Expected Market Reaction and the Choice of Method of Payment for Acquistions - Statistical Data Included

Financial Management (Financial Management Association), Winter, 1999 by Gary W. Emery, Jeannette A. Switzer

The cross-sectional regression models' feature that is important to note at this point is that the models fit the data well. Their F-values, 5.76 and 4.76, are significant at the 0.05 level. Therefore, we substituted each of the test sample transaction's characteristics into these models and computed the abnormal returns the bidder's expected from acquisitions for stock and cash. The means of these expected CARs and the differences between them and the bidders' actual CARs are our test statistics. These test statistics are reported in Table 4. The hypothesized sign of each test statistic, drawn from Table 1, is given below the result.

Column 1 of Table 4 shows the actual abnormal returns from the acquisition announcements. The mean two-day CAR for the 99 bidders that used cash as the method of payment was -0.18%, which is not significantly different from zero. In contrast, the mean of the two-day CAR for the 75 bidders that announced acquisitions for stock was -2.02%, which is significantly less than zero. The differences between these CARs and the CARs for the entire sample (reported in Table 2) are not statistically significant.

Columns 2 and 3 of Table 4 give the means of the expected CARs computed from Equations (2) and (3). We predicted that bidders that used cash as the method of payment expected abnormal returns that were greater than or equal to zero and greater than the abnormal return they expected from an acquisition for stock. These results, presented in Columns 2 and 4 of the first line of Table 4, confirm these predictions. The average of the CARs they expected from announcing an acquisition for cash was 0.37% which is significantly greater than zero. This return is also significantly greater than -2.79%, the abnormal return they expected if they announced an acquisition for stock. These results are consistent with our hypothesis that managers forecast the market's reaction and choose the method of payment that provides the higher expected abnormal return.

We predicted that bidders that used stock as the method of payment expected an abnormal return that was greater than or equal to zero and greater than the abnormal return they expected from an acquisition for cash. These results, presented on line 3 of Columns 3 and 4 in Table 4, do not confirm these predictions. The average of their expected CARs from an acquisition for cash was -0.16%, which is not significantly different from zero. However, this return is significantly greater than -1.23%, the abnormal return they expected if they announced an acquisition for stock. These results imply that managers that announced acquisitions for stock chose the wrong method of payment.

We also predicted that the bidders' actual CARs equaled their expected CARs for the chosen method of payment and that their actual CARs exceeded their expected CARs for the rejected method of payment. The results, given in Columns 5 and 6 of Table 4, partially confirm these predictions. Contrary to our hypothesis, the cash bidders did not earn as large an abnormal return by using cash (-0.18% minus 0.37% = -0.55%) as our expectations models predicted they would. Similarly, the stock bidders did not earn as large an abnormal return by using stock (-2.02% minus -1.23% = -0.79%) as our models predicted. The stock bidders also did not earn a higher abnormal return by using stock rather than cash (-2.02% minus -0.16% = -1.86%). However, cash bidders' actual CARs, -0.18%, were significantly greater than their predicted CARs for the method of payment (stock) they rejected (-2.79%), a result that is consistent with our hypothesis. [5]