This another company. As a result, the new


literature review covers definitions of M&As as well as reasons for M&A
activity and analyses previous studies regarding M&As and consequent
short-term and long-term shareholder wealth effects.


3.1 Definition of the Term “Mergers &

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concept of M&As is commonly used in the literature to embrace everything
from pure mergers to strategic alliances. Although the word “M&As” is often
used interchangeably, “mergers” and “acquisitions” have very different meanings.

Lucks and Meckl (2002) conclude that there is still no set definition for
M&A activity; indeed, there is plenty of literature providing various
definitions for what a merger and an acquisition are, and how they differ. The definitions
below are used in this paper due to their narrow sense and relevance to this

Merger is
the combination of one or more companies with another company. As a result, the
new combined corporation legally emerges (Reed, Lajoux and Nesvold, 2007).

Acquisition is
the process, whereby stocks or assets of an organization come to be owned by
the buyer (Reed, Lajoux and Nesvold, 2007).


The deal being researched is seen as an acquisition rather
than a merger, because Microsoft purchased LinkedIn
for $196 per share in an all-cash transaction valued at $26.2 billion,
inclusive of LinkedIn’s net cash, rather than two companies combined forces to
create a new, joint organization (which would be a merger). In this case, a new
company does not emerge; therefore, it is an acquisition. Theoretically, the value of an
acquisition could be measured as Net Acquisition Value (Gaughan, 2007):



Where NAV is
net asset value of acquisition,  is value of the combination of firm A and B,  is standalone value of firm A (acquirer),  is standalone value of firm B, P is premium
paid for B, E is expenses for the acquisition.


As long as
Net Acquisition Value is bigger than zero, then the acquisition is justified.

If it is negative, then the company A has overpaid for company B. Thus, the
value of an acquisition depends on if the synergies will outweigh the costs.


Pfeffer (1972) suggested three types of M: horizontal,
vertical and diversifying. Horizontal M denote mergers and acquisitions
within the same industry, usually competitors, with a motive to strengthen
market share or acquire dominance in a particular market. In the opposite,
vertical M seek for forward or backward integration, for example
purchasing a wholesaler or taking over a supplier. In contrast to these
intra-industrial strategies, a diversifying M activity is used as a
portfolio management tool (Salter and Weinhold, 1979). The latter type of
M is the case of Microsoft acquiring LinkedIn, since companies operate
in different industries. Nevertheless, Microsoft CEO is still planning to
integrate products and services of both organizations to achieve synergies. Synergy, or the potential
financial benefit achieved through the combining of companies, is
often a driving force behind M. This paper therefore decides Microsoft’s
acquisition of LinkedIn is a diversifying synergy.


3.2 Theoretical Reasons for M&A
Activity and Real-Life Examples


Reasons behind M&A activity are similar, which is why they
are often combined and discussed together in different suggested theories. The
Valuation theory argues that acquirers have better information about a target
firm than the market and can therefore make better estimations, which could
help them benefit from undervalued firms (Holderness and Sheehan, 1985). According to the Empire-building theory
mergers are driven by managers who maximize their own utility (Trautwein,
1990). The Process theory claims that the decision to merge is driven by the
strategic decision-making of a firm; in reality, however, it is more likely to
be also influenced by political factors, agency issues, organizational routines
and limited information accessibility (Trautwein, 1990). Finally, the Monopoly
theory views M&As as a way to achieve market power whereas the Efficiency
theory explains M&As as being planned and executed to achieve synergies, as
discussed in Trautwein’s (1990) study. A synergy is “an effect arising
between two or more agents, entities, factors, or substances that produce an
effect greater than the sum of their individual effects” (Zhou, 2010).


The theories
formulated by Trautwein (1990) only explain the motives to merge from two or
more firms’ internal perspective. Logic dictates that the reason for M&As
should always be to improve the organization’s performance, although several
cases show this is not as simple as it seems (Zhou, 2010). A merger can,
however, be caused by technological and supply shocks and could be the only
solution to the possible overcapacity (Jensen, 1993). Other major shocks, such
as deregulation, financial innovations, increased foreign competition and oil
price shocks, can also promote mergers (Mitchell and Mulherin, 1996; Harford,


applying Trautwein’s (1990) theories to Microsoft’s case of acquiring LinkedIn, the
Efficiency theory suits best, since both CEOs indeed agree that this
acquisition would help companies to achieve synergies through integration of
their products and services and shared access to research and development. Out
of all types of synergies, this particular acquisition may benefit from both
complementary products, which can then produce higher sales for Microsoft
customers, and shared access to research and development efforts that, when applied
to their counterpart firm, allow for better development or room to cut costs in
production without sacrificing quantity or quality.


Historically, some M were great successes, and some were
absolutely disastrous. The merger of
Walt Disney and Pixar in 2006 is a great example: Disney had released all of
Pixar’s movies before, but with their contract about to run out after the
release of “Cars,” Disney acquired shares worth $7.4 billion in Pixar and made
it Disney’s subsidiary, which made perfect sense. The key reasons for the success of the merger of the two companies was
that investors saw potential for Disney to leverage on Pixar’s computer
animated character to be used in its vast networks (Qrius (formerly The Indian
Economist), 2018). However, corporate
mergers do not always work: Mercedes-Benz manufacturer Daimler Benz merged with
U.S. automaker Chrysler to create Daimler Chrysler for $37 billion in 1998. The
logic was obvious: to create a global car-making powerhouse that would dominate
the markets. However, a new corporation never attained the power over markets
and suppliers that this global position was supposed to deliver. By 2007,
Daimler Benz sold Chrysler to the private-equity giant Cerberus, which
specializes in restructuring troubled companies, for a mere $7 billion (Harvard
Business Review, 2018). As suggested in many articles, the potential reason of
the deal not ending up successful is a case of two very different corporate
cultures (The Economist, 2018).


3.3 Short-Horizon Shareholder
Wealth Effects


Earlier review papers of
the evidence on M&As by Jensen and Ruback (1983) and by Jarrell, Brickley
and Netter (1988) survey the pre-1980 and 1980s empirical literature,
respectively, and conclude that in the short term M&As create value for the
stockholders of the combined firms, with the majority of the gains accruing to
the stockholders of the target. The impact of M&A on returns for the
acquiring firms has largely been either significantly negative (Dodd, 1980;
Firth, 1980; Eger, 1983; Chang, 1998) or insignificantly positive (Asquith,
1983; Eckbo, 1983; Dennis and McConnell, 1986; Amihud, Dodd and Weinstein,
1986; Morck, Shleifer and Vishny, 1988; Byrd and Hickman, 1992). Later surveys
with similar approach and results are conducted by Bruner (2003) on the 1990s
wave, Sudarsanam, Mahate and Freeman (2001) on takeover profitability across
the decades, Powell and Stark (2005) on operating performance post UK


discreetly, Bruner’s (2003) research summarises the findings of 21 studies,
which reveal returns and analyses returns to acquiring firm shareholders as
well as combined returns to shareholders of both acquiring and target firms.

His conclusion is that an investment is deemed to “pay” in the short term if it
earns at least the opportunity cost of capital. Abstracting from the studies,
the majority meets the test. But the buyer in M transactions must prepare
to be disappointed: synergies, efficiencies, and value-creating growth seem
hard to obtain. This paper will therefore compare Bruner’s (2003) findings to
the ones obtained in this research of Microsoft’s acquisition of LinkedIn. Sudarsanam,  Mahate and Freeman (2001), in their turn,
analyse specifically glamour acquirers, their methods of payment and
post-acquisition performance using the UK data for the period 1983-1995 and
conclude that acquirers show a 1.4% negative abnormal return but results vary
with method of acquisition and price-earnings ratio. Powell
and Stark (2005) analyse whether companies’ operating performances increase
post-takeover for UK takeovers and conclude that the gains vary depending on
methodology (matching characteristics 0.13% – 1.78%; regression analysis 0.8%
-3.1%). This paper will compare the findings
discussed above, which all report insignificantly positive or significantly
negative abnormal return for acquirers, to the ones obtained in this research
of Microsoft’s acquisition of LinkedIn.


Some recent
papers, however, show different results. For example, Yuce and Ng (2009) examine the merger announcements of Canadian
companies between I994 and 2000 during an exceptional merger boom. Their
results show that both the target and the acquiring company shareholders earn
significant and positive abnormal returns for a two-day holding period starting
with the announcement day, which is consistent with many findings that
mergers do pay. Since this paper uses two different
short event windows (-1, 1) and (-3, 3), as discussed in 4.2.2 Event
Definition and Identification of the Period of Study, this
paper will be able to directly compare the results to the ones obtained by Yuce
and Ng (2009) for a two-day holding period starting with the announcement day.


Some papers
suggest that no set conclusion can be made in regards to how much shareholders
actually gain from M, since each corporate transaction is different, and
all characteristics of the firms as well as the time at which the event is
being announced should be taken into consideration. For example, Martynova and
Renneboog’s (2008) paper complements the earlier surveys with an overview of 65 studies that have reported abnormal
returns around takeover announcements. The
analysis of shareholder gains at the announcement of M&As reveals that a
positive effect is anticipated by the stock market. Overall, the magnitude of
these gains varies hugely across the decades and depends on the characteristics
of each deal; therefore it is difficult to make a general conclusion for these
65 studies.


Overall, the shareholders
of the bidding firm earn insignificant abnormal returns at the announcement of
a takeover, as suggested by most studies of late 1970s, 1980s as well as Morck,
Shleifer and Vishny (1988), Byrd and Hickman (1992). Nevertheless, some papers
have different results: Chang (1998) reports negative abnormal returns between
1.2% to 0.7%. Theoretically, as the bidders’ shareholders do not lose much on
average and the target’s shareholders tend to earn large positive abnormal
returns, takeovers tend to increase the combined market value of the merging
firms’ assets. The empirical evidence on the short-run wealth effects for the
bidder shareholders is mixed; some reap small positive abnormal returns whereas
others suffer small losses.


3.4 Long-Horizon Shareholder Wealth


It is
important not to solely concentrate on the short-horizon wealth effects; therefore
this paper will assess the long-horizon shareholder wealth effects as well.

Exploring the long-term as well as short-term wealth effects of this
acquisition would expand this paper’s research, as capital markets might have
to wait and revise their judgment based on new information about the
acquisition integration and competitor reaction. Long-horizon event studies have a long history, which started with the
original stock split event study by Fama et al. (1969). Many of these studies
summarise extensively the long-horizon security price performance following
corporate events and document apparent abnormal returns spread, including Fama
(1997), Kothari and Warner (1997), Kothari (2001) and Schwert (2002).


Long-horizon studies, specifically those
employing the market model, tend to reveal significantly negative cumulative abnormal returns over the three years following M&A
announcements. For example, Agrawal, Jaffe and Mandelker (1992) used a substantial sample of acquisitions and observed that they suffer a statistically significant loss
of about 10% over the five-year post-merger period. Contrary to the above
findings, other researchers, including Franks, Harris and Titman (1991), did
not find significant negative performance over three years after the
acquisition. Loderer and Martin (1992) also reported that the five-year post
acquisition performance is positive but insignificantly different from zero. The majority
of long-run studies therefore show that acquisitions are not creating
any value (i.e.

post-acquisition puzzle).

The evidence on long-term abnormal returns demonstrates that takeovers lead to
a decline in share prices over several years subsequent to the transaction.


However, there
are some limitations to this approach, which means that the results may be
sensitive to the method of estimation. Firstly, over longer periods it is
increasingly difficult to isolate the takeover effect, as many other strategic
and operational decisions or changes in the financial policy may have arisen
(Martynova and Renneboog, 2008). Nevertheless, Microsoft’s acquisition of
LinkedIn was quite recent with the announcement date on June 13, 2016, meaning
that it is less likely for new strategic and operational decisions or changes
to have happened and influenced the abnormal returns. This paper is looking at the
shareholder wealth effects since the announcement, which would only be in the
last 18 months, even though Martynova and Renneboog (2008) are considering the
effects in a 3 years period, which could be seen as both an advantage and a
potential flaw in the results.


The second
limitation is that the benchmark performance often suffers from measurement or
statistical problems (Barber and Lyon,
1997). These problems might arise from any testing procedures, including the
one in this paper. Heteroscedasticity and autocorrelation tests will be
therefore conducted to see whether either of these occurs in equations used in
this paper for minimisation of any potential statistical problems. The third
limitation is that most methods rely on the
assumption of financial market efficiency, which predicts that the
effect of mergers should be fully incorporated in the announcement returns and
not in the long-term abnormal returns. This implies that, when a significant
negative or positive long-term wealth effect occurs, the market corrects its
initially inefficient predictions (the short-term wealth effects). Furthermore,
the evidence on long-term returns conflicts with the results, reported in the
paper by Andrade, Mitchell and Stafford (2001), that mergers improve the
long-term cash flow performance of the merging parties, relative to their
industry peers.


The studies discussed
above mostly show that
acquisitions are not creating any value in the long run. Moreover, considering
all limitations of the long-horizon studies, this paper should be
cautious in drawing conclusions and comparing the obtained results to previous
studies. Nevertheless,
long-horizon shareholder wealth effects still need to be considered to evaluate
the impact of the acquisition.


Finally, this literature review summarises theoretical and empirical
research papers, which argue whether M can create any value for the
acquiring firm’s shareholders. Although results vary depending on the decade
and characteristics of the firm, short-run studies mostly conclude that M&A
activity leads to insignificantly positive or significantly negative abnormal
returns for the acquirers, while the long-run studies do not see any value
creation. These results will be compared to the ones obtained in this research.