The Behaviour of Announcement Period Returns of Bidders and Targets Involved in Takeovers and Mergers in the U.K. for the Period 1985 to July 1988

This study examines the behaviour of announcement period returns of bidders and targets involved in takeovers and mergers in the U.K. during the period 1985 to July 1988. In particular it examined the following aspects: (1) The validity of the 'information hypothesis' as suggested by Myers and Majluf (1984) on bidder returns in cash and share offers. (2) Comparison of announcement period returns to target shareholders in cash offers and those in share offers, in view of the presence of capital gains tax liability for shareholders in cash offers and the possibility that the bidders compensate them for this liability. (3) The effect of the takeover announcement on the returns to bidders and targets respectively. (4) The effect of takeover announcements on the wealth of shareholders in the combined firm. (5) The possibility that shareholders in high leveraged bidding firms earn higher returns than those in the low leveraged bidding firms. (6) The effect of merger announcement on the returns to bidders and targets respectively. (7) The effect of merger announcement on the wealth of shareholders in the combined firm. A sample of 90 bidders and targets in hostile bids and 21 bidders and targets in mergers which satisfied the sampling requirements were collected for the period January 1985 to July 1988. The market model was used to generate expected returns. The daily abnormal returns and cumulative abnormal returns for the two-day announcement period were used to measure the wealth effect of takeover and merger announcement. For takeovers, the findings of this study show that shareholders of share bidders earned significant negative abnormal returns for the two-day announcement period, whereas shareholders of cash bidders did not suffer losses, in support of the 'information hypothesis' suggested by Myers and Majluf (1984). The two-day announcement cumulative abnormal returns of all bidders in the takeover sample are significantly negative, in support of the notion that takeovers are negative net present value investments for bidder shareholders. However, the combined gains of bidders and targets are significantly positive implying that takeovers do create wealth for the shareholders of the combined firm. Shareholders of target firms in takeovers earned significant positive abnormal returns for the two-day announcement period irrespective of the form of payment (cash, shares, and combination) offered. However, there was no significant difference in the two-day announcement period returns of cash and share targets, in support of the notion that target shareholders in cash offers are not compensated for their capital gains tax liability. There is no evidence of shareholders in high leveraged bidding firms earning higher returns than those in the low leveraged bidding firms. For the sample of mergers, the two-day announcement period returns were positive for the targets, consistent with the findings of the earlier studies on merger targets in the U.K. and the US. The returns to bidders for the same period were not significantly different from zero. The combined gains at the two-day announcement period were significantly positive implying that the announcement of mergers does have a positive wealth effect on the share price of the combined firm. This contrasts with the findings of earlier studies which suggest that the combined gains in U.K. mergers are not significantly different from zero (Firth (1979)). This research was based on the assumption that the capital market is at least semistrong efficient. Since the analysis covered only eleven days surrounding the official announcement, it is not possible to infer that the findings of this study support this assumption. However, the significant positive combined gains of bidders and targets in both takeovers and mergers at the two-day announcement period imply that the securities market is strong form inefficient