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Do takeovers create value? A residual income approach on UK data

Author

Listed:
  • Magnus Bild
  • Paul Guest
  • Andy Cosh
  • Mikael Runsten

Abstract

This 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.

Suggested Citation

  • Magnus Bild & Paul Guest & Andy Cosh & Mikael Runsten, 2002. "Do takeovers create value? A residual income approach on UK data," Working Papers wp252, Centre for Business Research, University of Cambridge.
  • Handle: RePEc:cbr:cbrwps:wp252
    Note: PRO-1
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    File URL: https://www.cbr.cam.ac.uk/fileadmin/user_upload/centre-for-business-research/downloads/working-papers/wp252.pdf
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    References listed on IDEAS

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    1. Frankel, Richard & Lee, Charles M. C., 1998. "Accounting valuation, market expectation, and cross-sectional stock returns," Journal of Accounting and Economics, Elsevier, vol. 25(3), pages 283-319, June.
    2. 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.
    3. Fama, Eugene F & French, Kenneth R, 2000. "Forecasting Profitability and Earnings," The Journal of Business, University of Chicago Press, vol. 73(2), pages 161-175, April.
    4. 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 344-361, July.
    5. 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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    Cited by:

    1. Mfon Akpan & Peter Wanke & Jorge Junio Moreira Antunes & Rangan Gupta, 2018. "Unveiling the Endogenous Relationship between Technical Efficiency and Value Creation in Mergers and Acquisitions in Nigeria," Working Papers 201821, University of Pretoria, Department of Economics.
    2. Raj Thamotheram & Helen Wildsmith, 2007. "Increasing Long-Term Market Returns: realising the potential of collective pension fund action," Corporate Governance: An International Review, Wiley Blackwell, vol. 15(3), pages 438-454, May.

    More about this item

    Keywords

    takeovers; valuation; accounting studies; event studies; residual income.;

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G34 - Financial Economics - - Corporate Finance and Governance - - - Mergers; Acquisitions; Restructuring; Corporate Governance
    • M4 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting

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