A New Measure for Shareholder Value Creation and the Performance of Mergers and Acquisitions
Julie Lei Zhu
Boston University - School of Management
December 6, 2011
This paper develops a new measure for shareholder value creation to assess the efficiency of acquiring firms in utilizing capital before mergers and acquisitions (M&As) and links this measure to acquirers’ post-acquisition performance. Based on the concept of residual earnings, I define the measure as the residual from regressions of firms’ excess earnings — earnings in excess of cost of capital — on invested capital and other firm characteristics for each industry and year. A positive (negative) residual indicates a firm is able to generate excess return on invested capital at a higher (lower) rate than its industry peers in a given year. The announcement returns for acquirers with low residuals are lower than those for acquirers with high residuals. Moreover, this measure, constructed before the M&A transaction, (a) predicts both the operating and long-run abnormal stock performance of merged firms after the acquisitions and (b) hedge portfolios based on the measure generate substantial abnormal returns. Overall, the results indicate that investors do not fully recognize how efficient acquirers have been in utilizing capital before M&As and that incorporating the new value creation measure into the decision process of large-scale M&As can help protect shareholder wealth.
Number of Pages in PDF File: 46
Keywords: Merger and acquisition, earnings, residual earnings, invested capital, stock returns
JEL Classification: G14, G34, M41working papers series
Date posted: December 7, 2011
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