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ALFRED

P.

WORKING PAPER SLOAN SCHOOL OF MANAGEMENT

Paul M. Healy MIT's Sloan School of Management

Krishna G. Palepu Harvard Business School

and
Richard S. Ruback Harvard Business School

Working Paper /'BlAg-SO

MASSACHUSETTS INSTITUTE OF TECHNOLOGY 50 MEMORIAL DRIVE CAMBRIDGE, MASSACHUSETTS 02139

DOES CORPORATE PERFORMANCE IMPROVE AFTER MERGERS?
by
Paul M. Healy MIT's Sloan School of Management

Krishna G. Palepu Harvard Business School

and
Richard S. Ruback Harvard Business School

Working Paper

^t'Bl'tS-SO

April 1990

We

thank Robin Cooper, George Foster, Michael Jensen, Bob Kaplan, Richard Leftwich, Mark Wolfson, Karen Wruck, and seminar participants at Baruch College, Carnegie Mellon, Columbia, Dartmouth, Duke, Federal Reserve Bank OVashington D.C.), Harvard, Michigan, MIT, NYU, Rochester, Stanford, USC, and U.S. Department of Justice for helpful conmients on earlier drafts, Chris Fox and Ken Hao for research assistance, and the International Financial Services Center at MIT and the Division of Research at HBS for financial support.

DOES CORPORATE PERFORMANCE IMPROVE AFTER MERGERS?

Abstract

We examine the post-acquisition operating performance of merged firms using a sample of the 50
between U.S. public industrial firms completed in the period 1979 to 1983. The merged firms have significant improvements in asset productivity relative to their industries after the merger, leading to higher post-merger operating cash flow returns. Sample firms maintain their capital expenditure and R&D rates relative to their industries after the merger, indicating that merged firms do not reduce their long-term investments. There is a strong positive relation between post-merger increases in operating cash flows and abnormal stock returns at merger announcements, indicating that expectations of economic improvements underlie the equity revaluations of the merging firms.
largest mergers
results indicate that

DOES CORPORATE PERFORMANCE IMPROVE AFTER MERGERS?

1.

Introduction
This study examines the post-merger cash flow performance of acquiring and target firms,

and explores

the sources of merger-induced
inability

changes

in

cash flow performance. Our research

is

motivated by the
real

of stock price performance studies to determine whether takeovers create

economic gains and

to identify their sources.

There

is

near unanimous agreement that target stockholders benefit from mergers, as

evidenced by the premium they receive for selling their shares.

The

stock price studies of

takeovers also indicate that bidders generally break-even, and that the combined equity value of the

bidding and target firms increase as a result of takeovers.
typically attributed to

These increases

in equity

values are

some unmeasured source of

real

economic

gains, such as synergy. But the

equity value gains could also be due to capital market inefficiencies. For example, the equity value

gains

may simply

arise

from

the creation of an over-valued security.

Previous studies have analyzed the stock price performance of unsuccessful takeovers to

determine

if

the equity increases in takeovers are

from

real

economic gains or

capital

market

inefficiencies.!

However, the studies of unsuccessful takeovers cannot distinguish between the
inefficiency explanations.
is

real

economic gains and the market

The

fact that the stock prices of

unsuccessful merger targets return to their pre-offer level
anticipated

consistent with the loss of an
is

premium — whatever

its

source.

The
It is,

anticipation of real economic gains

observationally equivalent to market mispricing.

therefore, difficult to conceive of a pure

stock price study that could resolve the ambiguity in the interpretation of the stock price evidence

because of

this inherent identification

problem.

Stock price studies also cannot provide evidence on the sources of any merger-related

1

Dodd

(1980), Asquith (1983).

Dodd and Ruback

(1977), Bradley, Desai and

Kim

(1983), and

Ruback

(1988).

Post-merger corporate performance
gains.

page 2

Yet, differences of opinion about the source of the gains in takeovers underlies

much of

the public policy debate

on

their desirability.

Gains from mergers could arise from a variety of

sources, such as operating synergies, tax savings, transfers
stakeholders, or increased

from employees or other

monopoly

rents.

Equity gains from only

some of

these sources are

unequivocally beneficial at the social

level.

Our approach

is to

use post-merger accounting data to directly test for changes in

operating performance that result from mergers. 2

Our

tests

use accounting data collected from
for

company annual
large mergers

reports,

merger prospectuses, proxy statements and analysts' reports
industrial firms

50

between U.S. public

which were completed

in the

period 1979 to

1983.

We recognize

that accounting data are imperfect

measures of economic performance and

that these data

can be affected by managerial decisions. As

we

explain in section 2,

we

use cash

flow measures of economic performance to mitigate the impact of the financing of the acquisition

and the method of accounting for the transaction.

We also recognize that our cash

flow variables

measure period-by-period performance which

is

affected by firm-specific and industry factors.

We therefore use industry performance as a benchmark to evaluate post-merger performance.

Results reported in Section 3

show

that the

merged firms have increases

in

post-merger

operating cash flow performance relative to their industries. These increases arise from post-

merger improvements

in asset productivity.

We find no evidence

that the

improvement

in post-

merger cash flows

is

achieved

at the

expense of the merged firms' long-term viability since the

sample firms maintain their capital expenditure and
results differ

R&D rates relative to their industries.

Our

from the findings reported by Ravenscraft and Scherer (1987), and Herman and

Lowenstein (1988)

who examine

earnings performance after takeovers and conclude that merged

2

Three recent studies have examined earnings performance subsequent to management buyouts of

corporations (Bull (1988), Kaplan (1990), and Smith (1990)). Our paper focuses on acquisitions of one public company by another either in a merger or a tender offer, rather than on management buyouts.

3

Post-merger corporate performance
firms have no post-takeover operating improvements.

page 3

In section 4

we examine

the relation between our cash flow
in earlier studies.

measures of post-merger
in operating cash

performance and stock market measures used

Improvements

flow returns

in part

explain the increase in equity values of the merging firms at the
indicates that the stock price reaction to mergers
is

announcement of the merger. This
anticipated

driven by

economic gains

after the merger.

2.

Experimental Design

2.1

Sample

We
limit the

base our analysis on the largest 50 acquisitions during the period 1979 to 1983.
studied to

We

number of acquisitions

make

the

hand data collection tasks manageable. The

largest acquisitions have several important advantages over a similarly sized
First, if there are

random sample.

economic gains from a takeover, they are most

likely to

be detected when the
total

target firm

is large.

Second, while the sample consists of a small fraction of the

number of
for a

acquisitions in the sample period, the total dollar value of the
significant portion of the dollar value of takeover activity.'*

50 firms selected accounts
Finally,
it is

less likely that the

acquirers in the sample undertake equally large acquisitions prior or subsequent to the events,

reducing the probability of confounding events.

The sample period (1979-83)

is

selected to focus on recent mergers and also to have

sufficient post-merger performance data.

To

select the acquisition sample,

we

identify the

382

3

See Caves (1989) for a review of the studies

that

examine the ex post perfonnance of merged firms.

4

The aggregate market value of equity of
is

the

50

target firms in

our sample one year prior to the

acquisition

$43

billion.

Post-merger corporate performance
merger-related delistings on the

P^g^ ^
the sample period.

CRSP database in
.

The names of the

acquirers

are identified from the Wall Street Journal Index
the

The sample comprises acquisitions involving
criteria: the

50

largest targets that satisfy the following

two

acquirer

is

a

US company which is
companies.

listed

on

the

NYSE or ASE,
is

and the

target

and acquirer
as the

are not financial or regulated

Target firm size

computed from Compustat

market value of

common

stock plus the book

values of net debt and preferred stock at the beginning of Uie year prior to the acquisition.
Acquisitions are deleted from the sample
post-acquisition financial information
utilities)
is

if the

acquirers are

non-US or

private companies since

not available for these mergers. Regulated (railroads and

and financial firms are deleted because they are subject to special accounting and

regulatory requirements,

making them

difficult to

compare with other firms.

Table

1

reports descriptive statistics

on

the time distribution of the

sample mergers,
Panel

their

industry distribution, and relative sizes of the target and acquiring firms.

A

of die table

shows

that twelve of the fifty

sample mergers

are

completed

in

1981 and fourteen in 1983. The

remaining 24 mergers are approximately evenly distributed over the other three sample years.
Since the sample
is

clustered in time, the sample firms' post-merger performance

is

likely to

be

influenced by economy-wide changes.

Our
their

tests, therefore,

control for these factors by

comparing sample

firms'

performance with

corresponding industries'. Evidence in Panel

B

shows

that the

sample targets and acquirers represent a wide cross-section of Value Line
target firms

industries.

The

belong to 27 different

industries; the acquiring firms

come from 33

different industries.

A

list

of target and acquirer firms

in

our sample and a description of their

businesses

is

reported in an appendix.

Summary
Panel

statistics

on the

relative sizes of the target

and acquirer firms are reported

in

C

of Table

1.

The

sizes of targets

and acquirers

are

measured by the book value of net debt

Post-merger corporate performance

poge 5
and marketable
securities) plus the

Oong-term

debt, plus short-term debt, less cash

market value

of equity one year prior to the merger. The relative size of the two firms
the target to that of the acquirer.

is

the ratio of the size of

On

average, the target firm

is

42%

of the assets of the acquirer,

indicating that the acquisition

is

a significant economic event for the purchasing fums.

Descriptive statistics on the

method of accounting, number of
Panel

bidders, and

method of

payment, are reported
transactions

in

Table 2 for the 50 mergers.
for

A

shows

that the majority of
that

(80%) are accounted

under the purchase method. Panel B shows

most of the

acquisitions (70%) are uncontested.

Twenty percent

are contested by

two bidders (including the
bidders.

ultimate acquirer) and only ten percent of the transactions attracted
distribution of the basis of

more than two
in the

The

payment

in

Panel

C

indicates that

payments

form of 100% cash,

100%

stock and a combination of cash and stock are equally

common.

2.2

Performance Measurement

We use pre-tax operating cash flows to measure improvements in operating performance.
We define operating cash flows as sales, minus cost of goods sold, and selling and administrative
expenses, plus depreciation and goodwill expenses. This measure
is

deflated by the market value
is

of assets (market value of equity plus book value of net debt) to provide a return metric that

comparable across firms. Unlike accounting return on book
the effect of depreciation, goodwill, interest expense/income,

assets,

our return measure excludes

and

taxes. It is therefore unaffected

by the method of accounting for the merger (purchase or pooling accounting) and/or the method
of financing the merger (cash, debt, or equity).
difficult to

As discussed below,

these factors

make

it

compare

traditional accounting returns of the

merged firm over time and

cross-

sec tionally.

Post-merger corporate performance
Effects of Purchase

poge 6

and Pooling Accounting
requires that the assets and liabilities of target firms be restated at

The purchase method
their current

market values.

No

such revaluation

is

permitted under the pooling method.

Further, under the purchase
price

method the acquirer records any difference between the acquisition
liabilities

and market value of identifiable assets and
it.

of the target company as goodwill, and

amortizes
first

No

goodwill

is

recorded under the pooling-of-interests method. Finally, for the

year of the merger, the purchase method consolidates results of the target with those of the

acquirer from the date the merger took place; the pooling firms from the beginning of the year regardless of

method consolidates
merger took place.

results for the

two

when

the

The same transaction

typically results in

lower post-merger earnings under purchase

accounting than under pooling. The purchase method increases depreciation, cost of goods sold,

and goodwill expenses subsequent to the takeover. Also,
usually lower under purchase accounting because
it

in the

year of the merger, earnings are

consolidates the target's earnings with the

acquirer for a shorter period of time than pooling.

The lower earnings reported under
method of accounting
for the

the

purchase method are entirely due to differences

in the

merger and

not due to differences in economic performance. Furthermore, post-merger book assets under
the purchase

method wiU be
It is

larger than those under pooling because of the asset write-up

under

the purchase method.

therefore misleading to

compare pwst- and pre-merger accounting

rates of return for firms that use

purchase accounting to infer whether there are economic gains

from mergers.
transaction.

In our sample,

80%

of the firms use the purchase method to account for the

Our operating cash flow performance measure —unlike earnings based performance
measures

-

is

unaffected by depreciation and goodwill.

It is

comparable cross-sectionally and on

Post-merger corporate performance
a time-series basis

pog^ 7
methods of accounting for
the merger.

when

firms use different

We exclude

the first year of the merger in our analysis because of the differences between the purchase and

pooling methods in timing the consolidation of the target with the acquirer. Excluding the

first

year also mitigates the effect of inventory write-ups under the purchase method, since
inventory
is

this

usually included in cost of sales in the merger year. 5
is

Since the asset base in our
it is

return metric

the market value, rather than
to record the

book

value, of assets,

also unaffected by the

accounting method used

merger.

Effects of Method of Financing

Mergers

Post-acquisition accounting earnings are also influenced by the

method of financing

the

merger. Accounting income

is

computed

after deducting interest

expenses (the cost of debt), but
is

before allowing for any cost of equity. Thus,
post-acquisition profits will be lower than
if

if

an acquisition
acquisition

financed by debt or cash,

its

the

same

is

fmanced by

stock. Since the

differences in earnings reflect the financing choice and not differences in economic performance,
it is

misleading to compare reported accounting earnings, which are computed after interest
for firms that use different

income and expense,

methods of merger financing. Panel

C of Table

2 shows that cash and stock methods of financing are equally

common

in

our sample.

We use

operating cash flows before interest expense and income from short-term investments deflated by
the market value of assets to measure performance. This cash flow return
is

unaffected by the

choice of fmancing.

5

Firms using the LIFO inventory valuation method expense the written-up inventory as inventory layers

are depleted,

making

it

difficult to

determine

not

make any

adjustments for these firms.

when to adjust However, this

earnings for the effect of the write-up.
is

We therefore do
bias in our

unlikely to lead to a serious

downward

earnings measure since

LIFO

inventory liquidations are relatively infrequent.

Post-merger corporate performance
2.3

page 8

Performance Benchmark

We
the

add the accounting data of the

target

and bidding firms prior to the merger

to obtain

pro forma pre-merger performance of the combined firms.
to this

Comparing

the fwst-merger
in

performance

pre-merger benchmark provides a measure of the change

performance.
to

But some of

the difference

between pre-merger and post-merger performance could be due
Hence,

economy-wide
target

or industry factors.

we

use the industry-adjusted performance of the
to evaluate the

and bidding firms as our primary benchmark

post-merger performance.

Industry-adjusted performance measures are calculated by subtracting the industry median from
the sample firm value.

The data

for

merging firms are excluded when calculating the industry

median. Value Line industry definitions immediately prior to the merger are used for the target

and acquirer

in

both the pre-merger and post-merger analysis. Industry data are collected from

Compustat

Industrial

and Research

files.

2.4

Comparison with Prior Research

We examine more recent mergers than those analyzed by
performance. Ravenscraft and Scherer's sample
is

previous studies of post- merger
to 1977.

from the period 1950
,

While Herman

and Lowenstein
data after 1981.

select firms that

merge

in the

period 1975 to 1981 they have limited post- merger

Neither

Herman and Lowenstein, nor Ravenscraft and Scherer examine performance

expectations prior to the merger, or restate earnings and assets for firms using purchase
accounting, making
their return
it

difficult to interpret their findings.
in the

Herman and Lowenstein do

not adjust
fail to

on equity measure for differences

method of financing the merger, and

control for the effect of common industry shocks on post- merger earnings performance.

Post-merger corporate performance
Ravenscraft and Scherer focus exclusively on lines of business.
not obvious

page 9
It is

why

gains from mergers would only be reflected in the acquired segments; synergies are just as likely
to

improve the performance of the other
line of business data

lines of business

of the acquiring firms. They also use
Definitions of business

FTC

which have several potential problems.
after

segments may change systematically

mergers

if

acquirers restructure their operations.

Results of tests using segment data reported to the

FTC

are also likely to be difficult to inteipret

since reporting firms have incentives to use accounting discretion to reduce the likelihood of antitrust suits

by the

FTC

(see Watts and

Zimmerman

(1986)).

3.

Cash Flow Return Performance
Operating Cash Flow Returns before Industry Adjustments

3.1

To
the target

construct the pre-merger performance benchmark,

we

aggregate the cash flow data for
for the

and acquiring firms to determine the pro forma performance measures
-1).

combined

firm in each of the five years before the merger (years -5 to

Performance measures for the

combined firms
where

are weighted-averages of values for the target and acquiring firms separately,

the weights are the relative sizes of the

two firms

at the

beginning of each year.

The
0, the

pre-tax operating cash flows of the
is

merged firm

are

computed

for years
First,

1

to 5.

Year
the

year of the merger,

excluded from the analysis for two reasons.

many of

acquiring firms use the purchase accounting method, implying that in the year of the merger the

two firms

are consolidated for financial reporting purposes

from only

the date of the merger.

Results for this year are therefore not comparable across firms or for industry comparisons.

Second, year
difficult to

figures are affected

by one-time merger costs incurred during

that year,

making

it

compare them with

results for other years.

Post-merger corporcue performance

page 10
Pre-tax op»erating cash

We deflate the operating cash flows by the market value of assets.

flow returns are computed as the ratio of pre-tax operating cash flows during the year to the

market value of assets at the beginning of the year. The market value of assets
the beginning of

is

recomputed

at

each year to control for changes
is

in the size

of the firm over time.

For pre-

merger years the market value of assets

the

sum of the
is

values for the target and acquiring firms.

The market value of assets of the combined firm

used in the post-merger years.

We exclude

the

change

in equity values of the target in the

and acquiring firms

at the

merger

announcement from the asset base

post-merger years. 6

This adjustment

is

important

because an efficient stock market capitalizes the value of any expected improvement in equity
prices at the merger

announcement.

If this

equity revaluation
will not

is

included in the asset base, the
increase, even

measured pre-tax operating cash flow returns
the

show any abnormal

when

merger

results in an increase in operating cash flows.

For example, consider an acquiring

firm (company A) and a target (company T) with annual operating cash flows of $20 and $10
respectively forever.

Both firms have the same cost of capital (10%), implying
$1(X) respectively. Therefore, a portfolio

that their market

values are

$200 and

comprised of

A

and

T has a market
that

value of
acquires

$300 and cash flows of $30, producing an annual

return of

10%. Suppose

when
this

A
$5

T combined cash
at

flows increase to $35 per year.

An

efficient

market capitalizes

improvement

$50. If post-merger cash flow returns are computed as the ratio of post-merger

cash flows ($35) and post-merger assets including the

premium ($350), measured performance
of

will be identical to the pre-merger operating return for the portfolio

A

and

T

(10%). There

is

no improvement
increased by $5.
6

in the

measured cash flow return even though cash flows per year have
is

Our measure of performance

computed

as the ratio

of post-merger cash flows

before the

The change in equity value of the target at the announcement of the merger is measured from five days was announced (not necessarily by the ultimate acquirer) to the date the target was delisted from trading on public exchanges. The change in equity value of the acquirer is measured from five days before its first offer was announced to the date the target was delisted from trading on public exchanges.
first offer

1

Post-merger corporate performance

page

1

($35) and post-merger assets excluding the asset revaluation ($350-$50). This return measure
(1

1.7%) correctly

reflects the

improvement

in operating

performance after the merger.

Panel

A of Table 3
and
1

reports

median pre-tax operating cash flow returns
returns range

for the

merged firm
to

in years -5 to -1,

to 5.

The median pre-tax operating

from

26%

27.5%

in

the five years before the merger.

After the merger, the median pre-tax operating returns are

lower, ranging from

19%

to

23%

with a median annual value of 21.8% for the whole period.
is

This indicates that post-merger performance

lower than the pre-merger benchmark.''

These data do not adjust for the impact of contemporaneous events on the merged

firms'

cash flow returns that are unrelated to the merger, and are therefore difficult to interpret. For

example, since
to overall

we

deflate cash flows

by

the

market value of

assets,

changes

in equity values

due

market movements will affect the measured returns over time. Equity values increased

during most of our sample period. This

may

explain the decrease in the cash flow returns in the

post-merger period.

We

focus on industry-adjusted performance measures because they

incorporate any contemporaneous changes in the overall cash flow performance and equity values

of the industry.

3.2

Operating Cash Flow Returns after Industry Adjustments
Industry-adjusted cash flow returns are the differences between values for the

merged

firm and

its

weighted-average industry median estimates. Prior to the merger industry values for

the sample firms are constructed by weighting median performance measures for the target and

acquiring firms' industries by the relative asset sizes of the two firms at the beginning of each

' To calculate the sample median pre-tax operating cash flow return for years 1 to 5, we first compute the median return in these years for each sample firm. The reported sample median is the median of these values. Sample median returns in the jwe-merger period are calculated in the same way.

Post-merger corporate performance

page 12

year. In all of the post-merger years target and acquirer industry cash flow returns are weighted

by the

relative asset sizes of the

two firms one year before

the merger.

The

industry-adjusted data reported in Panel

B

of Table 3

show

that

merged firms have

superior pre-tax operating cash flow returns on assets relative to their industries' in the post-

merger period. The industry-adjusted pre-tax operating return on

assets for the

merged firms
zero.

is

2.7%

in

year

1,

3.8%

in

year

2,

and 2.7%

in year 3, all significantly different

from

Years 4

and 5 also exhibit superior performance
statistically significant

relative to the industry, but these differences are not
is

Overall, the annual median pre-tax return in the five post-merger years
in the post

2.8%. Stated differently, the merged firms' pre-tax operating returns
are about

merger period

15%

larger than their industries' returns. 8

In contrast,

no

supjerior industry-adjusted

pre-tax operating cash flow returns occur in the five years before the merger; the median annual
return
is

0.4%.

In Panel

C

of Table 3

we

report the sample median difference in the industry-adjusted

performance

in the post-

and pre-merger periods.^

The improvement
is

in industry-adjusted pre-tax

operating cash flow returns in the post-merger years

confirmed; the median difference
is

in

industry-adjusted returns between the post- and pre-merger periods
reliable.

2.2%, which

is statistically

The

industry-adjusted results are strikingly different from the operating cash flow returns

8

We calculate the percentage increase relative to the industry as 2.8/(21.3-2.8).
To compute
the

9
first

sample median performance difference between the post- and pre-merger periods,

we

calculate the median returns for each sample firm in the post- and pre-merger years.

We

then compute

differences in the medians for each fum.

The median of these pairwise

differences

is

the sample median.

Post-merger corporate performance

page 13

before industry adjustment. The industry-adjusted results show a significant increase in post-

merger performance and the unadjusted returns show a decrease
Industry-adjusted returns are a

in

post-merger performance.

more

reliable

measure of performance since they control for
are also confounded

industry events unrelated to the merger.

However, they

by two

factors.

First, they are sensitive to the definitions

of industries used in the analysis.

To

test

whether the industry-adjusted

results are sensitive to the particular industry definitions

employed

by Value Line, we use a market performance benchmark.
as the
tapes.

We estimate the market index each year

median operating cash flow return for

all

firms on the Compustat Industrial and Research

The

difference in the pre-merger
is

and post-merger market-adjusted cash flow return for the
in

sample firms

4.5%, confirming improvements

industry-adjusted performance.

Second, industry-adjusted returns can increase in the f)Ost-merger period even

when cash

flows remain constant or decline
their industries
.

if

the market value of sample firms' assets decline relative to

Increased returns resulting from decreased asset values cannot be interpreted as

evidence that there are economic gains from mergers.

To

test

whether there are declines

in post-

merger market equity values of the sample firms

relative to their industries,

we compute

the

difference between the annual stock returns for the sample firms and their industries in years

surrounding the merger.

The industry-adjusted equity

returns of the sample firms are

insignificant in the post-merger period (as well as in the pre-merger period).

The

industry-

adjusted returns are:

0.4%

in year 1,

0.4%

in year 2,

0.2%

in year 3,

-3.7%

in

year 4, and 3.7%

in year 5. This implies that the

improvements

in

post-merger industry-adjusted cash flow returns
in their

are

due

to increases in

sample firms' operating cash flows rather than declines

market

values.

Post-merger corporate performance
3.3

page 14

Components of Industry Adjusted Cash Flow Returns
The improvements
in pre-tax

cash flow returns in the post-merger period can arise from a

variety of sources. These include improvements in operating margins, increased asset
productivity, or decreased labor costs. Alternatively, they

may be

achieved by focusing on shortthis section

term performance improvements

at the

expense of long-term viability of the firm. In

we

provide evidence on which of these sources contribute to the sample firms' post-merger cash
in the text

flow return increases. The specific variables analyzed are italicized
Table
4.

and are defined

in

The

results are reported in Table 5.

Operating Performance Changes

The pre-tax operating cash flow

return on assets can be

decomposed

into pre-tax

cash

flow margin on sales and asset turnover.

Pre-tax cash flow margin on sales measures the

operating cash flows generated per sales dollar.

Asset turnover measures the sales dollars

generated from each dollar of investment in assets. The variables are defined so that their product
equals the pre-tax operating cash flow return on assets.

The
returns
is

results in

Table 5 suggest that the increase in industry-adjusted pre-tax-operating

attributable to an increase in asset turnover, rather than an increase in pre-tax operating

margins.
-0.3,

In years -5 to -1 the

merged firms have industry-adjusted median
thirty cents less sales

asset turnover of

implying that they generated

than their competitors for each dollar of
in their industry-adjusted asset
is

assets.

The merged firms show

a significant

improvement
1

turnover ratios in the post-merger period. In years
0.1, indicating that the

to 5 the industry-adjusted asset turnover

sample firms generate ten cents more sales than

their industry counterparts

for each dollar of assets.
is 0.2,

The sample median
significant

difference in asset turnovers between these periods

which

is statistically

The merged firms

also have higher pre-tax operating

1

Post-merger corporate performance

page 15
post-merger years. But these cannot be attributed to

margins on sales than
the

their industries in the

merger

itself,

since operating margins of the

merged firms

are also higher than those of their

industries in the pre-merger period. lO

The difference between

the prein

and post-merger industry

adjusted operating margin
that the

is

insignificant.

The absence of changes

operating margins suggest

post-merger cash flow improvements are not due to increases in monopoly rents. Rather,
to use their assets

merged firms seem

more productively.

Mergers also provide the acquirer with an opportunity
labor contracts to lower labor costs and achieve a
Schleifer and

to renegotiate

expHcit and implicit

more

efficient

mix of

capital

and labor (see

Summers

(1988)). Because

we

are unable to obtain sufficient data

on wages
to analyze

direcdy,

we examine employee growth

rates

and pension expense per employee
mergers.

changes

in labor costs in years surrounding the

The median number of employees
industry-adjusted employee growth rate

declines in each of the post-merger years. Overall, the
is

significantly less than in the pre-merger period,

n

There

is

also evidence of a decline in pension expense per
significantly higher

employee

after the merger. Before the

merger the sample firms have a
industries. After the

pension expense per employee than their
is

merger the pension expense of the merged firms

reduced

to the

same

level

as the industry. are followed

There are two ways to view these findings. One interpretation
in operating efficiency

is that

mergers

by improvements
to a

through reduced labor costs. Alternatively,

mergers lead

wealth redistribution between employees and stockholders through

10 Prior to the

merger, the higher operating margins are primarily due to higher industry-adjusted margins
their industries in these years.

by acquirer. Targets do not show higher operating margins than

1

Wages

per employee for the merged firms also decline relative to the industry after the merger.

However,
wages.

this finding

should be interpreted with caution since only a small number of firms report information on

Post-merger corporate performance
renegotiations of explicit and implicit

page 16

employment

contracts.

Whatever

the explanation, the

magnitude of labor cost reductions
there are

in the

post-merger period does not appear to be large since

no

significant changes in the post-merger operating margins.

Investment Policy Changes Since our analysis
is

limited to only five years after the merger,
this period.

we cannot provide direct
short-

evidence on cash flows beyond

To

assess whether the

merged firms focus on

term performance improvements
capital outlays, and research

at the

expense of long-term investments,

we examine

their

and development (R&D).

Tliese expenditure patterns are reported in

Table

5.

The median
1

capital expenditures as a percentage

of assets

is

15%

in the

pre-merger

period and
-5 to -1,

1%

in the

post-merger years. The median
1

R&D expense
and

is

2.1% of

assets in years

and 2.4%

in years

to 5.

The

capital expenditures

R&D of the sample firms

are

not significantly different from those of their industry counterparts in either the pre- or the post-

merger periods.

Asset sales
policies.
It is

is

another area where merged firms can potentially change their investment

possible that post-merger improvements in asset turnover arise from the sale of

assets with

low turnover.
on

We

therefore

examine

asset disposals in the pre-

and post-merger

years. Statistics

asset sales as a percent of the market value of assets are reported in Table 4.

The median

asset sales for the

merged firms

are

1.6% and 0.9% of assets

in the pre-

and post-

merger periods respectively. The merged firms have significantly higher asset
their industry counterparts both before

sales rates than

and

after the

merger.

However,

there

is

no

significant
all

difference in industry-adjusted asset sales before and after the merger. Further, asset sales in

years are small in magnitude relative to capital expenditures or the market value of total assets.

7

Post-merger corporate performance
In

page

1

summary, we find

that

merged

firms have significant

improvements

in

cash flow
increased

operating returns in the five years following mergers. These improvements
asset productivity.

come from

There

is

no evidence of increased asset

sales, or decreased capital

expenditures or

R&D following mergers.

4.

Relation Between Cash Flow

And

Stock Price Performance
is

Our post-merger data on cash flow performance

consistent with the hypothesis that the

stock market revaluation of merging firms at merger announcements reflects expected future

improvements

in operations.

A more powerful test of this hypothesis

is to

correlate the mergerIf the

related stock market performance and the post-merger cash flow performance.

stock

market capitalizes these improvements, there should be a significant positive correlation between
the stock market revaluation of

merging firms and the actual post-merger cash flow

improvements.

Stock Returns at Merger Announcements

Market-adjusted stock returns for the target and acquirer

at the

announcement of

the

merger are reported
before the
target
first

in

Panel

A of Table 6.12

Returns for the target are measured ft"om five days

offer

was announced

(not necessarily by the ultimate acquirer) to the date the

was

delisted

from trading on public exchanges. Returns for the acquirer are measured from
offer

five days before

its first

was announced

to the date the target

was

delisted

from trading on

public exchanges. Similar to findings reported by earlier studies, target shareholders earn large
positive returns from mergers

(mean 45.6%, and median 41.8%), and acquiring stockholders

earn insignificant returns.

12

Risk-adjusted returns,

computed using pre-merger-announcement market model

estimates, are similar

to the market-adjusted returns reported in the papCT.

Post-merger corporcae performance

page 18
for the

We

also

compute the aggregate market-adjusted return
is

two firms

in the

merger

announcement
target

period. This return

the weighted average of the market-adjusted returns for the

and

acquirer,

where

the weights are the relative market values of equity of the

two firms

prior to the merger

announcement period. The mean aggregate
is

return, reported in Panel

A of

Table

6, is

9.1%, and the median

6.6%. Both these values are significantly different from zero.

These findings

are consistent with those of Bradley, Desai,

and

Kim

(1988).

Relation Between Announcement Returns and Post-Merger Cash

Flow Improvements
merger announcements can be
In Section 3

Our

tests

examine whether the change

in equity

values

at

explained by cash flow improvements in the post-merger period.

we measured

post-

merger performance using cash flow return on assets whereas the merger announcement returns

computed above

are return

on

equity.

Therefore, before

we

correlate

announcement returns and

cash flow improvements,

we compute

asset returns at merger announcements

from equity

returns to ensure that the anticipated gains from mergers and ex post measured gains are

comparable.

Asset returns

at the

merger announcement (A VAO

are weighted averages of returns to

equity (aE/E) and debt (aD/D):

jlY = I^iEiE + £AD}D

(1)

V
Assuming
the equity
at the

E V

D V

that the value

of debt does not change

at

takeover announcements, asset returns equal

announcement returns multiplied by

the equity-to-assets ratio (E/V)A'i

We use leverage
ratio.

beginning of the year of the takeover announcement to compute the equity-to-asset

13

A

number of studies including Asquith and Kim (1982), report evidence consistent with

this

assumption.

9

Post-merger corporate performance

poge
and

1

Summary
combined firms
targets are

statistics

on

the estimated asset returns for the target firms, acquiring firms,

are reported in Panel

B

of Table

6.

The mean and median
are 8.8%,

asset returns for the

40.6% and 32.5%, and

for the

combined firms

and 5.2%.

The

asset

returns for the bidding firm are insignificant

The hypothesis

that

merger-induced abnormal returns

reflect the capitalized value

of future

cash flow improvements implies:

aV
where

= PV(CF)

(2)

AV

is

the change in the market value of assets at the merger announcement,

PV
(2)

is

the

present value operator, and

CF

is

the vector of cash flow improvements.

Equation

can be

converted to a returns model by dividing both sides of the equation by V:

^V V
Consistent with equation
(3),

= py(CF)

V

(3)

we

estimate the following cross-sectional regression:

ARETi= a
Where

+

pCFRETi

+

Ei

(4)

ARET is

the

combined

firms'

measured abnormal

asset retiun at the

merger announcement

(unlevered abnormal equity returns) and

CFRET

is

the

median annual industry-adjusted pre-tax

operating cash flow return in the post-merger period.

The valuation model (equation
(4)

(3))

does not have a constant, implying that the intercept

in

should equal zero.

Since

ARET

is

the capitalized value of future cash flow return

improvements, and

CFRET is the pre-tax

cash flow return improvement per year, the slope in (4)

equals the present value factor at the pre-tax capitalization rate.
capitalization rate
is

For example,

if

the pre-tax

20%,

the slope coefficient
last for five years.

would be 5

if

the

improvements are perpetual, and
rate

2.99

if the

improvements

For a capitalization

of 30%, these coefficients

Post-merger corporate performance

poge 20

would be 3.33 and 2.44

respectively.

The estimates of

regression equation (4) are reported in Panel

A

of Figure

1.

The

regression has an R2 of 21%, implying a cross-sectional correlation of 0.46 between the asset
returns at the merger announcement
the estimated slope coefficient
is

and the realized improvements and

in cash

flow returns. While
is

positive

statistically reliable, its

magnitude

only 0.96,

implying a very high discount rate. Also, the intercept

is statistically

significant.

However, these

regression estimates are likely to be biased since the operating cash flow returns have substantial

measurement

error.

This measurement error results
bias in the

in

a

downward

bias in the estimated slope

coefficient and an

upward

estimated intercept (see Johnston (1972)).

To provide

a

bound on the coefficient estimates, we reverse
in (4)

the

dependent and

independent variables

and estimate the following regression equation

:

CFRET = Y
i

+

XARETi
1.

+ Vi

(5)

The

results are reported in Panel

B

of Figure

The estimated

slope coefficient in equation (5)

is

0.22.

That

is,

the market capitalization rate

is

22%

if

the

improvements are a perpetuity. This
(4).

estimate corresponds to a slope coefficient value of 4.55 in equation
in

The estimated

intercept

equation (5)

is

insignificant

These regression estimates are more

in line with the predicted

values. 14

Since the regression analysis

is

affected by measurement error,

we also compute

a hack-

le Specification tests are

conducted for regression equations (4) and

(5) to assess

whether the residuals are

honwskedastic (see White (1980)), and normally distributed. We cannot reject the hypotheses that the residuals are homoskedastic and normally distributed at the 0.05 level. Belsley, Kuh and Welsch (1980) diagnostics for the effect of extreme observations on the coefficients, and for multicollinearity indicate that the reported estimates are
not influenced by extreme observations. Finally,
variables in the regression.

we

estimate Spearman
is

Rank Correlation

coefficients

between the

The

correlation

is

0.45 and

significant at the 0.01 leveL

1

Post-merger corporate performance

page 2

of-the-envelope estimate of the merger announcement asset return implied by the sample median

cash flow improvement.

The data
on

in

Table 3 indicate that the merged firms' median annual preis

tax operating cash flow return
industries' return.

assets in the post-merger period

about 2.2% larger than their

To

convert this to a rough estimate of the value change,
risk of

we assume

that the

risk of the

improved performance equals the

an average security.

We

use an

8%

risk

premium along with a 10%
gain
is

risk free rate for an

18%

before-tax cost of capital. If the cash flow
is

treated as a perpetuity, the implied increase in the asset value
lasts for just five years, the asset

12%.

If the

increased

performance

value increase

is

about 6.6%. The actual mean and

median

asset returns at the

merger announcement reported

in

Table 6 are consistent with these

rough estimates.

In

summary,

the

abnormal equity returns for the combined firms

at

the

merger

announcement

are broadly consistent with the value increases implied

by the post-merger cash

flow return increases.

5.

Discussion

Our

finding that cash flows increase following mergers advances the debate on mergers
there are cash flow changes after these transactions to
in

from whether

why

these cash flow

improvements occur. The improvements
of increased asset productivity.

sample firms' cash flow returns are primarily a result
attributed to tax

The reported post-merger gains cannot be
They cannot be

benefits, since the cash flow returns are pre-tax.

attributed to increased
is

monopoly

rents since there is

no increase

in

post-merger sales margins. While there

some

evidence that gains

come

at the

expense of labor, reduced labor costs do not significantly increase
Finally, there
is

sample firms'

profitability.

no decrease

in capital outlays

and

R&D

expenditures, or increase in asset sales after the merger, indicating that merged firms do not

Post-merger corporate performance
reduce
their long-term investments.

P<3ge

22

Our

findings raise

two

interesting questions. First, are the increases in cash flow returns

and asset productivity caused by the merger, or would they have occurred even without a merger?

Mergers can lead

to increased asset productivity if

sub-optimal policies pursued by the target or

the acquirer prior to the merger are eliminated, or if they provide

new

opportunities for using

existing resources of the merging firms. In contrast, if mergers arise
target firms by the stock market, there will be

from undervaluation of the
is

improvements

in

cash flows whether or not there

a merger. Acquirers that anticipate the cash flow improvements will pay a
targets.

premium

to acquire the

A

second interesting question

is

what are the economic factors

that explain the cross-

sectional variation in post-merger cash flow changes?

While

there

is

an improvement in cash

flow performance on average, a quarter of the sample firms have negative post-merger cash flow
changes. These firms

may have performed

poorly because of bad luck. Alternatively, there
to these outcomes.

may

have been systematic business and managerial reasons which led

These questions, which have important managerial and public policy implications, can
only be answered by developing structural models of
not attempt
to

how mergers improve cash

flows.

We do

undertake such an ambitious exercise in this paper. However,

we do provide some

preliminary evidence and suggest directions for future research.

One

popular structural model of

how mergers improve

cash flows

is

that they

provide

opportunities for economies of scale and scope, synergy, or product market power. This implies
that mergers by firms that have related products or production will

show

greater cash flow

.

Post-merger corporate performance

page 23

improvements than mergers between unrelated firms. 15
classifying our sample firms as related or unrelated, and by

We

examine

this

proposition by

comparing the average post-merger

cash flow improvements of the two groups.

We classify

mergers between firms with the same

Value Line industry definition as

related.

The

results indicate that there are

no differences

in the

post- merger industry-adjusted operating cash flow retiuns

between related and unrelated mergers.

We also classify
for undertaking

mergers into related and uru-elated categories by examining the reasons
in the

mergers stated by the sample firms' managers
is

merger prospectuses. The
stated reason
in the

potential to exploit product similarities or other associations

the

most commonly

For example, the managers of Maryland Cup and Fort Howard Paper Co. (both
products industry) expected the merger to create "a
result

paper

number of new business

opportunities as a

of the compatibility of the two companies' businesses and customers." In addition, they

argued that "Maryland

Cup

could benefit from Fort Howard's production experience."
for

The

second most frequently stated reason

merging

is

to reduce earnings volatility, as in the

Raytheon

/

Beech Aircraft merger. The managers of Raytheon

anticipated that the acquisition

would "provide Raytheon with
better balance

additional stability through product diversification as well as a
sales

between commercial and government-generated
is

and earnings."

We examine

whether there

a difference in post-merger cash flow returns for

sample mergers undertaken to

exploit synergies

and other mergers, and

find

no difference between the two groups.

The

relation

between

the

merging firms' businesses does not appear to be the sole

determinant of post-merger performance. For example. Pan
in the airline business, yet their

Am and National AirUnes were both
Am expected the acquisition to
edge over
later

merger was unsuccessful. Pan
to
its

expand the domestic feeder routes
15

international flights, providing a competitive

Kaplan and Weisbach (1990) find

that acquirers

of firms in unrelated businesses are more likely to

divest these targets than acquirers of related businesses.

Post-merger corporate performance
other international carriers.
airline, especially in the

page 24
the expertise to run a domestic

However, the company did not have

competitive conditions after deregulation.

Further,

Pan

Am

later

divested
coast.

its

Pacific routes, reducing the value of the National's domestic services to the west

Given

the complexity

and heterogeneity of reasons for mergers,

we

believe that large
that

sample studies are unlikely to provide significant new insights into the structural factors
influence the outcomes of mergers.

A

promising approach

is

to

examine a smaller number of
evidence on the

mergers

in greater detail.

These

clinical studies will provide valuable

mechanisms through which mergers increase cash
research.

flows, and will be fruitful avenues for future

6.

Summary
This paper examines the post-acquisition operating performance of merged firms using a

sample of the 50 largest mergers between U.S. public industrial firms completed

in the period

1979

to 1983.

We

find that

merged firms have
from increases

significant

improvements operating cash flow

returns after the merger, resulting

in asset productivity relative to their industries.

These cash flow improvements do not come
sample firms maintain
merger. There
is

at the

expense of long-term performance, since

their capital expenditure

and

R&D rates relative to their industries after the

a strong positive relation between post-merger increases in operating cash flows
at

and abnormal stock returns

merger announcements, indicating

that expectations

of economic

improvements underlie

the equity revaluations of the

merging firms.

Post-merger corporate performance

page 25

REFERENCES
Asquith, Paul, 1983, Merger bids, uncertainty, and stockholder returns, Journal of Financial 11, 51-84.

Economics,

Asquith, Paul, and E. Han Kim, 1982, The impact of merger bids holders. Journal of Finance 37, 1209-1228.

on

participating firms' security

Bradley, Michael,

Anand Desai and

E.

Han Kim,

offers: Information or synergy?. Journal

1983, The rationale behind interfirm tender of Financial Economics, 11, 183-206.

Bradley, M., A. Desai and E. Kim, 1988, Synergistic gains from corporate acquisitions and their division between the stockholders of target and acquiring firms, Journal of Financial Economics, 21, 3-40.
Bull, I., 1988, Management Performance and leveraged buyouts: Unpublished paper, University of Illinois at Urbana-Champaign.
E., 1989, Effect of Mergers and Acquisitions on the Organization Perspective.

An

empirical analysis,

Caves, Richard

Economy: An

Industrial

Dodd,

Peter, 1980, Merger proposals, Financial Economics, 8, 105-138.

management

discretion

and stockholder wealth, Journal of

Dodd, Peter and Richard Ruback, 1977, Tender
analysis. Journal of Financial

offers

and stockholder returns:

An

empirical

Economics,

5,

351-374.

Herman, E. and L. Lowenstein, 1988, The efficiency effects of hostile takeovers, in J. Coffee Jr., L. Lowenstein and S. Rose-Ackerman, eds.. Knights, raiders and targets: The impact of the hostile takeover, (Oxford University Press, New York, NY).
Jensen, M. and R. Ruback, 1983, The market for corporate control: Journal of Financial Economics, 1 1, 5-50.

The

scientific evidence.

Johnston,

J.,

1972, Econometric Methods, Second Edition, (McGraw-Hill,

New

York, NY).

Kaplan, S., 1990, The effects of management buyouts on operating performance and value, Journal of Financial Economics, forthcoming.
Kaplan, S. and M. Weisbach, 1990, Acquisitions and diversification: What much does the market anticipate? Working paper. University of Chicago.
is

divested and

how

Ravenscraft, D., and F. M. Scherer, 1987, Mergers, selloffs, and economic efficiency, (Brookings, Washington, D.C.)
R., Do target shareholders lose in unsuccessful control contests?, in Corporate Takeovers: Causes and Consequences, National Bureau of Economic Research, 1988.

Ruback,

Schleifer, A. and L.

Summers, 1988, Breach of

trust in hostile takeovers, in

Corporate

Post-merger corporate performance
Takeovers: Causes and Consequences, National Bureau of Economic Research.

page 26

Smith, A., 1990, Corporate ownership structure and performance: buyouts, Journal of Financial Economics, forthcoming.

The case of management

Post-merger corporate performance

page 27

Table

1

distribution

Descriptive statistics on time distribution of mergers, industry and relative asset sizes for 50 acquiring and 50 target firmsa

Panel A: Distribution of Merger Years

Number
1979 1980
1981

of firms

Percent of firms

9
6 12

18 12

24
18

1982 1983
Total

9 14

28
100

50

Panel B: Distribution of Target and Acquiring Firms' Industries
Target firms

Acquiring firms

Number

of industries
1

27
15 8

33

Industries with

firm

22
9

Industries with 2 firms

Industries with 3 firms Industries with 4+ firms

2 2
in

2
6

Maximum number of firms

one industry 7

Panel C: Relative Asset Sizes of Target and Acquirers

Mean
First quartile

42.0%
16.5 31.1

Median
Third quarter

62.5

a

The sample mergers

are the largest acquisitions completed in the period 1979 to 1983 between public non-financial and
is

non-utility U.S. firms. Acquisition size

preferred stock for the target firm
the
size is the mailtet value of

at the

measured by the market value of common stock plus the book values of debt and beginning of the year prior to the acquisition. The merger year is the year in which
is

merger was completed. Relative

asset size

the target's size as a percent of the size of the acquiring firm,

where asset

common

stock plus the book values of debt and preferred stock at the beginning of the year prior
to the merger.

to

completion of the acquisition. Industries are based on Value Line industry definitions prior

Post-merger corporcae performance

page 28

Table 2

Summary

statistics on merger transaction accounting methods, number of bidders, method of payment, and merger type for 50 mergers in the period 1979 to 1983.

Panel A: Distribution offirms by method of accounting for merger
Accounting method
Purchase method Pooling of interests

78%
22

Panel B: Distribution affirms by number of bidders

Number of bidders
One
bidder bidders Three bidders Four or more bidders

76%
12
8

Two

4

Panel C: Distribution offirms by merger method ofpaymera

Method of payment

cash Cash and stock Cash and notes Cash, stock and notes

100% 100%

stock

24%
34 30
10

2

Post-merger corporate performance

page 29

Table 3

Firm and industry-adjusted median annual operating pre-tax cash flow return on assets for 50 combined target and acquirer firms' in years surrounding merger a

Year relative
to

merger

Post-merger corporate performance

page 30

Table 4
Definitions of variables used to analyze actual performance of 50 targets and 50 acquirers in years surrounding mergers

Variable

Definition

A. Operating Performance
Pre-tax operating margin

Earnings before depreciation,
sales

interest,

and taxes as a percent of

Asset turnover

Sales divided by market value of assets at beginning of year (the market value of common equity plus the book values of debt

and preferred stock)

Employee growth

rate

Change

in

number of employees
in the

employees
Pension expense/employee

as a percent of number of previous year

Pension expense per employee

B. Investment Policy
Capital expenditure rate

Capital expenditures as a percent of the market value of assets at beginning of year

Asset sale rate

Asset sales as a percent of the market value of assets of year

at

beginning

R&D rate

Research and development expenditures as a percent of the market value of assets at beginnig of year

M

oi
^
.-9

^^ 5§

u

•s

.a •=

o

o
a.

00

s e
E S 3
SJ

g

•I

1

i ^ ^

^ s

OO
C3

_

u 3
a-

•o

U

c
C3

s

.1.

OO

IS

1^
S

U
CI.

OO

u

^
o

3
>

8

Post-merger corporate performance

page 32

Table 6

Equity and asset returns

at

merger announcements for 50 target
in the

and acquiring firms merging

period 1979 to 1983

*

Panel A: Distribution of equity returns
Target equity

at

merger announcement
Acquiring equity

Combined

equity

Mean
First quartile

45.6%b

-2.2%

9.1%''

21.2%
41.8%''

16.6%
-3.6%

-2.9%
6.6%''

Median
Third quartiJe

64.1%

3.4%

16.7%

Panel B: Distribution of asset returns
Target firms

at

merger announcement
Acquiring firms

Combined

firms

Mean
First quartile

40.6%''

0.6%

8.8%''

19.0%

-2.3%
5.2%''

Median
Third quartile

15.1%

Post-merger corporate performance

page

3i

Figure

1

Panel A:

ARETi = y +

A.

CFRETi

+

"Oi

Unexpected
returns

asset

(ARET)

70% T
ARET(i) = 0.06
+ 0.96

CFREr(i)

(2.3)

(3.3)

60% +

R

square = 0.21

-25%

-20%

-5%.^^^0?'

5%

\(h

15%

20%

25%

-20%
-30%

..

..

Median post-merger

industry-adjusted pre-tax cash flow returns (CFRET)

a The mergers are completed in the period 1978 to 1983. The unexpected asset return is computed by unlevering the combined equity announcement returns for the target and acquiring firms. The combined equity return for these firms is the sum of the market-adjusted change in equity value for the target and acquirer in the meigo' announcement period as a percentage of the sum of the pre-merger equity values for the two rirtns. Post-merger todustry-adjusted cash flow returns are

defined in table

3.

Post-merger corporate performance

page 34

Figure

1

continued

Relation between median px)st-merger industry-adjusted cash flow returns and

unexpected asset returns

at

merger announcements

for

50 merging firms*

Panel B:

CFRETj

=

a

+ p

ARETi +

ei

Median post-merger industry-adjusted
pre-tax cash flow returns

(CFRET)

70%

CFRET(i) =

0.01 + 0.22
(1.2) (3.3)

ARET(i)

-25% i

R
Unexjjected asset
returns

square = 0.21

(ARET)

.

Post-merger corporate performance

page 35

Appendix
Acquiring/Target Firms and their Industries

1. American Medical Intemarional /Lifemark American Medical owns and operates proprietary hospitals and other health care businesses, and

offers medical-technical support (including diagnostic, cardio-pulmonary, and physical therapy services, and management consulting services). Lifemark owns and manages general hospitals,

and provides cardio-pulmonary, physical therapy, pharmacy, and
2.

clinical laboratory services.

Anheuser-Busch Companies / Campbell Taggart Inc. Anheuser-Busch is the world's largest brewer of beer. Campbell Taggart's business is baking and distributing bread, rolls, crackers, cake and other sweet products, and food products.
Associated Drv Goods / Caldor Inc. Associated Dry Goods operates general department stores in 25 promotional discount department stores in five states.
3.

states.

Caldor operates 65

4.

Avon Avon is

Products Inc./ Mallinckrodt
the world's largest manufacturer of cosmetics

and

toiletries,

and also

sells

costume

jewellery and ceramics. Mallinckrodt develops and manufactures fine chemicals, drugs and other health care products, and chemicals for the food, cosmetics, laboratory, petrochemical and printing industries.

Best Products / Modem Merchandising Inc. Best and Modem Merchandising are both catalog showroom
5.

retailers.

Brown-Forman Distillers / Lenox Inc. Brown-Forman manufactures a wide variety of
6.

alcoholic beverages. Lenox operates produces furnishings (including china and crystal), and personal use products (including jewelry and luggage).

home

7. Burroughs Corp./ Memorex Corp. Burroughs is a major participant in the data processing and business computer equipment industry. Memorex develops, manufactures, markets and services a wide range of computer peripheral equipment systems, and products employed in the recording, retrieval, communication, and storage of information. 8. Coca Cola Co./ Columbi a Pictures Industries Inc. Coca-Cola is the largest manufacturer and distributor of

soft drink concentrates and syrups in the world. The company also manufactures citrus, coffee, tea, wine and plastic products. Columbia Pictures produces and distributes theatrical motion pictures, television series and features, amusement games, and commercials.
9. Con Agra Inc./ Peavey Co. Con Agra is a diversified food

processor engaged in agriculture (agricultural chemicals, formula feed, and fertilizers), grain (flour, by-products, and grain and feed merchandising) and food (frozen foods, broiler chicken, eggs, seafood, and pet products) industries. Peavey is also a diversified food processor and retailer engaged in grain merchandising, food processing (flour,

bakery mixes, and jams), and operating specialty

retail stores,

Post-merger corporate performance

poge 36

10. Cooper Industries /Gardner-Denver Cooper is a diversified, international corporation which produces consumer and industrial tools, aircraft services, mining and construction, and energy services. Gardner-Denver makes portable and stationary air compressors, drilling equipment for above- and underground, and air-operated

tools. 11. Dart Industries /Kraft Inc. Dart is diversified company

that manufactures and markets consumer products, including Tupperware containers, Duracell batteries, and West Bend appliances. Kraft manufactures food products and markets them to retail, industrial and food service customers.
12. Diamond Shamrock / Natomas Co. Diamond Shamrock is a domestic integrated

chemicals. Natomas
13.

is

principally

engaged

in

oil and gas company with interests in coal and petroleum exploration and production.

E. I. Du Pont de Nemours / Conoco Inc. Pont manufactures diversified hnes of chemicals, plastics, specialty products, and fibers. Conoco is engaged in the exploration, production, and transportation of crude oil, coal, and natural gas; petroleum refining; and the production, processing and transportation of chemicals.

Du

in areas of transportation, materials handling, industrial automation, security, construction, agriculture and consumer durables. Cutler-Hammer designs and manufactures electronic and electrical components and system for industrial, aerospace, air traffic control, semiconductor, housing, and consumer markets.
15. Exxon Corp./ Reliance Electric Co. Exxon is engaged in the exploration, production, and

14. Eaton Corp./ Cutler-Hammer Inc. Eaton is engaged in technologically related businesses

transportation of crude oil and natural gas; and the production and transportation of petroleum and chemicals. Reliance develop, manufacture, and servicing a broad line of industrial equipment, including electric motors and drives, mechanical power transmission components, industrial and retail scales and weighing systems, and telecommunications equipment
16. Fairchild Industries / VSI Corp. Fairchild produces military aircraft and parts, commercial aircraft and parts, spacecraft and parts,

and domestic communications systems. VSI is a diversified manufacturer of a wide range of precision metal products (including fastening systems for aircraft and missiles, steel mod bases for the plastics industry, door knobs, stainless steel cabinets, and building hardware.
17. Fluor Corp./ St. Joe Minerals Corp. Fluor designs, engineers, procures and constructs complex manufacturing plants, processing plants, and related facilities for energy, natural resources and industrial clients. St. Joe is a diversified producer of natural resources (principally coal, lead, gold, oil and gas, zinc, silver and

iron ore).
18. Fort Howard Paper Co./ Maryland Cup Corp. Fort Howard manufactures a broad line of disposable sanitary paper products, principally table napkins, paper towels, toilet tissue, industrial and automotive wipes, and boxed facial tissues. Maryland Cup manufactures a variety of single use paper and plastic products for food and beverage service, including plates, cups, bowls, cutlery, cirinking straws and toothpicks.

Post-merger corporate performance

page 3 7

19. Freeport Minerals Co./ McMoran Oil Gas Co. Freeport Minerals is a diversified company engaged in exploration and development of natural resources, including agricultural minerals, oil and gas, uranium, oxide and kaolin. McMoran is engaged in the acquisition, exploration and development of oil and gas properties, and the production and sale of oil and natural gas.

&

20. Gannett Co. Inc./ Combined Communications Corp Gannett and its subsidiaries publish daily newspapers. Combined Communications Corporation is engaged in television and radio broadcasting, outdoor advertising and newspaper publishing.
.

21. General Foods Corp./ Oscar Mayer & Co. Inc. General Foods is a leading processor of packaged grocery products. Oscar Mayer operates the meat packing and processing industry.

in

22. Genstar Ltd./ Flintkote Co. Genstar manufactures building materials and cement, and is engaged in housing and land development, construction, marine transportation, financial services, and venture capital investment Flintkote is engaged in mining, and manufactures various building and construction materials, including gypsum wallboard, floor tile, sand and gravel products, concrete, cement and various Ume products.
23. Gulf & Western Industries / Simmons Co. Gulf and Western is a conglomerate with interests

in the manufacture of automotive and airconditioning components, paper products, leisure, financial services, automotive replacement parts, consumer products sugar growing and processing, citrus farming, natural resources, and apparel. Simmons produces furnishings for home, commercial and institutional customers.

24. Harris Corp./ Lanier Business Products Inc. Harris designs and produces voice and video communication, and information processing systems, equipment, and components. Lanier develops, manufactures, and services a broad line of dictating equipment, several models of video-display text-editing typewriters, and small business computers. 25. Holiday Inns Inc./ Harrahs Holiday Inns owns and operates hotels throughout the world.

Harrahs operates two luxury

hotel/casinos.

26. Intemorth Inc./ Belco Petroleum Corp.

Intemorth owns and operates natural gas businesses; produces, transports, and markets liquid fuels and petrochemicals; and is involved in the exploration and production of oil and gas. Belco is engaged in the exploration and production of crude oil and natural gas, and the production of
coal.

27. Kroger Inc./ Dillon

Com panies Inc.
food through supermarkets and convenience stores.

Kroger operates the country's second largest supermarket chain; manufactures and processes food for sale by these supermarkets; and operates one of the country's largest drugstore chains.
Dillon
distributes retail

28. Litton Industries / Itek Corp. Litton produces advanced electronics products for defense, industrial automation and geophysical

Post-merger corporate performance

page 38

markets. Itek develops and manufactures a variety of aerial reconnaissance and surveillance products based on optical and electronic technologies.
29. LTV Orgyp R gpy flJg Stggl LTV and Republic are respectively
/

the nation's third and seventh largest steel producers.

in the exploration and production of and natural gas liquids; pipeline transportation of natural gas liquids and anhydrous ammonia; and marketing natural gas liquids, refined petroleum products, domestic and foreign crude oil, and liquid fertilizers. Earth Resources is a diversified energy and resources development company engaged primarily in refining, transporting and marketing petroleum

30. Mapco Inc./ Earth Resources Company Mapco is a diversified energy company principally engaged
coal, oil, natural gas,

products.
31. McGraw-Edison Co./ Studebaker Worthington Inc. McGraw-Edison manufactures and distributes products

electrical appliances, tools and other products for the consumer market; px>wer system and related equipment for electrical utilities and industry; and a wide range of services and equipment for industrial and commercial uses. Studebaker Worthington's business operations are the manufacture of process equipment and
industrial products.

32. Motorola Inc./ Four-Phase Systems Inc. Motorola produces data communication equipment and systems, semiconductors, and other high technology electronic equipment. Four-Phase produces clustered video display computer systems for distributed data processing applications.

33. Morton-Norwich Products / Thiokol Corporation Morton-Norwich produces salt for domestic and industrial uses, household cleaning and laundry products, and specialty chemicals. Thiokol manufactures specialty chemical products, and propulsion and ordnance products and services for the government
34. Occidental Petrole um / Cities Service Companv Occidental produces and markets crude oil and coal, and manufactures industrial chemicals and plastics, metal finishes, agricultural chemicals, and fertilizers. Cities Service is an integrated oil

company.
35. Pan Am Corp./ National Airlines Inc. Pan Am is a commercial air carrier providing territories and possessions, and 58 cities in 43

services to ten cities in the United States, its foreign countries. National Airlines provides

scheduled

air transportation

Miami,

to

New York, San Francisco and Los

of persons, property and mail over routes extending from its hub in Angeles, and transatlantic service to London, Paris,

Frankfurt and Amsterdam.
36. Penn Central Corp./ GK Technolo gies Penn Central is a diversified company
Inc.

whose primary businesses include oil refining, transporting and marketing refined petroleum products and crude, real estate development, Technologies produces operating amusement parks, and producing offshore drilling rigs. wire and cable primarily for the telecommunications industry, electronic components, and provides engineering services for weapons systems and environmental products.

GK

Post-merger corporate performance
37. Phillips Petroleum

page 39

/

General American Oil of Texas
a fully integrated oil
is

Phillips Petroleum
exploration.

is

company engaged
primarily engaged in

in

production, and refining. General American

petroleum exploration, oil and gas production and

38. Raytheon Corp./ Beech Aircraft Corp. Raytheon develops and manufactures electronic systems for government and commercial use. Raytheon is also supplies energy services, manufactures major home appliances, designs and manufactures heavy construction equipment, and publishes textbooks. Beech Aircraft designs, manufactures, and sells airplanes for the general aviation market. Beech is also a substantial aerospace contractor producing a variety of military aircraft, missile targets, and cryogenics

systems for aerospace vehicles.
39. Revlon Inc./ Technicon Corp. Revlon is in the beauty products and health products and service business. Technicon designs and produces automated testing systems for blood and other biological fluids, chemical reagents and consumables, industrial analytical instruments, and medical information systems.

40. R.J. Revnolds Corp./

Del Monte Corp.

and international manufacture and sale of tobacco products, transportation (container size freight transportation systems carrying general cargo), energy (oil and gas products), food and beverage products, and aluminum products and packaging. Del Monte's principal business is in food products (primarily processed foods, and fresh fruit), and related services (including transportation, and institutional services).
R.J. Reynolds' lines of business are the domestic

41. Si gnal

Companies

/

Wheelabrator Frye

Inc.

Signal is a diversified, technology -based company which manufactures aerospace equipment, professional audio-video systems, and heavy trucks. Wheelabrator Frye's products and services include environmental, energy and engineered products and services, and chemical and specialty products.
42. Smithkline Corp./

Beckman

Instruments Inc.

Smithkline researches, develops, manufactures, and markets ethical drugs, proprietary medicines, animal health products, ethical and proprietary eye care products, and ultrasonic and electronic instruments. Beckman is an international manufacturer of laboratory analytical instruments and related chemical products that are used widely in medicine and science, and in a broad range of industrial applications.
43. Sohio
/ Kennecott Corp. Sohio is an integrated petroleum company engaged in all phases of the petroleum business. Kennecott produces copper, gold, silver, molybdenum and lead; manufactures industrial abrasive and resistant materials; manufactures and markets industrial engineered systems; and owns twothirds of a Canadian producer of titanium dioxide slag, high purity iron, and iron powders.

44. Standard Brands /Nabisco Inc.
a manufacturer and marketer of food products (specializing in cookies and crackers), pharmaceuticals, and household accessories. Standard Brands is a manufacturer, processor and distributor of food and related products.

Nabisco

is

toiletries,

Post-merger corporate performance
45. Tenneco / Houston Oil & Minerals Corp The major businesses of Tenneco are integrated
.

page 40

oil and gas operations, natural gas pip)elines, construction and farm equipment, automotive components, shipbuilding, chemicals, packaging, agriculture and land management, and life insurance. The recent business emphasis of Houston Oil Minerals has been on the exploration for oil and natural gas on undeveloped properties, and the development of production upon discovery.

&

Tosco Corp/ ATT, Resources Inc. Tosco owns and operates petroleum refineries and related wholesale distribution facilities. AZL has been in the process of changing its focus from agricultural-based businesses to oil and gas
46.

exploration and production.
47. U.S. Steel / Marathon Oil Co. U.S. Steel's principal business include steel, chemicals, resource development, fabricating and engineering, and transportation. Marathon is an integrated petroleum company engaged in the

production, refining, and transportation of crude

oil,

natural gas and petroleum products

48. United Technologies / Carrier Corp United Technologies designs and produces high-technology power systems, flight systems, and industrial products and services. Carrier's principal business is the manufacture and sale of air

conditioning equipment

Westinghouse Electric / Teleprompter Corp. Westinghouse Electric is a diversified corporation primarily engaged in the manufacture and sale of electrical equipment. Westinghouse's wholly owned subsidiary operates six TV stations, 12 radio stations, and cable television systems. Teleprompter is nation's largest cable television company, and owns MUZAC, the leading supplier of music to offices and other commercial establishments.
49.

WBC

Companies / Northwest Energy Company Williams is primarily engaged in the chemical fertilizer, energy and metals businesses. Northwest is primarily engaged in interstate natural gas transmission, oil and gas exploration, and
50. Williams

marketing natural gas

liquids.

7253

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