Massive Shareholder Wealth Destruction: Lessons from a Recent Merger Wave

Mergers and acquisitions activity tells a great story about the economic and business environment of a given period in financial history. The recent merger wave of 1998-2001 was by far the largest in American history. It depicts a shockingly disturbing tale of vast amounts of shareholder wealth being lost--$240 billion. Authors Sara Moeller of SMUCox, Frederik Schlingemann of the University of Pittsburgh and Rene Stulz of the Ohio State University discover that the substantial losses in shareholder wealth are attributed to 87 large firms from the 4,136 acquisitions during that period. These large loss deals offer important lessons to corporate finance decision-makers about the effects of mergers and acquisitions on shareholders and the potential for poor performance when one last deal goes bad.

In "Wealth Destruction on a Massive Scale? A Study of Acquiring-firm Returns in the Recent Merger Wave" forthcoming in the Journal of Finance, the authors find the phenomenon of a number of large firms that are in fact destroying wealth in vast proportions. These deals represent only 2.1% of acquisitions, yet account for over 43% of the money spent on acquisitions with a total wealth loss of $397 billion. The remainder of the acquisitions made gains of $157 billion. In the 1980s acquiring firm shareholders lost only $4 billion; the period 1990 to 1997 ushered in gains of $24 billion to acquiring firm shareholders. "Systematically, it is the large firms that are making the really bad decisions, not the smaller ones. In the period 1998 to 2001, value was literally being thrown away," Moeller explained. "We are not saying that mergers and acquisitions are themselves bad. We are showing the financial world that when it goes wrong, it can go drastically wrong. For the large loss deals, for every $1 spent, the value of the acquirer decreased by $0.46.  So it seems that not only is that particular merger perceived poorly but it is a watershed event which acts as a negative signal to the market.  Subsequently, future acquisitions are also negatively perceived."

What the Findings Reveal
Findings reveal that when one of the large loss deal firms makes a bad acquisition, not only does the market discount the firms value in terms of the acquisition itself, but thereafter the firm performs poorly. Large loss deals have a negative abnormal return of 10.6%. These firms tend to have a high market-to-book value and are possibly overvalued. One possibility is that firms with higher valuations allow for more managerial discretion, making the environment ripe for choosing bad acquisitions when good ones have run out. Investors then learn from the acquisition announcement that the true value of the firm is not as high as believed, and thus the discounting process begins.

While prior research has examined the change in synergy value, the combined bidder and target value, this is the first paper to document periods which had considerable synergy losses. From the period 1980 1990, gains were roughly $11.6 billion; 1991-2001 saw $ 90.16 billion lost; and 1998-2001 witnessed synergy losses of $ -133.67 billion of shareholder wealth (subtracting gains from losses). The combined bidder and target dollar losses total $212 billion for the latter period. Overall, there are more large loss deals in the latter period than at any other time. The increase in the frequency and magnitude of large dollar loss acquisitions dwarfs the increase in large dollar gain acquisitions.

Portrait of a Large Loss Firm
Possible reasons for these large loss deals are varied and numerous. However, one possibility could be that the acquisition surprised the markets by revealing that management is overcome by hubris, the firms strategy of growth through acquisitions has reached its limits, or the firms governance is such that management can make large mistakes without being stopped by the board. Acquisition announcements with shareholder losses in excess of $1 billion, the large loss deals, are unusual.  Most large loss deals of public firm acquisitions with a large equity component in the consideration. (See Table II in paper for the distribution of announcements over the sample period.)

Almost all large loss deals take place in the period from 1998 to 2001. Large gain deals, those with a shareholder gain in excess of $1 billion, are also unusual. They tend to be large firms with lower leverage, but not necessarily with more cash than other firms. They also tend to have lower operating cash flow. Most of these deals are within the acquirers industry, and not diversification attempts. Large loss firms generally make a large loss deal when their valuation is historically high.

Another common denominator of firms making large loss deals is that they tend to be serial acquirers. Findings indicate that for the two years before the large loss deal, the firms create value through acquisitions for a total of $20 billion. In the year before the large loss deal announcement, 26 firms make an economically significant acquisition and the mean abnormal return is 2%. Even more striking, the firms making large loss deals make 17 acquisitions of public firms paid for with equity in the sample in the two years before making their large loss deal. With these acquisitions, the firms create wealth for their shareholders of $2.67 billion. The large loss deal, however, is a watershed event. In the two years after the large loss deal, announcements of acquisitions are associated with a reduction in shareholder wealth of $110 billion.

Conclusion
It seems sensible to conclude that the announcement of the large loss deal provides information to the market that the firms valuation is not justified and that earlier acquisition announcements did not provide similar information. Alternatively, the market could just have overreacted to the large loss deal announcements. Future research by the authors will analyze the reasons behind the large loss deals and their firms. The firms that make large loss deals are successful with acquisitions until they make their large loss deal.

These findings have important implications for corporations and their management. By dissecting the lessons of the worst and most punitive cases of decisions gone awry, financial decision-makers can have better information about creating value for their shareholders.