Stock Market Valuation and Mergers

Much of the recent research on mergers and acquisitions (M&;A) seeks to link the market valuations of individual companies, as well as overall stock market levels, with merger activity and performance.

In their review of work conducted in this field, the authors present a primer on ways to measure whether M&;A actually creates value and then offer an overview of the "winners" and "losers."

But the long-held observation that stock prices affect merger activity was confirmed in 2001, they say, by work that revealed a correlation between high merger activity and high market valuations. Several other studies have shown that acquirers who pay with stock underperform their peers in the long run, whereas acquirers who pay cash outperform their peers.

Another line of inquiry, according to the authors, finds that the level of the stock market when an acquisition is announced affects short-term and long-term merger performance. The short-term effects are positive for acquisitions announced in high-valuation markets and negative for those undertaken in low-valuation markets.

Supporting evidence is provided in other recent work too: Acquisitions that take place during periods of below-average economic growth create more shareholder value than strong-economy acquisitions. The strong performance of low-valuation acquirers and weak-economy acquirers suggests that they are not distracted by short-run market reactions, but instead focus on business fundamentals and true potential synergies. Two articles published in 2002, suggesting that the root cause of such links between valuation and performance may be incorrect valuation by the market, are empirically supported by current work that Bouwman et al. also describe.

The conclusion of these various research streams is that stock prices matter, say the authors. The key implication for managers: Be wary of acquisitions made when market or firm valuations are high, and be optimistic about acquisitions when valuations are low. This review includes a comprehensive sidebar of all referenced and relevant research.