Predicting merger targets : an econometric approach

Abstract

The theory of predicting merger targets is a subject of frequent debate in the financial economic literature. The basic question considered is whether a certain characteristic of merger target companies exists and can be distinguished from surviving firms. The inconsistency of the findings of empirical research on this subject has been a contributing factor to the continuing controversy.

The research's aim is to extend the early work of this subject in two significant ways. First, this research presents a more comprehensive empirical model of merger target prediction through carrying out diagnostic tests. These tests are to examine the sufficiency of the models, which were deficiencies of previous studies. Second, this research has an objective to establish whether the theory of merger in overseas countries may apply to the New Zealand firms, and whether characteristics of merger targets suggested by past decades are relevant to the application in the present condition.

By examining six frequent characteristics of merger targets suggested by previous literature, this research found that theoretical propositions of management inefficiency, undervaluation, and industry disturbances are supported by New Zealand evidence. This indicates that a New Zealand firm with inefficient management, whose value is low, and which is in industry subjected to disturbances is likely merger target.

However, the premises of size effect, bootstrapping and growth-resources mismatch seem inappropriate in applying in New Zealand. The results of the study show that variables used by previous researchers to express the size effect hypotheses are significant; however, their signs are different from what theory suggested. Also, the results appear that a firm with low price-earning ratio is likely target, however, diagnostic tests for the bootstrap game model reject the significance of the hypothesis in explaining merger probability. Having imbalance in company’s growth and its resources has further no effect on the likelihood of merger.

The research has resulted in a useful knowledge: 1) to equip public policy makers, corporate managers and financial investors with a more relevant and reliable analytical tool, 2) to improve corporate decision-making, and 3) to add to the stock of existing ideas by clarifying the characteristics of merger targets.