Does operating performance really improve following corporate acquisitions? Aloke Ghosh )
Zicklin School of Business, Baruch College, The City UniÕersity of New York, Box E-725, 17 Lexington AÕenue, New York, NY 10010, USA Accepted 1 May 2001
Abstract Previous research indicates that operating performance improves following corporate acquisitions relative to industry-median firms. Such performance results are likely to be biased because acquiring firms undertake acquisitions following a period of superior performance and they are generally larger than industry-median firms. Using firms matched on performance and size as a benchmark, I find no evidence that operating performance improves following acquisitions. I also analyze if performance is higher in cash acquisitions as suggested by various studies. The results indicate that cash flows increase significantly following acquisitions that are made with cash, but decline for stock acquisitions. q 2001 Elsevier Science B.V. All rights reserved. JEL classification: M41 Keywords: Acquisitions; Operating performance
1. Introduction This paper focuses on merging firms’ operating performance following corporate acquisitions. While many studies analyze stock returns around acquisitions, few studies consider changes in operating performance. Perhaps the most notable study that analyzes changes in operating performance around acquisitions is by Healy et al. Ž1992.. They estimate acquisition-induced improvements in cash flow performance as the intercept of the regression of post-acquisition industry-adjusted )
Corresponding author. Tel.: q 1-212-802-6431; fax: q 1-212-802-6423. E-mail address: Aloke – Ghosh@baruch.cuny.edu ŽA. Ghosh..
0929-1199r01r$ - see front matter q 2001 Elsevier Science B.V. All rights reserved. PII: S 0 9 2 9 - 1 1 9 9 Ž 0 1 . 0 0 0 1 8 - 9
A. Ghoshr Journal of Corporate Finance 7 (2001) 151–178
cash flow of merging firms’ on the corresponding pre-acquisition number. Using this methodology, they conclude that cash flow performance improves following acquisitions. However, inferences from a regression analysis are likely to be biased when industry-median firms are used as a benchmark. Measurement errors from using industry-median firms, and not the correct benchmark, are unlikely to be random because merging firms tend to undertake acquisitions following a period of superior performance ŽMorck et al., 1990.. A nonrandom measurement error will be absorbed in the intercept of the regression which will bias conclusions about merging firms’ post-acquisition performance. I therefore re-examine the question whether operating cash flow performance improves following corporate acquisitions by using a research design that accounts for superior pre-acquisition performance. I follow the research design prescribed by Barber and Lyon Ž1996. that accounts for pre-event performance and size. Specifically, I compare the post- and pre-acquisition performance of merging firms relative to matched firms to determine whether operating cash flow performance improves following acquisitions. Firms are matched on pre-acquisition performance and size of merging firms as in Loughran and Ritter Ž1997.. Using a sample of large acquisitions between 1981 and 1995, I find that merging firms’ post-acquisition operating cash flow performance increases significantly when I use the Healy et al. Ž1992. research design. However, I also find that merging firms systematically outperform industry-median firms over preacquisition years which implies that estimates of improvements in cash flow from a regression model are likely to be biased. Once I account for any superior pre-acquisition performance, I do not find evidence of improvements in the operating performance of merging firms following acquisitions. In particular, merging firms’ post-acquisition operating cash flow does not increase when...