Sources of Gains in Corporate Mergers

The following post comes to us from David Becher, Associate Professor of Finance at Drexel University, Harold Mulherin, Professor of Banking and Finance at the University of Georgia, and Ralph Walkling, Stratakis Chair in Corporate Governance at Drexel University.

In the paper, Sources of Gains in Corporate Mergers: Refined Tests from a Neglected Industry, forthcoming in the Journal of Financial and Quantitative Analysis, we provide new tests of the synergy, collusion, and anticipation hypotheses using stock and product pricing data from the utility industry in the United States. The utility industry has been omitted from prior analysis of synergy and collusion in mergers and thus provides out-of-sample tests of these hypotheses. Moreover, features of the industry allow ready identification of geographic rivals and thereby facilitate clean tests of the competing hypotheses.

Our analysis employs a comprehensive sample of 384 utility mergers in the 1980 to 2004 period. This centers the analysis on the Energy Policy Act of 1992 which deregulated the industry and facilitated merger activity by removing Depression-era obstacles to utility ownership. This research design also enables us to examine whether deregulation was accompanied by a greater likelihood of collusion following mergers. We find that utility mergers create wealth for the combined bidder and target. These positive wealth effects are consistent with both the synergy hypothesis and the collusion hypothesis.

To distinguish between the hypotheses, we examine stock price returns to industry rivals across several dimensions specifically linked to collusion: after deregulation, in the subsample of horizontal mergers, stratified by geography and in withdrawn deals. We conclude with an analysis of the impact of utility mergers on consumer prices. The results are consistent with synergy and inconsistent with collusion. Further, results from industry rivals that become targets support the anticipation hypothesis rather than the collusion hypothesis.

Our results are an important contribution to the literature on tests of the synergy, collusion, and anticipation hypotheses. In the extant literature there is a disconnection between the results in the multi-industry event studies of industrial firms and the single-industry event studies in (formerly) regulated settings. Many single-industry studies of product prices in industries such as airlines and banking find evidence of collusion. In our single-industry study, by contrast, we find no disconnect between stock price analysis and product price results; both are consistent with the synergy hypothesis and inconsistent with collusion.

Finally, our results have important policy implications. Federal and state regulators, concerned about collusive effects of utility mergers, continue to call for the defeat of proposed mergers (Leonard (2007)). These concerns have heightened in the post-regulatory period. Also, many states are considering imposing more stringent controls on the industry (Kelderman (2007), Kennedy (2007)). While collusion in the industry is plausible, our evidence indicates the role of utility mergers is to obtain synergies rather than foment collusion. Although we document a significant increase in utility mergers after deregulation, we find little or no evidence that this increase in merger activity induced collusive pricing in the industry. Hence, this particular case of a relaxed antitrust attitude has benefited consumers as well as shareholders.

The full paper is available for download here.

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