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Can long-term performance plans mitigate the negative effects of stock consideration and high cash for acquirers?

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Abstract

Following Travlos (J Finance 42: 943–963, 1987), Loughran and Vijh (J Finance 52: 1765–1790, 1997), Harford (J Finance 54: 1969–1997, 1999), and Oler (Rev Acc Stud 13: 479–511, 2008), we investigate whether acquisitions involving stock consideration and acquirers with high cash levels are associated with poor performance or not. In addition, we investigate whether including a long-term performance plan in top management’s compensation package can mitigate these negative effects. We find that acquirers with a long-term performance plan are less likely to hold a high cash balance and are less likely to use stock consideration, thus avoiding scenarios that are more likely to be value-destructive. Even if an acquirer with a long-term performance plan carries a high cash balance or uses stock, we find that the plan is associated with improved fundamental performance; however, this relationship does not flow through to improved post-acquisition returns.

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Notes

  1. Previous studies in this journal have examined the association between long-term performance plans and earnings management as well as firm performance (Richardson and Waegelein 2002), merger performance (Ramaswamy and Waegelein 2003) and audit fees (Vafeas and Waegelein 2007).

  2. Proxy statements are often vague as to precisely who is included in “top management,” but at minimum, top management always includes the CEO.

  3. Carrying a high cash balance and using stock consideration need not be mutually exclusive, because an acquirer with a high cash balance may still choose to offer only stock consideration to target shareholders and retain its cash for other investments.

  4. We operationalize high cash as being ranked in the top 20% of acquirers when ranked by cash level.

  5. Specifically, Tehranian et al. (1987) examine 164 acquirers from 1972 to 1981; Ramaswamy and Waegelein (2003) examine 162 acquirers from 1972 to 1990; we investigate 1,683 acquirers from 1972 to 2003.

  6. For example, most papers reviewed by Jensen and Ruback (1983) report insignificant or negative announcement period returns for acquirers. Long-run post-acquisition returns reviewed by Jensen and Ruback are also often negative. Loughran and Vijh (1997) also report post-acquisition returns that are either significantly negative or insignificantly different from zero. Oler (2008) reports similar results for a more recent sample of acquisitions.

  7. Note that these factors are not mutually exclusive: an acquirer with a high cash balance may still choose to offer voting stock as consideration for an acquisition.

  8. Specifically, we use the Wall Street Journal Index, Dow Jones Online (later renamed Factiva), and Lexis-Nexis.

  9. To keep our SDC-drawn sample consistent with our CRSP-drawn sample, we also require that the target firm have a CRSP permno.

  10. We also note that the plan was in place for the entire period (i.e., from the pre- to the post-acquisition period) for all the firms in our dataset.

  11. We also include the delisting return for any delisted peer firm in the returns calculations.

  12. SAS version 9.1 offers a convenient robust regression package “proc robustreg” that uses Huber’s (1973) M-estimation technique as its default setting.

  13. However, as our investigation focuses on firms retaining a high cash balance, we follow Oler (2008) in defining a high cash acquirer as an acquirer in the top 20% of acquirers in a given year ranked by cash level.

  14. As mentioned previously, we bootstrap to estimate the significance of long-run returns. However, p-values based on ordinary t-statistics are very similar.

  15. For brevity we do not show correlations between all our control variables.

  16. We find that the use of stock consideration is positively correlated with the acquirer’s cash level, which may be confusing because one would intuitively believe that a firm with a lot of cash would use that cash as consideration. However, as Opler et al. (1999) find, a firm’s market-to-book ratio is positively related to a firm’s cash level; that is, the more cash a firm has, the more likely it is to be overvalued, and overvalued firms are more likely to use stock consideration (Rau and Vermaelen 1998).

  17. We run a number of robustness checks on these results. Our results become stronger if we define a high cash firm as a firm in the top 10% of all acquirers in that year; they are weaker, but still significant, if we drop our classification to the top 30% of all acquirers.

  18. We also note that this variable loads significantly negatively in Opler et al.’s fixed-effects regression, consistent with our results here.

  19. Our results here, however, are admittedly weaker than our results for high cash, and we also find that they are not as robust to changes in variable specification as our high cash results.

  20. However, even with the interactions removed, our plan dummy alone does not load significantly.

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Authors and Affiliations

  1. Rawls College of Business, Texas Tech University, Area of Accounting, Box 42101, Lubbock, TX, 79409-2101, USA

    Derek Oler

  2. Department of Accounting & Information Systems, Emporia State University, Emporia, Kansas, 66801, USA

    James F. Waegelein

Authors
  1. Derek Oler
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  2. James F. Waegelein
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Correspondence to James F. Waegelein.

Appendix: variable definitions and calculations

Appendix: variable definitions and calculations

Stock price and shares outstanding are taken from the CRSP database. All financial statement information is taken from the combined CRSP/Compustat (annual) database provided by Wharton Research Data Services (WRDS). Information is taken as at the most recent month-end that is at least 30 days before the announcement of the acquisition. We assume a three-month lag between a firm’s year-end and when financial statements are publicly available.Multivariate BHARs are calculated as follows:

$$ BHAR_{{_{i} }} = \prod\limits_{t = s}^{e} {\left( {1 + R_{i,t} } \right)} - \prod\limits_{t = s}^{e} {\left( {1 + R_{mp,t} } \right)} = BHR_{firm} - BHR_{mp} . $$

Where:

R i,t  = returns for firm i over the period beginning with day s and ending with day e, where s = day −2 and e =+2 relative to the announcement date for announcement period returns, s =+3 and e = target delisting date for interim period returns, and s = day + 1 relative to target delisting and e = end of month + 24 for post-acquisition returns, and

R mp,t  = mean portfolio returns (from four peer firms) over the same period

Table 8 provides details on our calculations of independent variables.

Table 8 Description and calculation of independent variables
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Oler, D., Waegelein, J.F. Can long-term performance plans mitigate the negative effects of stock consideration and high cash for acquirers?. Rev Quant Finan Acc 37, 63–86 (2011). https://doi.org/10.1007/s11156-010-0195-y

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