Stock Price Reactions to Merger and Acquisition in India

Mergers and Acquisitions are seen as an important exercise in corporate restructuring. India is emerging as one of the top countries in M&A deals. In an efficient market M&A announcements will have an immediate effect on the stock price of that firm. Investors can earn significant returns during an M&A deal.

Event Study Methodology is used to find the effect of an event on a specific dependent variable. Here the merger or acquisition announcement is an event and the underlying stock price is the dependent variable. The event study will study the change in stock price beyond expectation which we call the abnormal return over a period of time called an event window.

In this project using an event study methodology we measure the abnormal returns (actual – predicted returns) during an event window, on stock prices of selected firms which have undergone an M&A deal. An econometric model is also developed for calculating predicted returns during the event window.

INTRODUCTION:

Mergers and Acquisitions and Corporate Restructuring are among the key areas of Corporate Finance. Every day investment bankers work on M&A transactions to bring separate companies together and form a larger one. M&A deals often make news. Deals are worth hundreds of thousands or millions or even billions of dollars. They have become popular due to enhanced competition, breaking of trade barriers, free flow of capital across countries and globalization of businesses.

Mergers and acquisitions (M&As) in India surged by 270% in terms of deal value from jan 2011 to march 2011. The deal value came to around $18.31 billion. According to Hong Kong based research agency mergermarket, this is nearly four times of the previous year’s first quarter of $4.94 billion1. Experts believe that this trend is set to continue as healthy firms in India are seeking for more of M&A deals.

“Inbound M&A drove deals in Q1 2011 with India proving itself an attractive investment destination as it lured buyers in the energy, insurance and IT space. Despite the ongoing wave of corporate scandal and political corruption, India will continue to entice suitors on the back of strong fundamentals such as its growing population. Buyers from typical markets such as the US, Europe and Japan could be joined by those from Korea and Russia and deals across borders – consumer, financial services, energy, industrial, engineering and chemicals – will continue. Overseas activity in energy, consumer and IT is also expected to grow.”

– Spokesperson, Mergermarket Asia Pacific

So how does an investor benefit from this? A popular belief is that mergers and acquisitions strengthen businesses by making their operations more synergetic. Announcements of mergers and acquisitions immediately impact a target company’s stock price, as induced reaction in the stock market cause investors to revise expectations about the company’s future profitability2.

1 http://www.indiaincorporated.com/index/item/158-india-on-big-ticket-ma-spree-in-2011.html

2.Panayides and Gong, 2002, The Stock Market Reaction to Merger and Acquisition Announcements in Liner

Shipping

An event study is a statistical method used to study the impact of a corporate event. In a corporate context, the usefulness of event studies arises from the fact that the magnitude of abnormal performance at the time of an event provides a measure of the unanticipated impact of this type of event on the wealth of the firms’ claimholders3.

Here the corporate event of interest is mergers and acquisitions and its impact on the stock price of the underlying firm is studied. Event studies are frequently used to test market efficiency4. Measurement of Abnormal Returns in an event window is the central focus in an event study. Abnormal Returns is the difference between the Actual returns and Expected returns.

Expected returns during the event window are calculated using the Box Jenkins Methodology, popularly known as the ARIMA Model. Box-Jenkins forecasting models are based on statistical concepts and principles and are able to model a wide spectrum of time series behavior. It has a large class of models to choose from and a systematic approach for identifying the correct model form. There are both statistical tests for verifying model validity and statistical measures of forecast uncertainty.

3. S.P. Kothari and Jerold B. Warner, 2006, Econometrics of Event Studies.

4. Brown and Warner, 1980, Using daily stock returns – The case of event studies

Objective of the Project:

To Measure the Abnormal Returns on Stock Prices around the Event.

To Develop an Econometric Model in Predicting Abnormal Returns.

To test the hypothesis that investors do not earn any abnormal returns during an event

Limitations of the Study:

Larger samples are difficult to use because abnormal returns has to be calculated individually. Using all the samples would have made the research more robust.

Various forecasting models are available. We will be sticking to ARIMA model.

Valuation of the firm after a merger or acquisition and its financial performance is out of scope.

Report Organization:

Section 2 presents the Literature Review on M&A effect. Section 3 starts with a small introduction to mergers, types of mergers, acquisitions and motives of a merger or acquisition. Section 4 explains what an event study analysis is and the steps involved in conducting such a study. A Null and Alternate Hypothesis which needs to be tested is defined. Section 5 briefly outlines the time series analysis. Concept of stationarity, methods to test stationarity, transforming non-stationary time