Productivity, restructuring, and the gains from takeovers

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Abstract

This paper investigates how takeovers create value. Using plant-level data, I show that acquirers increase targets' productivity through more efficient use of capital and labor. Acquirers reduce capital expenditures, wages, and employment in target plants, though output is unchanged. Acquirers improve targets' investment efficiency through reallocating capital to industries with better investment opportunities. Moreover, changes in productivity help explain the merging firms' announcement returns. The combined announcement returns are driven by improvements in target's productivity. Targets with greater productivity improvements receive higher premiums. These results provide some first empirical evidence on the relation between productivity and stock returns in takeovers.

Introduction

Though it is well documented that takeovers increase the combined announcement returns for targets and acquirers (Andrade, Mitchell, and Stafford, 2001), focusing solely on stock market reaction to takeover announcements does not identify the sources of such gains. To shed light on the sources of gains from takeovers, several studies examine changes in plant-level productivity. For instance, Maksimovic and Phillips (2001) show that takeovers are followed by improved productivity.1 These studies, however, do not attempt to identify the detailed mechanisms that lead to these changes in productivity. Yet identifying these mechanisms is important to understand which factors influence a merger's success or failure. In addition, little empirical evidence exists on the direct relation between announcement returns and productivity changes. Determining whether such a relation exists is critical because, if it does, it suggests that the stock market is not just a sideshow, but rather it embeds information about underlying efficiency changes. The goal of this study, therefore, is to uncover the sources of productivity gains from takeovers and to relate them to the cross-sectional differences in announcement returns.

In this paper, I show that acquirers increase the productivity of targets through more efficient use of capital and labor and that the combined firms' announcement returns reflect these underlying efficiency improvements. I conduct the analysis on 1,430 mergers completed between 1981 and 2002, using data from the Securities Data Company (SDC) Mergers and Acquisitions database and plant level data from the US Census Bureau. These data allow me to identify the detailed changes in plant-level output and input from before to after a takeover.

I analyze the channels through which productivity gains are created after a takeover. Because an increase in productivity, measured by total factor productivity (TFP), requires a relative increase in output compared with inputs, I consider changes to output vis-à-vis input following a takeover. The results show that, relative to comparable plants, capital expenditures, wages per worker, and employment all experience substantial declines while output remains constant. Essentially, the acquired plants are able to produce the same amount of output using less input. I find that employee layoffs are concentrated mostly among nonproduction workers in target plants, which supports the hypothesis that acquirers reduce management slack and transfer their own management know-how. Also, investment efficiency, measured as the sensitivity of targets' capital expenditures to investment opportunities, rises significantly after a takeover. These increased investment efficiencies are mainly achieved by acquirers that were conglomerate firms and that already had an active internal capital market prior to a takeover. These results indicate that increases in productivity stem primarily from acquirers' more efficient use of targets' capital and labor.

Building on these findings, I relate targets' productivity changes to the combined firms' announcement returns. The literature on corporate control proposes that wealth gains to shareholders reflect future efficiency improvements (Jensen and Ruback, 1983). Following this argument, the combined firm's announcement returns, which measure the total synergy gains, should capitalize at least in part the acquired firm's post-takeover productivity improvements. I construct a variable ΔTFP to measure the target firms' pre- to post-takeover percentage changes in TFP and estimate the effect of ΔTFP on the combined announcement returns.

My analysis uncovers a statistically and economically significant effect of the target firm's ΔTFP on the combined announcement returns. Ceteris paribus, compared with acquiring a target at the 25th percentile of ΔTFP, acquiring a target at the 75th percentile increases the combined three-day announcement returns by 1 percentage point. If the target's pre-takeover market value is half of the acquirer's, such an interquartile change increases the combined returns by about 2.5 percentage points. The economic significance of the point estimates is considerable given that the sample median of the combined returns is about 3.1%. This evidence indicates that increases in the acquired firm's productivity are an important driver of the total synergy gains.

I next investigate the gains to targets and acquirers separately. Prior literature has consistently shown that targets receive high offer premiums from acquirers (Moeller, Schlingemann, and Stulz, 2004). Unfortunately, studies have yet to find specific economic gains that warrant such high premiums (Betton, Eckbo, and Thorburn, 2008). Many researchers attribute the high premiums to either behavioral distortions (Roll, 1986, Malmendier and Tate, 2008, Baker et al., 2012) or agency conflicts (Wulf, 2004, Hartzell et al., 2004). In this study, I hypothesize that a target firm's expected post-takeover improvements in productivity enhance its bargaining power in merger negotiation. Assuming that such anticipated post-takeover improvements in productivity materialize, I expect target firms with greater post-takeover productivity improvements to receive higher premiums from acquirers. The empirical evidence supports this hypothesis. Other things being equal, an acquirer pays a target with ΔTFP at the 75th percentile about a 10 percentage points higher offer premium than a target at the 25th percentile. This result is consistent with insights from Rhodes-Kropf and Robinson (2008), who emphasize targets' expected future surplus in determining bilateral bargaining positions. Lastly, I look at acquirers' own announcement returns. The results show that targets' improvements in productivity have a statistically and economically significant effect on acquirers' announcement returns only when the target is relatively large compared with the acquirer. Other things equal, if the target is half the size of the acquirer, an interquartile increase in target's ΔTFP is associated with 2 percentage points increase in acquirer's three-day announcement returns. This is a significant amount considering that the sample median of the acquirer returns is almost zero. Overall, these results indicate that announcement returns embed information about the target firm's post-takeover improvements in productivity.

This paper contributes to two related strands of literature on corporate takeovers. First, it builds upon studies on how takeovers affect targets' factor productivity. Maksimovic and Phillips (2001) find that acquired plants' productivity experiences greater improvements when the acquirer is more productive than the target. Schoar (2002) shows that acquired plants increase productivity when the acquisition is diversifying. More recently, Maksimovic, Phillips, and Prabhala (2011) present evidence that acquirers selectively choose target plants to retain and that only retained plants increase in productivity. Maksimovic, Phillips, and Yang (forthcoming) compare productivity outcomes between on- and off-wave mergers and between acquisitions made by public and private firms. While these studies focus on the differences in productivity outcomes following different types of acquisitions, my approach is to peer inside the black box to identify how changes to labor and investments lead to increases in productivity. My findings concur with those in Devos, Kadapakkam, and Krishnamurthy (2009) who show that operating synergies come primarily from cutbacks in investment expenditures. According to my results, cutbacks in investments are just a first step, as I further show that targets' post-acquisition investments are more responsive to measures of investment opportunities. Moreover, conglomerate acquirers and acquirers that had an active internal capital market are better able to realize such investment efficiency gains. These results lend further support to the bright side view of conglomerate firms' internal capital market (Stein, 1997, Maksimovic and Phillips, 2007, Maksimovic and Phillips, 2008).

Second, this study adds to the literature on the determinants of cross-sectional variation of merging firms' announcement returns. Most existing studies attempt to regress announcement returns on various proxies for economic gains such as Tobin's Q (Lang et al., 1989, Servaes, 1991), insider and analyst forecasts of synergies (Houston et al., 2001, Devos et al., 2009), operating cash flow (Healy, Palepu, and Ruback, 1992), corporate governance measures (Masulis et al., 2007, Wang and Xie, 2009), and product market synergy (Hoberg and Phillips, 2010). My findings support the conclusion that wealth gains to shareholders reflect expectations of improved operating performance. The crucial difference is that I regress announcement returns directly on plant-level productivity changes. Adopting this approach has two key advantages. First, plant productivity is a more fundamental determinant of economic efficiency. Second, plant-level productivity measures are less subject to noise in accounting information surrounding mergers. This approach is similar to the one in Schoar (2002), who shows that stock market values track plant-level TFP in both conglomerate and single-segment firms. To the best of my knowledge, this is the first study that explores the relation between stock returns and plant-level productivity in the context of takeovers.

The rest of the paper is structured as follows. In the following section, I present the research objectives and develop some testable hypotheses. Section 3 describes the data, sample, and variables. Section 4 analyzes how takeovers affect targets' inputs and outputs. In Section 5, I examine possible determinants of merger announcement returns from the perspective of productivity changes. Finally, Section 6 concludes.

Section snippets

Hypothesis development and related literature

In this study, I attempt to address two questions: (1) How do takeovers create productivity gains? (2) Do announcement returns for the combined firm reflect these productivity gains? In this section, I discuss the prior literature related to these two questions and develop some hypotheses to guide the empirical analysis.

Data sample and variable construction

I use plant-level data from the US Census Bureau to test the above hypotheses. The main data used in this paper come from a linked sample between the Annual Survey of Manufactures (ASM), the Census of Manufactures (CMF), and the SDC Mergers and Acquisitions database. This section describes the sample.

Real effects of takeovers

In this section, I analyze the channels through which productivity gains are created by examining the detailed changes to targets in outputs, inputs, labor and investments.

Determinants of announcement returns

The above results show whether and especially how target plants achieve improvements in TFP after takeovers. In this section, I analyze the relation between what happens inside the target firm and what happens to stock returns when the merger is announced. In particular, I explore the connection between cross-sectional differences in announcement returns and the changes in target firm's productivity. To pursue this, I augment the standard announcement returns regressions with the target firm's

Conclusions

In this paper, I analyze how takeovers create value. I address this question in two steps. First, by examining changes to outputs and inputs after a takeover, I identify the detailed channels through which the acquiring firm improves the target firm's total factor productivity. Second, by establishing a direct relation between a target firm's post-takeover productivity changes and takeover announcement returns, I provide some micro-level evidence to understand the stock market revaluation of

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    This paper is based on various chapters of my dissertation at the University of Michigan. I am indebted to members of my dissertation committee, Amy Dittmar (co-chair), Jan Svejnar (co-chair), Charlie Brown, Francine Lafontaine, Amiyatosh Purnanandam, and Uday Rajan for their guidance and support. Suggestions provided by Ken Ahern, Angie Low, and an anonymous referee greatly improved this paper. I also thank Jagadeesh Sivadasan, Xianming Zhou, and seminar participants at the University of Michigan, University of Maryland, Cheung Kong Graduate School of Business, Peking University, Fudan University, and Shanghai Jiaotong University for helpful comments. The research was conducted when I was a special sworn status researcher of the US Census Bureau at the Michigan Research Data Center. Any opinions and conclusions expressed herein are mine and do not necessarily represent the views of the US Census Bureau. All results have been reviewed to ensure that no confidential information is disclosed. This research is funded in part by Ewing Marion Kauffman Foundation. All errors are my own.

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