Do takeovers create value? A residual income approach on UK data
AbstractThis paper develops and empirically tests a new methodology for evaluating the financial performance of takeovers. The existing accounting and event study methodologies do not adequately address the key issue of whether takeovers are a positive net present value investment for the acquiring company. Our methodology attempts this by employing the residual income approach to valuation, and comparing the present value of the acquirer's future earnings before the acquisition, with those that actually result following takeover. In contrast to existing methodologies, we explicitly take account of the cost of the acquisition, the acquirers cost of capital, and the earnings which are created beyond the sample period. The methodology is used for evaluating a comprehensive sample of U.K. acquisitions completed during 1985-96. Using the traditional accounting method, we find that acquisitions result in a significant improvement in profitability. However, the residual income approach reveals that on average, acquisitions destroy roughly 30 percent of the acquirer's pre-acquisition value.
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Bibliographic InfoPaper provided by ESRC Centre for Business Research in its series ESRC Centre for Business Research - Working Papers with number wp252.
Date of creation: Dec 2002
Date of revision:
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Web page: http://www.cbr.cam.ac.uk/
takeovers; valuation; accounting studies; event studies; residual income.;
Find related papers by JEL classification:
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing
- G34 - Financial Economics - - Corporate Finance and Governance - - - Mergers; Acquisitions; Restructuring; Corporate Governance
- M4 - Business Administration and Business Economics; Marketing; Accounting - - Accounting
This paper has been announced in the following NEP Reports:
- NEP-ALL-2002-12-09 (All new papers)
- NEP-CFN-2002-12-09 (Corporate Finance)
- NEP-COM-2002-12-09 (Industrial Competition)
- NEP-IND-2002-12-09 (Industrial Organization)
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Dickerson, Andrew P & Gibson, Heather D & Tsakalotos, Euclid, 1997. "The Impact of Acquisitions on Company Performance: Evidence from a Large Panel of UK Firms," Oxford Economic Papers, Oxford University Press, vol. 49(3), pages 344-61, July.
- Eugene F. Fama & Kenneth R. French, .
"Forecasting Profitability and Earnings,"
CRSP working papers
358, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
- Barber, Brad M. & Lyon, John D., 1996. "Detecting abnormal operating performance: The empirical power and specification of test statistics," Journal of Financial Economics, Elsevier, vol. 41(3), pages 359-399, July.
- Gregor Andrade & Mark Mitchell & Erik Stafford, 2001. "New Evidence and Perspectives on Mergers," Journal of Economic Perspectives, American Economic Association, vol. 15(2), pages 103-120, Spring.
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