Market-Based Estimates of Value Gains from Takeovers : An Intervention Approach

An unresolved issue in empirical research on corporate control is the extent to which takeovers improve target and bidder firm value. The bidder's abnormal return at the time of the bid gives a biased estimate of the market's valuation of the bidder's gain from takeover, because the form of the offer and the very fact that the bidder makes an offer may convey information about the stand-alone value of the bidder. For example, the fact of a bid may convey the good news that a bidder expects to have high cash flows, or the bad news that the bidder has poor internal investment opportunities. We provide a technique, the intervention method, that extracts the market's estimate of the value improvement due to the takeover from the abnormal return of the initial bidder when a competing bid arrives. The associated stock return is informative about value improvement because this event has a large effect on the probability of the initial bidder's success. Furthermore, this event does not occur at the discretion of the initial bidder. Hence, the arrival of a competing bid will reveal little or nothing about the non-takeover value of the initial bidder. We find four main results. First, takeover improvements from cash tender offers are perceived by investors to be large and positive - about 44.8 percent of target value. The conclusion that takeover improvements are positive is robust with respect to plausible variations in the parameters that have to be estimated and serve as input to computing the bidder's gain from the takeover. Second, the average profits that successful bidders earn from initial shareholdings are modest. This suggests that high concentration of share ownership may be more important for internal monitoring than for motivating takeovers. Third, point estimates indicate that bidders are overpaying for targets, but most of the premium can be explained by value improvements. Fourth, value improvements are of similar magnitude for friendly and hostile transactions. This suggests that both discipline of bad managers and the realization of business complementarities may be motivating takeovers