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Journal of Economics and Finance

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01-07-2013

Investment banks advising takeover targets

Author: Qingzhong Ma

Published in: Journal of Economics and Finance | Issue 3/2013

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Abstract

Should takeover target firms hire top-tier investment bank advisors? For a sample of mergers and acquisitions between publicly traded U.S. acquirers and targets, in deals in which targets hire top-tier banks, targets earn higher premiums and abnormal returns; the probability of stock payment is lower, especially when bidder stock is potentially overvalued; acquirers, however, do not necessarily earn lower abnormal returns, and combined returns are higher. Controlling for self-selection does not erode, but, in some cases even strengthens the results. The evidence suggests that top-tier investment banks advising targets benefit shareholders of client firms by making better deals, instead of simply bargaining against the acquirers. The findings shed light on the role of advisor incentives when linking advisor quality and shareholder wealth.

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McLaughlin (1990, p227) reports that, in some hostile takeover cases, target advisors are paid contingency fees only if targets stay independent. These contract terms favor entrenched management at the expense of shareholder value. In a later section (Section 5), I reexamine this issue and find that, on average, hostile deals are more likely to complete with target advisors than without.

The sampling procedure, which is quite similar to many large sample studies in the mergers and acquisitions literature, focuses on publicly traded acquirers and targets covered by both CRSP and COMPUSTAT, and is thus biased toward larger firms and firms that have used investment banking services. These firms are more likely to hire investment bank advisors when becoming takeover targets. For total of 9,546 deals involving publicly traded targets with transaction value exceeding $1 m (excluding buybacks, exchange offers and recapitalizations deals) from 1980 to 2003, the equal-weighted (value-weighted) percentage of targets hiring bank advisors is 63.7% (96.1%), based on data from SDC.

Bank advisors may also get involved at the end of the deal process, in which case they provide “fairness opinions” only. In the sample used in this study, only 4.6% (106 out of 2,309) target advisors are recorded as providing “fairness opinions” only, with 2.71% (18 out of 663) for top-tier and 5.41% (88 out of 1646) for non-top bank advisors. Excluding these advisors does not affect the main findings.

The determinants of target hiring top banks are examined in a later section.

Recently Bao and Edmans (2011) challenge the efficiency in practice of using market share as the basis for giving mandates when deciding which investment banks to hire as merger advisors. They document significant persistence in acquirer bank advisors’ performance. They find that investment banks past market share, instead of their past performance, predicts future market share, which is mainly due to acquirers’ failure to learn.

Due to the longer time-span covered in this study than in Rau (2000) and changes in the investment banking industry in the latter period, I check the robustness of this definition by adding into or dropping from the “top” list those banks that fall in the gray area, including Lazard Freres, Merrill Lynch, and Lehman Brothers. The main results in this paper do not change. Details are discussed in the robustness check section.

Considering mergers involving these banks, the following names are also recognized as top banks: First Boston, Citigroup, Salomon Smith Barney, and Schroder Salomon Smith Barney.

Using market model and continuously compounded returns to estimate expected returns as suggested in Schwert (2000) yields qualitatively similar results.

Other measures, such as the transaction value excluding assumed liability divided by target market value of equity, are also constructed for the purpose of robustness. The results are robust.

In my sample, the correlation coefficient is .334 between offer premium and return-based premium, .655 between target abnormal returns and return-based premium, and .350 between target abnormal returns and offer premium.

See also Rau and Vermaelen (1998), Agrawal and Jaffe (2000), and Mitchell and Stafford (2000).

If market-to-book measures investment opportunity, a similar argument can be reached: Banks on the acquirer side advise issuing stocks when issuing stocks is not optimal (low investment opportunity).

The four-month period is chosen so that the target firms’ stock price runup (Schwert 1996) due to possible information leakage does not go into the prior return variable.

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Title: Investment banks advising takeover targets
Author: Qingzhong Ma
Publication date: 01-07-2013
Publisher: Springer US
Published in: Journal of Economics and Finance / Issue 3/2013
Print ISSN: 1055-0925
Electronic ISSN: 1938-9744
DOI: https://doi.org/10.1007/s12197-011-9192-9

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