. If this were the case, a quadratic relationship between the premium and the acquiring company's returns would be expected. Therefore, we establish a new theoretical relationship between the premium and returns in M&A, and we then empirically test this relationship. This research aims to answer the following questions: * Do managers pay a price in acquisitions according to the expected synergies? * Do they pay too much in M&As? * When is the premium considered too high? The answers will be useful for market analysts, financial institutions, investors, regulators, and the scientific community in general, given that we will be able to determine when the premium is considered as overpayment and accepted negatively by the market, thus producing a negative effect in the acquirers' returns. The bidders' abnormal returns first are estimated using event study methodology in a sample of M&As performed by European banks from 1995 to 2004. The relationship between premiums and returns then is studied in a regression analysis. The results show a quadratic relationship between premiums and returns. …

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