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Asia Pacific Journal of Management

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01-12-2014

Role of industry relatedness in performance of Indian acquirers—Long and short run effects

Authors: Parama Barai, Pitabas Mohanty

Published in: Asia Pacific Journal of Management | Issue 4/2014

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Abstract

We explore the effect of industry relatedness on the performance of Indian acquirers using both short run and long run performance measures. We argue that mergers and acquisitions are distinct strategies, because of the unique regulatory structure and equity ownership pattern that exists in India. Their choice depends on control considerations on the one hand and regulatory imperatives on the other. Correspondingly, their sources of value creation or destruction do not always correspond to extant theories of synergy or agency. We present a modified synergy story and illustrate that, while related acquisitions create value and non-related acquisitions destroy value, both related and unrelated mergers create value.

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Source: www.imaa-institute.org

In India, controlling shareholder (usually the founder family) is known as promoter. One finds primarily three types of promoters, namely, Indian Business Groups, Foreign Business Groups, and Central and State Government (Verma, 1997).

The ownership data are based on a total sample of more than 22,000 Indian companies. We obtain their equity ownership data from Prowess database of CMIE.

To illustrate this point, if the promoter of the acquiring company A owns α_A fraction of the total shares of A (n_A) and the promoter of the target company T ownsα_T fraction of the total shares in T (n_T), then the stake of promoter of A after the merger will be \( \frac{\alpha_A\times {n}_A}{n_A+x\times {n}_T} \) while the stake of promoter T will be \( \frac{\alpha_T\times {n}_T\times x}{n_A+x\times {n}_T} \) in the merged company, where ‘x’ is the exchange ratio. If (α_A × n_A) < (n_T × x × α_T) then post merger, the stake of the target firm promoter will be greater than the stake of the acquiring firm promoter, and the acquiring firm promoter would surely prefer a controlling stake in T rather than merge with T.

Ramanujam (2006) describes how Indian promoters take special care to ensure that their equity stake does not fall below 51 % after the merger.

Under the Delaware Law, a simple majority of shareholders can remove the board (even a staggered board) without showing any cause. See http://delcode.delaware.gov/title8/c001/sc04/

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Khanna and Palepu (1997) discuss the different benefits that group companies get in India.

http://www.business-standard.com/india/news/transfer-pricing-explained/327373/

For example, Tata Steel’s acquisition of Corus Steel was partially funded by selling shares of Tata Consultancy Services, a Tata Group firm (http://articles.timesofindia.indiatimes.com/2006-10-19/india-business/27826752_1_tcs-shares-tata-steel-corus-group) or Hindalco’s acquisition of Novelis was partially funded by Essel Mining & Industries, another unlisted Aditya Birla Group firm (http://articles.economictimes.indiatimes.com/2011-12-26/news/30559124_1_essel-mining-industries-iron-ore-aditya-birla-group)

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About 4 % of the mergers state tax reduction as the cause for merger

A holding company holds shares in other companies (primarily other group companies). Indian promoters often control different group companies through the holding companies.

When holding company is 100 % subsidiary of the parent company, and is profitable, EPS would increase after merger.

While testing a hypothesis, power analysis is done to determine if the sample size is large enough to draw meaningful inferences at α = .05 and β = .2 (the power of the test = 1− β = .8). Cohen (1992) suggested a minimum sample size of 586, when α = .05 and the power of the test is 80 % for small effect size. Since our sample size exceeds 586, we believe our test results are pretty robust.

Martin and Sayrak (2003) summarized the various measures that have been used to measure relatedness, along with the benefits and costs of each. SIC codes are generally used to define relatedness in the US context (Akbulut & Matsusaka, 2010).

www.eaber.org/intranet/documents/112/1444/IGIDR_Kali_2005.pdf

There is also some merit in using a larger estimation period because of the likely presence of insider trading before the merger announcement. We test sensitivity of our results to longer estimation period (−260 to −11 days). We find that our results do not change when we use a longer estimation period.

Sensex is calculated using the “free-float market capitalization-weighted” methodology with 30 component stocks representing large, well-established and financially sound companies across key sectors.

Book value of equity = Total assets − Miscellaneous assets (specifically, capital expenses and amortization not written off) − Current liabilities − Borrowings − Revaluation reserves − Preferred stock. This is calculated at the end of March each year. Then, BTM = Book value of equity at March end/Market capitalization at September end.

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Title: Role of industry relatedness in performance of Indian acquirers—Long and short run effects
Authors: Parama Barai
Pitabas Mohanty
Publication date: 01-12-2014
Publisher: Springer US
Published in: Asia Pacific Journal of Management / Issue 4/2014
Print ISSN: 0217-4561
Electronic ISSN: 1572-9958
DOI: https://doi.org/10.1007/s10490-014-9372-1

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