Corporate financial restructuring
Chapter 1: Non-M&A Growth Strategies & Divestitures
1. The Rationale Behind M&A
The primary goal of Mergers & Acquisitions (M&A) is to generate value through synergies,
meaning the sum of the parts is greater than the parts alone.
Type of synergies:
• Economies of Scale (traditionally): Cost reductions in production, administrative
expenses and R&D, often associated with horizontal M&A → increased market power.
o Ex: food company, takes over other food company
• Economies of Scope: Expanding the range of products or services (Complementarities)
o Ex: food company, takes over non-food company
• Other drivers: Acquiring technology/patents, buying R&D capacity + know how
o attracting new skills/management (take over skills)
o following clients (client relationship)
o risk diversification/spreading (less efficient → be good at 1 thing)
o Globalisation (foreign markets) …
2. Types of M&A
Horizontal M&A: Between competitors in the same industry to achieve economies of scale. This
can lead to monopoly concerns.
Vertical M&A: Between companies in different stages of the supply chain (buy supplier/vendor
up/down the supply chain). The goal is supply chain coordination/efficiency, but it risks
"foreclosure" (excluding competitors from the supply chain → disrupting existing supply chain)
• Ex: IKEA buying forests → IKEA cannot buy wood from other forestry companies (=
downstream foreclosure) → IKEA forestry cannot sell to other companies anymore (=
upstream foreclosure)
Conglomerate M&A: Between unrelated supply chain/sector.
• Financial conglomerates seek risk diversification, avoidance of financial distress
(gambler’s ruin: gamble to stay in 1 sector), internal capital markets (=economies of
scale in financing = big mother company loans cheaper and distributes it to daughter
companies) and monitoring of management
• managerial conglomerates: Financial conglomerates + greater role for headquarters in
sharing management capacity.
• Concentric companies: conglomerate, with more links between different activities
(expanding into related activities; international expansion, etc.)
,Sustainable growth rate = maximum revenue growth percentage that a company can finance
without increasing the debt ratio (i.e. through internal resources and limited debt uptake)
Most sectors: sustainable growth > expected revenue growth → surplus of financial resources
→ lot of companies make more profit then they need to grow (to much money to spend)
3. Why M&A Often Destroys Value
Despite the potential for synergies, many deals fail to create value for the acquiring company
due to:
Agency Problems: When there is an absence of positive NPV projects, managers (agents) may
prioritize their own prestige ("empire building") over shareholder (principal) value. Often using
Free Cash Flow (FCF) to fund acquisitions rather than returning cash to shareholders.
• FCF issues potentially most problematic for large, listed companies with dispersed
shareholding (free riding in monitoring)
o Lot of shareholders → “somebody will check management” (everyone thinks
that, so free riding) → management don’t get checked anymore
• Entrenchment of managers: making acquisitions with FCF increases the scale of the
company and lowers the chance of being taken over → lowering the chance of
replacement by a more efficient management when taken over (bigger company = harder
to get taken over)
Deviations from neo-classical economic rules (completely rational classical theory) →
behavioral finance
• Hubris (The Winner's Curse): Managers are often overconfident, believing they can fix a
target company ("managerial kiss"). If multiple bidders compete, the winner is often the
one who overpaid/most optimistic. (justified by uncertain future synergy gains)
• value transfer from shareholders of bidder to shareholders of target
• Overvalued stock prices: Managers may use overvalued stock (asymmetric
information) to finance acquisitions.
o Long term: market seems to identify “bad” bidders → they become good targets
• Differences in organizational culture are difficult to bridge
4. Measuring Success: Event Studies
To determine if a deal creates value, researchers use Event Studies to analyze stock price
reactions around the announcement date (= day 0, day it becomes public knowledge)
Raw returns ignore general market conditions (market going up/down) → we use AR
• Abnormal Return (AR): actual return - "normal" expected return (what the stock would
have done without the event) (𝐴𝑅𝑡 = 𝑅𝑡 − 𝑅 ̂𝑡 ). How to determine normal return?
o Mean adjusted return method (easy): Normal return = the average return for a
period before the event period (clean period) = sum returns / # trading days
o Market model method (most used): 𝑅𝑡 = 𝛼̂ + 𝛽 ∗ 𝑅𝑚𝑎𝑟𝑘𝑒𝑡 𝑡 + 𝜖𝑡
▪ 𝑅𝑚𝑎𝑟𝑘𝑒𝑡 𝑡 = 𝐸(𝑅𝑚 − 𝑓𝑡)
▪ 𝛼̂ = basic return or risk free rate
o Market adjusted return method (stocks follow market): 𝑅𝑡 = 𝑅𝑚𝑎𝑟𝑘𝑒𝑡 𝑡
, • Cumulative Abnormal Return (CAR): The sum of ARs over the event window (looking at
multiple days instead of 1 day)
Profit/loss in dollar terms (economic significance):
𝐴𝑅
• 𝜎𝐴𝑅(𝑆𝑡𝑑𝑒𝑣.)
> critical value (depends on degrees of freedom + is given) = significant
𝐶𝐴𝑅
• (same reasoning as above)
√𝑒𝑣𝑒𝑛𝑡 𝑝𝑒𝑟𝑖𝑜𝑑 𝑑𝑎𝑦𝑠∗𝜎𝐴𝑅
Average abnormal return (AAR) = average AR of all companies in the sample
Cumulative average abnormal return (CAAR, sometimes also called ACAR): sum of the AARs
during the event window
Empirical Findings:
• Targets: Almost always see large, significant positive returns (the premium paid).
• Bidders: Returns mildly negative/mildly positive/non- significant. Investors are skeptical
of the premium paid and the realization of synergies.
• Combined effect (bidder + target): slightly positive, slightly decreasing over time
• Cash vs. Stock: Cash deals generally perform better than stock deals, as stock deals
signal that the acquirer's shares might be overvalued.
Event studies Strengths:
• Direct measure of shareholder value
• Forward-looking
Event studies Weaknesses:
• Relies on strong assumptions about the functioning of equity markets
• Vulnerable to interference from other events ("noise")
• Sensitive to design choices (checking robustness)
Standard event studie focus on short periods around announcement date → results are based
on investors' estimation of future earnings (ex-ante). Other methods:
• Long run performance (extended event studies): deal has actually created value ex post?
the share price should be considered over a longer period of time (too much noise) →
same findings
• Accounting data based studies: key ratio’s from buyers before and after the deal +
compare with peers without deals) → with this method: most underperform/same as
market
• Survey based: directly ask CEO/CFO if deals create value → biased
Across the different types of studies, the results on the profitability of M&A deals from the
bidder's point of view are not positive
, Not every deal destroys value for bidder. Value creation depends on:
• Magnitude of expected synergies (bigger synergies = better chance of value creation)
• Book-to-market ratio
• Market power (buyer increases market control → better chance of value creation)
• Payment method (cash or shares) (Stocks often overpay because they can print more
shares) → cash is king
• Amount of excess cash at the buyer (too much cash → pressure to spend it)
• Insider ownership at the buyer (managers have stake in company → likely to improve
value creation)
• Deals that diversify by sector or not (staying in sector → better chance of value creation)
• Number of past acquisitions ("serial acquirers" = they keep buying + making same
mistakes → often too big to fail)
• The bigger the size of the target, the bigger the return loss for the acquirer (long
integration process) …
5. Alternative Growth Strategies (Non-M&A)
M&A is expensive, time consuming and risky. Alternatives without going for full M&A:
Corporate cooperation: They have a positive effect on the stock market on average (0.6%-0.7%)
→ better than M&A deals + the amounts of money are much less
• Joint Ventures (JV): Creating a new entity with partners to share costs/risks (ex: entering
new markets like China).
• Strategic Alliances: Informal cooperation to pool resources → large number of partners
of equal magnitude
o Ex: Star Alliance in airlines: you will get the same experience everywhere in the
world with these companies (VIP Lounge, land close to airport gate, …). The
airlines can leave and join the alliance).
Alternatives forms of growth:
• Licensing: Monetizing intellectual property without heavy investment
o ex: Disney doesn’t make backpacks, but backpack companies pay Disney to use
image rights
• Franchising: Expanding without capital investment by letting locals take the risk
o ex: McDonald's: They have a blue-print of their business → local partner buys in
on the franchise (franchisees)
• Minority Investments: Buying a small stake to formalize cooperation or gain a foothold
in technology → if they have a profitable product in the future, we can buy them.
Chapter 1: Non-M&A Growth Strategies & Divestitures
1. The Rationale Behind M&A
The primary goal of Mergers & Acquisitions (M&A) is to generate value through synergies,
meaning the sum of the parts is greater than the parts alone.
Type of synergies:
• Economies of Scale (traditionally): Cost reductions in production, administrative
expenses and R&D, often associated with horizontal M&A → increased market power.
o Ex: food company, takes over other food company
• Economies of Scope: Expanding the range of products or services (Complementarities)
o Ex: food company, takes over non-food company
• Other drivers: Acquiring technology/patents, buying R&D capacity + know how
o attracting new skills/management (take over skills)
o following clients (client relationship)
o risk diversification/spreading (less efficient → be good at 1 thing)
o Globalisation (foreign markets) …
2. Types of M&A
Horizontal M&A: Between competitors in the same industry to achieve economies of scale. This
can lead to monopoly concerns.
Vertical M&A: Between companies in different stages of the supply chain (buy supplier/vendor
up/down the supply chain). The goal is supply chain coordination/efficiency, but it risks
"foreclosure" (excluding competitors from the supply chain → disrupting existing supply chain)
• Ex: IKEA buying forests → IKEA cannot buy wood from other forestry companies (=
downstream foreclosure) → IKEA forestry cannot sell to other companies anymore (=
upstream foreclosure)
Conglomerate M&A: Between unrelated supply chain/sector.
• Financial conglomerates seek risk diversification, avoidance of financial distress
(gambler’s ruin: gamble to stay in 1 sector), internal capital markets (=economies of
scale in financing = big mother company loans cheaper and distributes it to daughter
companies) and monitoring of management
• managerial conglomerates: Financial conglomerates + greater role for headquarters in
sharing management capacity.
• Concentric companies: conglomerate, with more links between different activities
(expanding into related activities; international expansion, etc.)
,Sustainable growth rate = maximum revenue growth percentage that a company can finance
without increasing the debt ratio (i.e. through internal resources and limited debt uptake)
Most sectors: sustainable growth > expected revenue growth → surplus of financial resources
→ lot of companies make more profit then they need to grow (to much money to spend)
3. Why M&A Often Destroys Value
Despite the potential for synergies, many deals fail to create value for the acquiring company
due to:
Agency Problems: When there is an absence of positive NPV projects, managers (agents) may
prioritize their own prestige ("empire building") over shareholder (principal) value. Often using
Free Cash Flow (FCF) to fund acquisitions rather than returning cash to shareholders.
• FCF issues potentially most problematic for large, listed companies with dispersed
shareholding (free riding in monitoring)
o Lot of shareholders → “somebody will check management” (everyone thinks
that, so free riding) → management don’t get checked anymore
• Entrenchment of managers: making acquisitions with FCF increases the scale of the
company and lowers the chance of being taken over → lowering the chance of
replacement by a more efficient management when taken over (bigger company = harder
to get taken over)
Deviations from neo-classical economic rules (completely rational classical theory) →
behavioral finance
• Hubris (The Winner's Curse): Managers are often overconfident, believing they can fix a
target company ("managerial kiss"). If multiple bidders compete, the winner is often the
one who overpaid/most optimistic. (justified by uncertain future synergy gains)
• value transfer from shareholders of bidder to shareholders of target
• Overvalued stock prices: Managers may use overvalued stock (asymmetric
information) to finance acquisitions.
o Long term: market seems to identify “bad” bidders → they become good targets
• Differences in organizational culture are difficult to bridge
4. Measuring Success: Event Studies
To determine if a deal creates value, researchers use Event Studies to analyze stock price
reactions around the announcement date (= day 0, day it becomes public knowledge)
Raw returns ignore general market conditions (market going up/down) → we use AR
• Abnormal Return (AR): actual return - "normal" expected return (what the stock would
have done without the event) (𝐴𝑅𝑡 = 𝑅𝑡 − 𝑅 ̂𝑡 ). How to determine normal return?
o Mean adjusted return method (easy): Normal return = the average return for a
period before the event period (clean period) = sum returns / # trading days
o Market model method (most used): 𝑅𝑡 = 𝛼̂ + 𝛽 ∗ 𝑅𝑚𝑎𝑟𝑘𝑒𝑡 𝑡 + 𝜖𝑡
▪ 𝑅𝑚𝑎𝑟𝑘𝑒𝑡 𝑡 = 𝐸(𝑅𝑚 − 𝑓𝑡)
▪ 𝛼̂ = basic return or risk free rate
o Market adjusted return method (stocks follow market): 𝑅𝑡 = 𝑅𝑚𝑎𝑟𝑘𝑒𝑡 𝑡
, • Cumulative Abnormal Return (CAR): The sum of ARs over the event window (looking at
multiple days instead of 1 day)
Profit/loss in dollar terms (economic significance):
𝐴𝑅
• 𝜎𝐴𝑅(𝑆𝑡𝑑𝑒𝑣.)
> critical value (depends on degrees of freedom + is given) = significant
𝐶𝐴𝑅
• (same reasoning as above)
√𝑒𝑣𝑒𝑛𝑡 𝑝𝑒𝑟𝑖𝑜𝑑 𝑑𝑎𝑦𝑠∗𝜎𝐴𝑅
Average abnormal return (AAR) = average AR of all companies in the sample
Cumulative average abnormal return (CAAR, sometimes also called ACAR): sum of the AARs
during the event window
Empirical Findings:
• Targets: Almost always see large, significant positive returns (the premium paid).
• Bidders: Returns mildly negative/mildly positive/non- significant. Investors are skeptical
of the premium paid and the realization of synergies.
• Combined effect (bidder + target): slightly positive, slightly decreasing over time
• Cash vs. Stock: Cash deals generally perform better than stock deals, as stock deals
signal that the acquirer's shares might be overvalued.
Event studies Strengths:
• Direct measure of shareholder value
• Forward-looking
Event studies Weaknesses:
• Relies on strong assumptions about the functioning of equity markets
• Vulnerable to interference from other events ("noise")
• Sensitive to design choices (checking robustness)
Standard event studie focus on short periods around announcement date → results are based
on investors' estimation of future earnings (ex-ante). Other methods:
• Long run performance (extended event studies): deal has actually created value ex post?
the share price should be considered over a longer period of time (too much noise) →
same findings
• Accounting data based studies: key ratio’s from buyers before and after the deal +
compare with peers without deals) → with this method: most underperform/same as
market
• Survey based: directly ask CEO/CFO if deals create value → biased
Across the different types of studies, the results on the profitability of M&A deals from the
bidder's point of view are not positive
, Not every deal destroys value for bidder. Value creation depends on:
• Magnitude of expected synergies (bigger synergies = better chance of value creation)
• Book-to-market ratio
• Market power (buyer increases market control → better chance of value creation)
• Payment method (cash or shares) (Stocks often overpay because they can print more
shares) → cash is king
• Amount of excess cash at the buyer (too much cash → pressure to spend it)
• Insider ownership at the buyer (managers have stake in company → likely to improve
value creation)
• Deals that diversify by sector or not (staying in sector → better chance of value creation)
• Number of past acquisitions ("serial acquirers" = they keep buying + making same
mistakes → often too big to fail)
• The bigger the size of the target, the bigger the return loss for the acquirer (long
integration process) …
5. Alternative Growth Strategies (Non-M&A)
M&A is expensive, time consuming and risky. Alternatives without going for full M&A:
Corporate cooperation: They have a positive effect on the stock market on average (0.6%-0.7%)
→ better than M&A deals + the amounts of money are much less
• Joint Ventures (JV): Creating a new entity with partners to share costs/risks (ex: entering
new markets like China).
• Strategic Alliances: Informal cooperation to pool resources → large number of partners
of equal magnitude
o Ex: Star Alliance in airlines: you will get the same experience everywhere in the
world with these companies (VIP Lounge, land close to airport gate, …). The
airlines can leave and join the alliance).
Alternatives forms of growth:
• Licensing: Monetizing intellectual property without heavy investment
o ex: Disney doesn’t make backpacks, but backpack companies pay Disney to use
image rights
• Franchising: Expanding without capital investment by letting locals take the risk
o ex: McDonald's: They have a blue-print of their business → local partner buys in
on the franchise (franchisees)
• Minority Investments: Buying a small stake to formalize cooperation or gain a foothold
in technology → if they have a profitable product in the future, we can buy them.
