The impact of Mergers and Acquisitions on Corporate Financial Performance in India

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IJRMBSS I ISSN No. : 2319-6998 I Vol. 1 I Issue 2 I July. 2013------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ Indian Journal of Research in Management, Business and Social Sciences (IJRMBSS) 13

The impact of Mergers and Acquisitions onCorporate Financial Performance in India

Dr. K. B. Singh 1

Abstract- Mergers & Acquisitions (M&A), as a corporate

restructuring activity in India has exhibited explosive growth

in recent years and has become an important corporate

strategy in the financial and economic environment all over

the world. Since 1991, Indian industries have been

increasingly exposed to both domestic and international

competition. The Indian economy has undergone a major

transformation and structural change following the economicreforms, size and competence have become the focus of

business enterprises in India. Hence, in recent times,

companies have started restructuring their operations

around their core business activities through (M&A). M&A

is a tool used by companies for the purpose of expanding

their operations often aiming at an increase of their long

term profitability (Seth, 1990). Even though M&A have been

an important element of corporate strategy all over the globe

for several decades, research on M&As has not been able to

provide conclusive evidence on whether they enhance

efficiency or destroy wealth. Therefore M&A related issues

have drawn considerable interest from practitioners and

academicians across the globe. Researchers (Yook, 2004;

Dickerson, Gibson, & Tsakalotos, 1997; Paulter, 2003;

Cochran & Wood, 1984) have documented that there are twomain streams in the existing post-acquisition performance

literature. One is the stock market approach which uses stock

market valuation to determine post-acquisition performance

(Paulter, 2003; King, Dalton, Daily, & Covin, 2004), and the

other is the accounting data approach which directly focuses on

a companys profitability through accounting and cash flow

ratios (Healy, Palepu, & Ruback, 1992; Ghosh 2001). Our

study uses long-term pre- and post-merger financial data to

assess firm operating performance. According to Bromiley

(1986), in many cases, accounting performance measures are

better than market-based measures because they are used more

frequently by managers to make strategic decisions. A sample

of 20 pair of public listed companies which have undergone

M&A during 2005 were taken for analysis. We use averages

of the financial ratios data of three years prior to (Pre-merger)and three year subsequent to the merger (Post-merger). These

ratios were compared and tested for any statistical significant

difference, using paired t test. The study found that there

was a long-term improvement in financial performance of

merging companies. Thus we conclude that mergers and

acquisitions is an effective methods of corporate

restructuring, and should become an integral part of the

long-term business strategy of corporates in India.

Key words: Mergers and acquisitions; M&A; takeovers;corporate fi nancial perf ormance; I ndia.

I. INTRODUCTION

Over the last two decades, Mergers and Acquisitions

(M&A)-related issues have drawn considerable interest from

practitioners and academicians. As a result, scores of

empirical studies have documented various aspects of M&A

activity, including trends in such M&A activities,

characteristics of the transactions, and corresponding gainsor losses to shareholders. While the majority of the existing

empirical evidences focus on the stock returns surrounding

the announcement dates, a smaller body of research has

examined the long-run post-acquisition stock returns and

operating performance.

In Indian industry, the pace for mergers and acquisitions

activity picked up in response to various economic reforms

introduced by the Government of India since 1991, in its

move towards liberalization and globalization. The Indian

economy has undergone a major transformation and

structural change following the economic reforms, and size

and competence" have become the focus of business

enterprises in India. Indian companies realised the need togrow and expand in businesses that they understood well, to

face growing competition; several leading corporates have

undertaken restructuring exercises to sell off non-core

businesses, and to create stronger presence in their core areas

of business interest. Mergers and acquisitions emerged as

one of the most effective methods of such corporate

restructuring, and became an integral part of the long-term

business strategy of corporates in India.

A survey among Indian corporate managers in 2006 by

Grant Thornton found that Mergers & Acquisitions are a

significant form of business strategy today for Indian

Corporates. The three main objectives behind any M&A

transaction, for corporates today were found to be: Improving Revenues and Profitability

Faster growth in scale and quicker time to market

Acquisition of new technology or competence

Table 1: Objectives of Indian Corporates for M&As

Objective behind the M&A

Transaction

Responses (in

%)

o improve revenue & Profitability

Faster growth in scale and quicker

ime to market

cquisition of new technology or

competence

o eliminate competition & increase

33%

28%

22%





market share

Tax shields & Investment savings

11%

3%Source: Grant Thornton (India), The M&A and Private

Equity Scenario, 2006

This paper examines the long-term operating performance of

Indian acquiring firms. Most of the prior studies focus on

the industrial developed nation such as US and UK

acquisition markets, where most of the M&A deals take

place. Indian M&A market is also considerably large and

vibrant; hence the present study focuses on the Indian

market.

II. OBJECTIVES

1.To analyzes the profitability of merged companies by

comparing key financial ratios during pre and postmerging year.

2.To analyze the change in financial leverage due to M&A.

III. RESEARCH METHODOLOGY

Sample -List of companies involved in mergers during the

year 2005 were compiled from Capitaline and Prowess

database and the same was cross-checked from the websites

of BSE and NSE (for names of name changes and delisted

companies). To such a list, the screening criteria were

applied to arrive at the final sample. These criteria were -

merger cases, where at least two years of data were not

available for pre-merger period and at least four years data

for post-merger period, were removed from the study

sample. Also companies where the target or acquirer were aforeign listed company was omitted and those acquirers

which went for multiple mergers were also removed. The

final sample size for the study was 20 public listed

companies from a total of 58 companies which have

undergone M&A during the period of the study.

We have taken sample firms of the year 2005, as the long-

term financial performance is tested for 3 years post mergers

and abnormal economic time period of recession starting

year 2008 is avoided.

Research Hypotheses: To test the objectives mentioned

above, the following hypotheses were formulated:

(i) H0: Mergers in India have no impact on the operating

performance of acquiring firms.

H1: Mergers in India have impact on the operating

performance of acquiring firms.

(ii) H0: Mergers in India have no impact on financial

leverage of acquiring firms.

H2:Mergers in India have impact on financial leverage of

acquiring firms.

We have adopted the methodology of comparing pre- and

post-merger performances of acquiring companies, using the

following financial ratios:

Operating Profit Margin (Profit Before Depreciation,

Interest and Tax/Net Sales)

Gross Profit Margin (Profit before Interest and Tax/Net

Sales) Net Profit Margin (Profit after Tax/Net Sales)

Return on Networth (Profit after Tax/Networth)

Return on Capital Employed (Profit before Interest and

Tax (PBIT)/Capital Employed)

Debt-equity Ratio (Book value of Debt/Book value of

Equity)

The pre-merger (for three years prior to merger) and post-

merger (for three years after the merger) averages of the

above financial ratios were compared and tested for

differences, using paired `t' test for two samples. The

observations of each pair of firms in the sample are not

independent, since the acquiring firm retains its identitybefore and after merger. Therefore, paired `t' test was

considered appropriate to measure merger induced operating

performance changes. Year of completion of merger,

denoted as year 0, has been excluded from estimation. The

pre-merger calculation has been done for both the acquired

and the acquirer for the period (-3 to -1) years and it is the

sum of their operating ratios for each year. Post the merger,

the operating ratios for the combined firm were taken for

(+1 to +3) years.

IV. LITERATURE REVIEW

There is a substantial body of literature that examines the

performance of M&A deals both for the acquiring firms and

target firms. There are generally three approaches followedin the literature for examining the performance of M&A

transactions. The most common approach is the

investigation of gains and losses to shareholders around the

deal announcement date. Evidence shows that target

shareholders generally earn significantly positive abnormal

returns (AR) but the acquirers' shareholders earn, on an

average, a zero abnormal return at the acquisition's

announcement, but considerable variation exists in these

results (Andrade et al., 2001; Fulleret al.,2002; and Bruner,

2002).

Most of these long-term studies conclude that the acquiring

firms experience significant negative abnormal returns over

one to three years after the merger (Agrawal et al., 1992;Gregory, 1997; Agrawal and Jaffe, 2000; and Andrade et al.,

2001).

Most of the US based studies either report an improvement

in operating performance (Linn and Switzer, 2001; and

Heron and Lie, 2002), or an unchanged performance

(Moeller and Schlingemann, 2005). Results from the studies

on other markets are also inconsistent. Sharma and Ho

(2002) find insignificant changes in acquirers' post-

acquisition operating performance for Australian firms.

Asian studies also present inconsistent results (Sharma and

Ho, 2002; and Rahman and Limmack, 2004). Rahman and

Limmak (2004) show that operating performance improves

significantly for Malaysian acquirer.





V. RESULTS AND INTERPRETATION

Table 2: Mean pre-merger and post-merger ratios formerging firms

Financial

Ratios

Pre-

merger

(3 yrs

before)

mean

Post-

merger

(3 yrs

after)

mean

t-stat

(paired)

P-value

(2-

tailed)

Operating

profit margin

Gross Profit

Margin

Net Profit

Margin

Return onNet worth

Return on

Capital

Employed

Debt-Equity

Ratio

21.385

19.447

15.455

21.247

20.24

1.685

23.225

17.658

18.584

24.541

21.65

2.422

1.211

1.023

2.115

2.682

3.457

2.314

0.231*

0.514**

0.034*

0.018*

0.076*

0.009*

Source:Authors calculation from Prowess.

*Significant at 5% significance level

**Not significant at 5% significance level

The comparison of the pre-merger and post-merger

operating performance ratios for the entire sample set of

mergers showed that there was an increase in the meanoperating profit margin (21.385% to 23.225%), but the

decline was not statistically significant (t-statistic value of

1.211). Similarly there was an increase in net profit margin

(15.455% to 18.584%), return on Net worth (21.247% to

24.541%) and return on capital employed (20.24% to

21.65%) and these increase are statistically significant (t-

statistic values of 2.115, 2.682 and 3.457 respectively).

However gross profit margin (19.447% to 17.658%)

declined the decline was not statistically significant in the

post-merger period (t-statistic values of 1.023). There was a

marginal but statistically significant increase in leverage

after the merger (1.685 vs. 2.422), confirmed by the high t-

value of 2.314.The results suggest that operating financial performance of

all mergers in the sample from Indian industry had increased

following mergers, as there was a increase in both the

profitability ratios and returns on net worth and invested

capital. The results are comparable to those obtained by

Ramakrishanan (2007) who found that most mergers during

1995-2005 in India have resulted in improving operational

efficiencies. The results above also agree with the results of

research studies in USA and Europe on operating

performance of acquiring firms - that the operating

performance of acquiring firms had either stagnated or

declined after mergers.

Based on the results of the analysis, the alternate hypothesisH1: Mergers in I ndia have impact on the operating

perf ormance of acquir ing fi rms isaccepted, since mergers

were found to positively impact the performance in terms ofboth profitability and returns on investment.

However, the analysis of debt-equity ratios suggest that

during post merger period leverage has increased and this

increase has been statistically significant. Therefore the

alternate hypothesis H2: Mergers in I ndia have impact on

fi nancial leverage of acqui ri ng fi rms is accepted.

VI. CONCLUSION

An analysis of pre- and post-merger operating

performance ratios for the entire sample set of mergers

shows that while there was significant increase in the mean

operating profit margin, net profit margin ratios, return on

net worth and return on capital employed after the merger.

These results corroborate with some of the general research

results on post-merger operating performance in other

countries, which suggested that the operating performance

increases after mergers, for acquiring firms.

VII. REFERENCES

[1]. Agrawal A, Jaffe J F and Mandelker G N (1992),"The Post-Merger Performance of Acquiring Firms: A

Reexamination of an Anomaly", Journal of Finance,

Vol. 47, No. 4, pp. 1605-1621.

[2]. Agrawal A and Jaffe J F (2000), "The Post-MergerPerformance Puzzle", Advances in Mergers and

Acquisitions, Vol. 1, pp. 7-41.

[3]. Andrade G, Mitchell M and Erik Stafford E(2001),"New Evidence and Perspectives on Mergers",Journal

of Economic Perspectives, Vol. 15, No. 2, pp. 103-120.

[4]. Bruner R F (2002), "Does M&A Pay? A Survey ofEvidence for the Decision-Maker",Journal of Applied

Finance, Vol. 12, No. 1,pp. 48-68.

[5]. Fuller K, Netter J and Stegemoller M(2002), "WhatDo Returns to Acquiring Firms Tell Us? Evidence

from Firms that Make Many Acquisitions", Journal of

Finance, Vol. 57, No. 4, pp. 1763-1793.

[6]. Ghosh A(2001), "Does Operating Performance ReallyImprove Following Corporate Acquisitions?", Journal

of Corporate Finance, Vol. 7, pp. 151-178.[7]. Ghosh A and Jain P J (2000), Financial Leverage

Changes Associated with Corporate Mergers", Journal

of Corporate Finance,Vol. 6, pp. 377-402.

[8]. Healy P M, Palepu K G and Ruback R S (1992),"Does Corporate Performance Improve After

Mergers?", Journal of Financial Economics, Vol. 31,

pp. 135-175.

[9]. Heron R and Lie E (2002), "Operating Performanceand the Method of Payment in Takeovers", Journal of

Financial and Quantitative Analysis, Vol. 37, No. 1,

pp. 137-155.

[10].Linn S C and McConnell J J (1983), "An EmpiricalInvestigation of the Impact of `Antitakeover'





Amendments on Common Stock Prices", Journal of

Financial Economics,Vol. 11, pp. 361-399.[11].Linn S C and Switzer J A (2001), "Are Cash

Acquisitions Associated with Better Post-acquisition

Operating Performance than Stock Acquisitions?",

Journal of Banking and Finance, Vol. 25, pp. 1113-

1138.

[12].Moeller S B and Schlingemann F P(2005), "GlobalDiversification and Bidder Gains: A Comparison

Between Cross-Border and Domestic Acquisitions",

Journal of Banking and Finance, Vol. 29, pp. 533-564.

[13].Rahman A R and Limmack R J (2004), "CorporateAcquisitions and the Operating Performance of

Malaysian Companies", Journal of Business, Finance

and Accounting, Vol. 31, Nos. 3/4, pp. 359-400.

[14].Sharma D S and Ho J (2002), "The Impact ofAcquisitions on Operating Performance: Some

Australian Evidence", Journal of Business, Finance

and Accounting,Vol. 29, No. 1, pp. 155-200.

________________________

1 Dr. K. B. Singh , Assistant Professor, Dept. of

Management, Birla Institute of Technology, Mesra (Noida

Campus). [email protected]

The impact of Mergers and Acquisitions on Corporate Financial Performance in India

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