Mergers during the first and second phase of globalization: Success, insider trading, and the role of regulation

Abstract

The merger wave that took place during the first phase of globalization, which lasted from 1895 to 1914, changed the industrial structure in Europe and the U.S. remarkably. Therefore, it is of great importance to assess whether mergers were successful during this period. Noteworthy, studies that evaluate the success of mergers during the first phase of globalization are still lacking for Germany. One may argue that this statement is false and could refer to Huerkamp (1979). However, he defined as success that a firm is able to stay among the 100 largest companies. Hence, shareholder value destroying mergers driven by `empire building´ that increase the firm size are seen as successful investments. Consequently, I totally disagree with his view. In contrast, I try to quantify the market response due to mergers and, hence, focus on the change in shareholder value. This imagination is in line with studies on the success of mergers for the United States and Great Britain. Generally, for the German case, economic historians concentrated on debates about the interrelation between the expansion of large scale enterprises, external growth, and mergers. Maintaining size and survivorship were seen as major factors of success. But also `traditional´ cross-country studies showed that the large German enterprise was a main guarantee for superior economic development in the pre-World-War I period. After reviewing new statistical material, however, the picture has to be corrected. A recent empirical cross-country study on that issue was written by Kinghorn and Nye (1996). They found evidence that German firms and production facilities were smaller compared to U.S. or French companies. In addition, the concentration process was less developed in Germany. Besides these astonishing results, additional doubts emerge regarding the alleged success of large firms. In several empirical studies, Baten (2001 a, b, c) showed that small firm exhibited a larger total factor productivity. Moreover, he provided evidence that contradicted the usual opinion suggesting a steady increase in firm size between 1895 and 1912. In contrast, he founds that the median of firm size stayed unchanged over time. When one turns to studies for the U.S. or Great Britain the scope regarding mergers is totally different compared to the `traditional´ research conducted in Germany. For instance, Leeth and Borg (1994, 2000) who covered the years 1905 to 1930 measured the economic impact of mergers by applying event-study methods. In their study, successful mergers should yield an upsurge in market value. Accordingly, my first aim is to assess the success of mergers based on the market response caused by merger announcements; thereby, a higher market value is the recipe for success and not firm size. Encouraged by the results of Baten (2001 a, b, c), I also collect data on mergers among smaller companies, which was, thus far, not done. Of course, my research contributes to close the data gap for Germany that is due to the absence of sources like Nelson (1957) and Eis (1971) who systematically collected data on mergers among U.S. companies. If I, indeed, detected an increase in market values stemming from a merger announcement, another question would arise. Which type of shareholder gains from higher market values? Focusing on two types, namely insiders and outsiders, my aim is to answer this question; thereby, the so called run-ups prior to merger announcements serve as a measure for insider gains. Run-ups are changes in stock prices triggered by an impending merger announcement. Because the merger is not yet public information, significant changes before the public release serve as a hint for insider-trading. If a market participant has only access to public sources like the official newspaper announcement, this participant belongs to the group of outsiders. In contrast, insiders possess private information; hence, they already know that a firm will announce publicly that they engage in merger activities. This superior knowledge leads to trading activities of insiders before the public announcement. Through this insider trading the private information is conveyed; thus, the market price is significantly influenced. Keown and Pinkerton (1981) used this measure to uncover insider activities around revealed mergers occurring in the years 1975-1978. Banerjee and Eckhard (2001) provided evidence for insider-trading in the year 1896-1903 known as the first merger wave. Both studies concentrate on the U.S. case. Lacking regulatory restrictions are responsible for the appearance of two different forms of disclosure in the pre-World War I period in Germany. Some firms announce mergers after these mergers have already been executed, and others declare their desire to merge before the transfer of assets. Thus, one consideration is to assess whether the way of disclosure influences the gains respectively losses for insiders and outsiders. By comparing the pre-Word-War I period with mergers that took place in the year 2000 in Germany, I try to shed some light on the impact of regulations on insider activities and the ability of legislative restrictions to protect outsiders from insider trading. Thus far, using event-studies, one concentrates on short-term market reactions caused by mergers. My additional concern is to measure the long-term impact of mergers; thereby, an event-study approach must be replaced by more sophisticated methods. These superior models belong to the group of vector autoregressions (VAR). Besides focusing on mergers and, thus, micro-level shock, I regard macroeconomic fluctuations as additional source of uncertainties. My panel VAR identifies the dynamics in share prices, dividends, and nominal capital caused by different kinds of shocks. In contrast to my short-term analyses, my long-run study covers the period from 1870 to 1913; thereby, I collected annual data. Changes in the regulatory environment at the beginning and in the middle of this period – especially the establishment of the new exchange law in 1896 – make the investigation promising from an institutional point of view. Reading daily newspapers for several months, collecting about 6550 daily returns for the sample of the year 1908, 4941 daily returns of individual stocks and several thousand daily observations of the market index, DAX30, for the year 2000 as well as 4620 observations of share prices, dividends, and nominal capital for the long-term study, one should wonder whether the effort was worth it. Hence, I should present my empirical findings. Newspaper announcements regarding an impending merger cause severe market responses in the short-run leading to considerable increases in market values of acquiring and target firms. Hence, based on my sample drawn in the year 1908, I can reject the presence of the merger paradox – shareholders of acquiring firms benefit from mergers. Accordingly, my empirical findings add an additional piece to the picture whether mergers create shareholder value, thereby, focusing on the pre-World-War I period in Germany. Using daily returns to improve the statistical power of event-studies is completely new for the pre-1914 period. Most noteworthy, my study underlines the high degree of informationally efficiency of stock exchanges because market reactions due to mergers are centered around the public release of information. Interestingly, this finding can also be confirmed using alternative approaches like transfer function models or panel GARCH models. Regardless which model is applied, they all point in the same direction: The market reacts fast. Going 100 years back in history, natural firm behavior without regulatory restrictions is observable; thereby, firms could decide to disclose price-sensitive information voluntarily. Event-studies and cross-sectional models confirm that hiding information is chargeable to outsiders. Ruling out the possibility that the way of disclose influence the total gain from mergers, one can concentrate on the distributive active. According to protecting outsider, a state intervention that forces firm to release information should be considered; particularly, a voluntary self-regulation cannot be supported by logit models. Henceforth, this historical experiment stresses that ad-hoc-publication requirements or other retaliations, like a negative public opinion regarding the misbehavior, ensure the protection of outsiders. Most noteworthy, the media in 1908 did not criticize that acquirers started buying shares of targets prior to official announcements – but newspapers spread rumors about impending transactions. The adaptation process of share prices in the presence of newly available information differs from the clear run-ups and steady increases in market values observed in the historical sample. Generally, a strong upsurge in share prices shortly before the newspaper announcement is followed by a pronounced fall in market values. Regardless which group of companies is considered, this pattern remains nearly unaffected. Correspondingly, this adaptation pattern could stem from following irrational trading rules like `buy on rumors and sell on facts´. This empirical finding supports the effectiveness of insider regulation during the last 92 years. Not only the event-studies but also GARCH models point out that the market in 1908 is highly informationally efficient. Besides the remarkable actuality of the `Berliner Börsenzeitung´ as shown by several case studies, insider trading may be mainly responsible for the tremendous speed with which new information is reflected in market prices. Accordingly, the benefit of informational efficiency comes with a loss, namely insider trading. Thus far, little historical research was conducted to quantify the number of insiders versus outsiders during the pre-1914 period in Germany. Since the new exchange law established in 1896, the nine leading banks in Berlin gained a larger role in trading. For the U.S., Warshow (1924) pointed out that smaller shareholders, the typical outsiders, were relatively unimportant. Mergers characterized as micro-level shocks possess a significantly negative impact on share prices; thereby, this direct impact also affects dividend streams with a time lag. After taking into account unexpected macroeconomic shocks, the effect of mergers disappears; hence, macro-level shock predominate in the period 1870 to 1914. Nevertheless, additional insights are gained by extending short-term evidence based on event-studies: macroeconomic surprises severely affect share prices and dividends. As far as I know, I provide the first empirical evidence for a merger wave in Germany centered around 1906. Executed mergers one or two years ago increase the likelihood for subsequent transactions significantly. Furthermore, mergers are more likely in periods exhibiting high inflation rates – but past and present share prices and dividends have no partial impact regardless which lag structure is permitted. Based on impulse response functions, an asymmetric response – triggered by shocks in inflation rates – of share prices and dividends can be observed. Hence, an unanticipated upsurge in inflation causes a phase of real undervaluation of equity. More formal models like hidden cointegration and the decomposition of time series yield similar outcomes. Consequently, I state that the first merger wave coincided with a period of real undervaluation of companies. A recent study for the period from 1978 to 2000 conducted for the United States by Dong et al. (2003) showed that mergers occur if markets are overvalued. Hence, my empirical finding for the first phase of globalization in Germany contradicts today’s empirical evidence. Besides the hard facts justified by empirical models, adding some narrative evidence told by case studies may help to get a clearer picture. During my investigation period, cross-boarder mergers did not occur – albeit very common nowadays. Furthermore, acquirers were relatively large compared to their target firms making an acquisition easer to finance and facilitating the integration of both entities. The velocity with which mergers were legally executed in the pre-1914 period is remarkably. As shown by the presented case studies, the announcement of a merger is followed by the approval of an extraordinary shareholder gathering within one month. Generally, nearly all mergers achieved the necessary majority in shareholder gatherings, and hostile takeovers were very uncommon. Although the leading companies included in my long-term study were very active to initiate mergers, mergers among these 35 largest companies did not occur. Accordingly, mergers are to some extent different in both phases of globalization – but maybe learning from historical evidence could help to making today’s merger as successful as 100 years ago. A possible conclusion could state: acquire only smaller companies in your line of business and be friendly. In the `resiliency´ paper (see Baltzer and Kling, 2003), my empirical result supports the inflation illusion hypothesis for the period 1870 to 1914 in Germany – but how can one interpret this finding. Since 1873, Germany joined the gold standard; thus, one can argue that by introducing an effective commitment to avoid inflation an inflation hedge provided by stocks was not needed. Unfortunately, this explanation has a blemish in that the inflation illusion can also be observed in later period (see Madsen, 2000). Inspiring the Hoffmann (1965) series, the cyclical movement in inflation rate characterized by alternating periods of inflation and deflation is apparent. Accordingly, I argue that during the pre-World-War I period trend inflation cannot be observed; thereby, the average annual inflation rate is lower than 1%. Considering a long-term investor, namely a bank or a strategic investor, the question arises whether market participants should worry about inflation in the long-run. Due to the overwhelming importance of large investors with strategic interest, nominal share prices should not reflect inflation and inflation illusion is likely. In addition, time series of nominal interest rates show that during the pre-World-War I period the development was almost stable over time; thus, inflation rates did not influence nominal interest rates considerably. Putting this argument in other words, it states that by observing nominal interest rates market participants were not able to improve their forecasts regarding future inflation rates. This finding is supported by my analysis on the predictability of macroeconomic variables. Hence, stable nominal interest rates suggest that inflation is not a major concern.

Die erste Fusionswelle, die in der ersten Phase der Globalisierung (ca.1870-1914) stattfand, hat die Industriestruktur weltweit beeinflusst. Phasen starker Fusionsaktivitäten sind ein immer wiederkehrendes Phänomen, was eine wirtschaftshistorische Untersuchung auch für die heutige Zeit attraktiv macht. Insbesondere ist es von erheblicher Bedeutung, ob Fusionen beim ersten Auftreten dieses Phänomens erfolgreich waren. Bisher wurde der Erfolg von Fusionen vor 1914 in Deutschland nur im Hinblick auf Wachstum (Unternehmensgröße) und Überleben untersucht (siehe u.a. Huerkamp, 1979, und Tilly, 1981). Meine Erfolgsmessung setzt dagegen an der Aktienmarktbewertung der Unternehmen an, was in dieser Form für den Untersuchungszeitraum für deutsche Unternehmen noch nicht vorgenommen wurde. Zwar gab es Studien für die USA (Leeth und Borg, 1994, 2000), aber diese basieren nur auf Wochen- oder Monatsrenditen, was nur einen groben Eindruck hinsichtlich der Marktreaktion vermittelt. Im Gegensatz dazu liegen meiner Studie Tagesrenditen zu Grunde, was die Erfassung der Marktreaktion ausgelöst durch eine Fusionsankündigung ermöglicht. Basierend auf Event Studies konnte ich nachweisen, dass nicht nur die Zielunternehmen eine Marktwertsteigerung nach einer Fusionsmeldung erfahren, sondern auch die akquirierenden Unternehmen. Dies widerspricht zahlreichen Studien zum Fusionserfolg in den 1970er Jahren bis hin zu heutigen Fusionen. Diese Ergebnisse rechtfertigen daher, dass man das sogenannte Fusionsparadoxon – Verluste für akquirierende Unternehmen – ablehnen kann. Zwar kann man einen generellen Anstieg der Marktkapitalisierung nach einer Fusionsmeldung nachweisen, allerdings stellt sich die Frage, welche Aktionäre gewinnen können. Dieser Fragestellung widme ich mich in einem eigenen Kapitel. Es zeigt sich, dass erhebliche Insidergewinne möglich waren, was auf das Fehlen von Regulierungen (v.a. Veröffentlichungspflichten hinsichtlich einer Fusion) zurückzuführen ist. Methodisch ähnliche Studien wurden für die USA von Keown und Pinkerton (1981) für 1975-1978 sowie Banerjee and Eckhard (2001) für 1896-1903 durchgeführt. In diesem Zusammenhang führe ich auch eine eigene Untersuchung für das Jahr 2000 aus. Dabei zeigt sich, dass Insidergewinne nicht mehr möglich sind. Neben der Beschäftigung mit kurzfristigen Marktreaktionen sind die langfristigen Folgen von Fusionen – über mehrere Jahre – von erheblichem Interesse. Dabei wird der gesamte Untersuchungszeitraum 1870-1914 abgedeckt, wobei man sich auf die 35 führenden Unternehmen konzentriert. Um den Einfluss von Fusionen auf Aktienkurse und Dividenden analysieren zu können, ist allerdings die Entwicklung weiterer statistischer Verfahren notwendig. Denn eine Event Study ist nicht dazu in der Lage zwischen verschiedenen Arten von Schocks wie z.B. Unternehmenszusammenschlüsse oder makroökonomische Schocks zu unterscheiden. Durch die Anwendung eines Panel Vektor Autoregressions (VAR) Modells gelingt eine solche Unterscheidung. Die ausgeprägten zyklischen Schwankungen in Inflations- und Wachstumsraten sind hauptverantwortlich für exogene Schocks auf Aktienkurse und Dividenden. Falls man diese makroökonomischen Faktoren berücksichtigt, ergibt sich kein zusätzlicher Effekt von Fusionen auf diese Unternehmenscharakteristika. Darüber hinaus findet man einen empirischen Beweis hinsichtlich des Auftretens einer Fusionswelle. Fusionen in der Vergangenheit erhöhen die Wahrscheinlichkeit, dass weitere Unternehmenszusammenschlüsse auftreten können. Basierend auf Panel Kointegrations-analysen ist es möglich, eine Aussage hinsichtlich der realen Bewertung von Aktien zu machen. Eine hohe Fusionsaktivität und reale Unterbewertung am Kapitalmarkt koinzidieren, allerdings besteht kein kausaler Zusammenhang für die Gesamtperiode. Dieses Ergebnis steht im Widerspruch zu heutigen Studien hinsichtlich der letzten Fusionswellen in den USA (siehe Dong et al., 2003).