Motives for corporate mergers and takeovers : an investigation of the `failing company' hypothesis and of post-merger performance

Abstract

The overall objective of the study was to determine the financial characteristics of companies involved in merger activity. More specifically, the study aims to determine: (a) whether acquired companies possessed financial characteristics similar to previous failed companies (the 'failing-company' hypothesis); (b) whether acquiring companies possessed financial characteristics similar to previous failed companies and (c) the impact of acquisition on the post-acquisition performance of acquiring companies, and particularly to consider whether their performance differs according to the financial characteristics of the companies they acquired. A new "bankruptcy prediction" model, contemporary with the acquisition data, was derived, tested for robustness, and applied to samples of acquired and acquiring companies. An indirect test of the 'failing-company' hypothesis was carried out by comparison with the results obtained on application of the model to control groups of non-acquired and non-acquiring companies. The test indicated that a higher proportion of acquired companies possessed financial characteristics similar to failed companies than the control group of non-acquired companies. This evidence tends to support the 'failing-company' hypothesis as a motive for mergers for acquired companies. Conversely, there was no such evidence in support of the hypothesis for acquiring companies. The approach adopted also allowed the dichotomy of acquired companies (failing vs. non-failing) which made it possible to test for differential post-acquisition performance of the acquiring companies. In order to evaluate the post-acquisition performance of acquiring companies, three different measurement criteria were adopted. They were: (a) accounting-based profitability and gearing ratios (b) industry-standardardised profitability measure (Meeks (1977)) and (c) performance analysis-scores (PAS-score) (Taffler (1983)). The results indicated that the acquiring companies generally incurred a decline in their post-acquisition profitability measures, while they increased their gearing ratios. Generally, the group acquiring potentially failing companies exhibited 'superior' post-acquisition performance compared with the group acquiring "non-failing" companies. These findings support the managerial motives for mergers since there appears to be little evidence that mergers are undertaken to increase profitability as implied in neoclassical motives. They also suggest the possible need for a review of public policy towards mergers; perhaps mergers ought to be encouraged only if they prevent impending bankruptcy by the acquisition of failing companies.