Shareholder Wealth Effects of Merger & Acquisition Essay (Critical Writing)

Introduction

Merger and acquisition (M&A) are mostly aimed at building internal capacity, attaining cross boarder expansion, increasing the market share, growing current business when organic growth has become challenging, and assisting in risk diversification. In addition, they are poised to develop synergies and build economies of scale and diversification. However, there has been evidence of a rapid decline in stock run-ups of U.S targeted companies preceding M&A announcements over the past many years. The main reason for mergers and acquisitions firms is to generate more profits than the combined profits of the merging firms. Liberalization and globalization have contributed to companies becoming more aggressive and deciding on M&A that enhances their competitiveness in the market. However, corporate announcements may destroy or create shareholder wealth to a sum of millions of dollars. The report critically discusses a recent academic article on the shareholder wealth effects of a corporate announcement of merger and acquisition.

The Article: Dutordoir, M., Vagenas‐Nanos, E., Verwijmeren, P., and Wu, B. (2021). A rundown of merger target run‐UPS. Financial Management, 50(2), 487-518.

Contribution to the Literature

The article’s key contribution to the literature is providing new insight for corporate managers that the current presumptions about the target run-ups’ magnitude as per older empirical studies should be revised. Target run-ups have considerably decreased over time and this research provides potential explanations for the observed phenomenon. In addition, the findings are helpful for regulators and policymakers by recommending that more stringent insider trading principles have restricted premerger targeted run-ups. The establishments that target run-ups of mergers are examples of declaration of share price patterns. The article offers strong evidence that target companies display a share price rise in the period before the deal announcement (Dutordoir et al., 2021). The researchers noted that the announcement period targeted abnormal stock returns surge over time, contributing to a relatively stable magnitude of generally target stock returns related to announcements of M&A.

Article’s Key Findings Based on Shareholder Value Effects

The literature offers strong evidence that targeted companies display a share price rise in the time before the deal declaration. However, the study found that this stylized fact has reduced over time. The research found average targeted run-ups of 9.71% in the past half of the 1980s, the same as the past studies. Nevertheless, the average run-ups decreased to 8.33% by the mid-1990s and continued to decrease in the 21st century. From 2010-2018, the findings revealed that average targeted run-ups were low at 3.75% have a median of 2.18% (Dutordoir et al., 2021). The authors noted observed that the declaration period targeted abnormal stock returns improvement over time leading to a relatively stable magnitude of general targeted stock returns related to M&A announcements. The findings showed that, over time, a smaller percentage of the target abnormal stock returns materialize before the declaration data and a bigger percentage occurs during the pronouncement date.

Further, a decrease in targeted run-ups over time might be associated with a reduced capability of shareholders to expect M&A deals or a drop in illicit insider trading activities in the market. The findings demonstrated that there was no evidence that the deal expectation explanation may account for the fall in targeted run-ups, even though this cannot be fully ruled out with the explanation with the test available. Results from the study revealed that consistent with an insider trading explanation, the trends vanish when controlling for incidents related to a decline in the preannouncement insider trading intensity. The study results found a spurious relationship between targeted run-ups and insider-trading decreasing events (Dutordoir et al., 2021). Hence, the lower target run-ups are the result of a decline in insider trading activities. The effectual on shareholder values effects of the corporate announcement is negative.

Consequently, the authors identified key determinants of cross-sectional differences in the stock price response to the mergers to be the negative effect of insider trading rules on targeted run-ups is stronger for transactions with a bigger number of targeted consultants. It is consistent with the transactions having a higher possibility of inducing pre-announcement insider trading activity. Further, the targeted shareholders’ posterior possibilities of informed trading on the positive information before announcements of a merge as per observed buying deals, there is a decreasing trend in targeted run-ups of positive shareholders’ values over their study window. The authors noted that the negative trend in merger positive values diminishes when controlling for transformations in insider trading regulation over the study period (Dutordoir et al., 2021). They observed that this is persistent with enhanced regulations as a success at preventing premerger insider trading activities.

Theoretical Predictions

The theoretical prediction to determine whether the decline in targeted run-ups might be associated with alterations in transaction and company features is related to the extent to which market participants may expect mergers. In addition, it was to examine whether the negative trend in targeted run-ups may be associated with growingly strict insider trading regulations adopted in the United States (U.S). The theoretical perspective concentrated on four significant modifications in insider trading regulations over the study period. The key findings are in line with the hypothesis because the decline in targeted run-ups over the period might be linked with decreased capacity of shareholders to expect M&A transactions or a drop in the illicit insider trading activities in the market (Dutordoir et al., 2021). Insider trading activities dropped because of increasingly stringent rules and regulations on a merger in the US.

Limitations of the Article

There may be some potential limitations in this research. There were issues with study samples and selection procedures because sampling errors it does not reflect the appropriate or general population concerned. It resulted in limitations of their study due to selection bias. For example, the samples comprised M&As that are domiciled companies acquired by the US domiciled publicly held companies. The bidders had to purchase a minimum of half of the targeted shares. In addition, the study eliminated privately held bidder transactions with Bondholders, investor groups, shareholders, or creditors and focused on bidding companies not a group of investors. Further, researchers removed transactions with missing values for deal anticipation proxies (Dutordoir et al., 2021). All these aspects created limitations to having a sample of the represented general population. The effect approximations in the model are founded on prospective and interventional observational studies. Hence, they are subjected to confounding biases that could have influenced their model approximations.

Scope of the Study

Nevertheless, the trend effects of target run-up changes were approximated from meta-analysis with confirmation to validity analyses. The authors cannot completely rule out the explanation of the deal anticipation with the test available (Dutordoir et al., 2021). It implies that the sample tested was inadequate to provide accurate information on the aspect. Further research needs to use a large sample size because of the magnitude of studies that relate to trends to get valid information on the generation of the current trends in the phenomenon being investigated. In addition, future studies could apply the event study method (ESM) to examine stock price behavior around the merger announcement (Eden et al., 2022). The study did not include this potentially beneficial effect of reduction in insider trading activities to merger to shareholder value.

Practical Implications of the Findings to Corporate Stakeholders

Corporate managers can learn from findings on the new insights on prevailing presumptions concerning the extent of target run-ups that should be revised. Directors or CEOs seen to be involved in illicit insider activities in the market can be cautioned due to current assumptions in the market. Thus, management is obliged to carry out their business activities with keenness and integrity to avoid being misinterpreted (Kliemt, 2022). The study results show that a decrease in the target run-ups over time might be associated with a decline in insider trading activities, which confirms that executives could be doing illegal transactions during announcements of a merger. Therefore, it calls for management to strictly follow any merger declaration to determine if the deal is properly instigated. Breach of insider trading may lead to criminal and civil fines, prison sentences for managers who commit this violation, and criminal and civil fines for companies that commit this breach (Blouin et al., 2021). Managers, directors, or CEOs are directly responsible for insider trading because they are exposed to material information before being made public.

However, the findings show a decline in insider trading activity among companies. Hence, management or directors will be denied the opportunity to get the benefits related to it. For example, insider trading has many advantages comprising increased efficiency, decreased risk exposure, financial rewards, and enhanced performance among market participants. The managers and directors end up presenting different ethical issues, for example, differing cultural norms, conflicting rights, and inequalities among the participants in the market (Grewal et al., 2020). In addition, it leads to a conflict of interests among the managers or directors and shareholders.

Investors

The findings revealed that insider trading activities have declined to contribute to a decrease in targeted run-ups in the market. Therefore, without insider trading, the market could operate with a lower efficiency level, which minimizes the market in informativeness, contributing to investors demanding a higher return to reimburse for the fact that they see less information as riskier investments (Grewal et al., 2020). Insider trading negatively influences market liquidity and contributes to transaction costs being higher, decreasing investor returns. Since many people in the country have a stake in the financial markets, this conduct hurts most American citizens. The findings reveal that insider trading can dampen the support of shareholders for companies’ investments (Dutordoir et al., 2021). If external investors control corporate behaviors, then company investment can drop below its financially efficient level.

However, a decline in insider trading activities can discourage investors from investing in companies. Barring shareholders from getting information indirectly or receiving it directly through stock price movements may result in errors. Investors could sell or buy stocks that they would otherwise not have traded when provided with information through insider trading activities (Serafeim and Yoon, 2022). It could discourage investments as they could feel deprived of their right to information.

Employees

Employees who engage in insider trading could suffer and are punished with several criminal and civil sanctions. For instance, under US securities laws, people can be subjected to imprisonment for close to 20 years and criminal fines amounting to approximately $5 million or civil fines of up to three times the loss avoided or profit gained (Islam and Van Staden, 2021). Therefore, the findings are significant as most employees are learning the new norms of deals on mergers and reducing their involvement in insider trading activity. Consequently, this has led to a decline in targeted run-ups, as most employees fear the repercussion of being caught. Further, it has enhanced them to adhere to their code of conduct and do better deals than those involved in illegal insider trading activities.

Policymakers

Policymakers may learn from the findings that selective disclosure negatively affects market integrity, similarly to the adverse effect of illicit insider trading activity. Therefore, the results provide new insights into insider trading to create more stringent rules and regulations to reduce it further, enhance operations in M&A, and improve shareholder value and wealth. Policymakers may adopt new assumptions to address three problems (Monga and Amanpreet, 2021). These include selective disclosure by those issuing material non-public information, possession of non-public material information, and violation of family or other non-business associations can lead to liability under the misappropriation insider trading theory.

Fortunately, the regulations are devised to facilitate the fair and full disclosure of information by issuers, clarification, and improvement of current prohibitions against insider trading activities. Policymakers should allow them to develop and support voluntary adherence to best practices. The new insights from the study findings will quell the economics and law debate on the necessity and effects of insider trading regulations on the stock prices in the global markets (Wasilewski et al., 2021). Further, the results reveal to the policymakers that insider trading needs to be regulated.

The Public

Insider trading activities are unfair and discourage the public from engaging in markets, making it more difficult for firms to raise capital; hence, it is illegal. However, rules and laws against insider trading activity, mostly when vigorously enforced, may lead to innocent people being imprisoned (Wasilewski et al., 2021). The regulations are more sophisticated to know whether it is legal, or illegal, which makes participants accidentally violate the law without knowing.

Conclusion

Mergers and acquisitions are well-known examples of corporate announcement stock price reactions. The report has shown a drastic decline over time in the targeted run-up companies since the introduction of strict insider trading activities regulations. However, the announcement targeted abnormal stock returns have increased over time, contributing to a relatively stable magnitude of the generally targeted stock returns related to the corporate declaration of M&As. However, a decline in insider trading has implications for different stakeholders in the corporation comprising managers, employees, investors, policymakers, and the public. Employees, investors, and the public find it challenging to follow insider-trading regulations and may accidentally get themselves breaching the law.

Reference List

Blouin, J. L., Fich, E. M., Rice, E. M., and Tran, A. L. (2021). Corporate tax cuts, merger activity, and shareholder wealth. Journal of Accounting and Economics, 71(1), 101315.

Dutordoir, M., Vagenas‐Nanos, E., Verwijmeren, P., and Wu, B. (2021). A rundown of merger target run‐UPS. Financial Management, 50(2), 487-518.

Eden, L., Miller, S. R., Khan, S., Weiner, R. J., and Li, D. (2022). The event study in international business research: Opportunities, challenges, and practical solutions. Journal of International Business Studies, 53(5), 803-817.

Grewal, J., Hauptmann, C., and Serafeim, G. (2020). Material sustainability information and stock price Informativeness. Journal of Business Ethics, 171(3), 513-544.

Hasnan, S. (2022). Corporate governance and ownership structure on illegal insider trading activities in Malaysian public listed companies. Management and Accounting Review, 21(1), 1-18.

Islam, M. A., and Van Staden, C. J. (2021). Modern slavery disclosure regulation and global supply chains: Insights from stakeholder narratives on the UK modern slavery act. Journal of Business Ethics, 180(2), 455-479.

Kliemt, H. (2022). What should moral managers do? The moral virtues of shareholder value conceptions of management. The ‘Betrieb’ as Corporate Actor, 3(2), 108-121.

Monga, S., and Amanpreet, D. (2021). Impact of Mergers and Acquisitions Announcement on Shareholders’ Wealth: Evidence from Indian Corporate Sector. Turkish Online Journal of Qualitative Inquiry (TOJQI), 12(10), 2546-2554.

Serafeim, G., and Yoon, A. (2022). Stock price reactions to ESG news: The role of ESG ratings and disagreement. Review of Accounting Studies, 3(1), 1-18.

Wasilewski, M., Zabolotnyy, S., and Osiichuk, D. (2021). Characteristics and shareholder wealth effects of mergers and acquisitions involving European renewable energy companies. Energies, 14(21), 7126.