THE USE OF FINANCIAL RATIOS TO PREDICT ACQUISITION TARGETS: A STUDY OF UK ...

363 Pages·2008·17.51 MB·English

Al-Mwalla, Mona Mamdouh (1992) The use of financial ratios to predict
acquisition targets: a study of UK mergers 1980-1986. PhD thesis.

https://theses.gla.ac.uk/676/

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THE USE OF FINANCIAL
RATIOS TO PREDICT ACQUISITION TARGETS:
A STUDY OF UK MERGERS 1980-1986
By
MONA MAMDOUH Al-MWALLA
Submitted in Fulfilment
of the
Requirements for the Degree
DOCTOR OF PHILOSOPHY
Department of Accounting and Finance
Glasgow Business School
University of Glasgow
Glasgow, Scotland
1992
ACKNOWLEDGEMENTS
I take this opportunity to thank those who have been
most helpful to me throughout this research. Special thanks
to my supervisor Doctor dare Roberts for her invaluable
advice, generous comments, and perpetual support.
My thanks to Professor S.J. Gray for his continued support
and encouragement. Professor Clive Emmanuel provided
valuable comments and suggestions for which I am grateful.
To the Ph.D. Committee in the Department of Accounting and
Finance, my many thanks.
The financial support provided by the University of Yarmouk
and the British Council is most appreciated.
Exclusive thanks are extended to my family and friends for
their continuous support and encouragement. Special thanks
to Miss Mary Mowat for her friendship and support during my
stay in Glasgow.
Last but not least, I want to thank my husband for his
compassion, and understanding during my absence from home
when my project took precedence over important family
duties.
In loving memory of
my father
and
To my mother
S TRACT
The Use of Financial
Ratios to Predict Acquisition Targets:
A Study of UK Mergers 1980-1986
Financial reporting should provide decision makers
with useful information . One qualitative characteristic
of useful information is its classificatory value. Prior
studies in accounting, economics and finance provide
evidence that balance sheet and income statement ratios can
be utilised to classify economic events such as mergers and
bankruptcy which are of interest to decision makers.
This research examines the financial profile of
U.K. firms acquired during the period 1980-1986. It also
investigates whether the profile of financial
characteristics of the observed firms provides a useful
criterion for identifying those firms with a high
probability of subsequently being acquired.
The use of funds flow measures in the analysis
contributes to the classification accuracy of the models
when one year data was employed. Although this has been
applied to bankruptcy predictions, its contribution has not
been tested in any previous U.K. merger studies.
The results for the univariate analysis indicate that
the acquired firms during the period 1980-1986 have low
profitability, high gearing ratios, low liquidity and low
valuation ratios when compared with the non-acquired firms.
The multivariate analysis indicates the usefulness of
accounting information in merger classification when the
most recent data is used. It also suggests the existence of
different attributes that are important in the acquisition
classification model. It provides a strong indication
throughout the different stages of the analysis that the
asset undervaluation hypothesis and the profitability
hypothesis are the most important discriminators and not
the size hypothesis as had previously been assumed.
TABLE OF CONTENTS
LISTOF TABLES ........................................vii
CHAPTERONE INTRODUCTION ..............................1

1.0 INTRODUCTION 1

1.1 RESEARCH OBJECTIVES 3

1.2 IMPORTANCE OF THE RESEARCH 4

1.3 PRIOR RESEARCH 6

1.4 RESEARCH HYPOTHESES 9

1.5 RESEARCH DESIGN AND METHODOLOGY 11

1.6 MAIN FINDINGS 13

1.7 RESEARCH OUTLINE 16
CHAPTER TWO THE HISTORY OF MERGER ACTIVITY
IN THE UNITED KINGDOM...................19

2.0 INTRODUCTION 19

2.1 THE PERIOD BETWEEN 1897-EARLY 1920s 23

2.2 THE PERIOD BETWEEN 1940-1969 25

2.3 THE PERIOD BETWEEN 1970-1980s 28

2.4 SUMMARY AND CONCLUSIONS 33
CHAPTER THREE ACCOUNTING INFORMATION AND THE
PREDICTIVE APPROACH TO ACCOUNTING
THEORYFORMULATION ................... 34
3.0 INTRODUCTION 34
1
3.1 ACCOUNTING INFORMATION THEORY AND

THE OBJECTIVES OF FINANCIAL STATEMENTS 35
3.1.1 The New Approaches Available for

the Formation of Accounting Theory 38

3.1.la The Regulatory Approach 38

3.l.lb The Behavioural Approach 39

3.1.lc The Events Approach 39

3.l.ld The Predictive Approach 40
3.2 ISSUE RELATED TO FINANCIAL STATEMENT

ANALYSIS 40
3.2.1 Shareholders and Investment Analysts 41
3.2.2 Managers 43
3.2.3 Employees 44
3.2.4 Lenders and Creditors 44
3.2.5 Customers 45
3.2.6 Government and Regulatory Agencies 46
3.3 FINANCIAL STATEMENTS AND THE PREDICTION OF
ECONOMIC EVENT 46
3.3.1 Corporate Bankruptcy Prediction 47
3.3.la Empirical Studies In The United States 48
3.3.lb Empirical Studies In The United Kingdom 52
3.3.2 Bond Premium and Bond Rating Prediction 57
3.3.3 Credit and Bank Lending Decisions 63
3.4 FINANCIAL STATEMENTS AND THE MARKET REACTIONS 65

3.4.1 The Efficient Market Hypothesis 65

3.5 SUMMARY AND CONCLUSIONS 67
CHAPTER FOUR THEORIES OF MOTIVES FOR MERGER .........70

4.0 INTRODUCTION 70
4.1 SHAREHOLDERS WEALTH-MAXIMISATION HYPOTHESIS 72

4.1.1 Economic Motives and Evidence 73

4.1.la Market Power 74

4.l.lb Operating Economies 76

4.1.2 Financial Motives and Evidence 80

4.1.2a Tax Incentives 82

4.1.2b Leverage Benefits 83
ii
4.l.2c The Growth Resources Imbalance Hypothesis 85
4.1.2d Diversification 86
4.l.2e Bankruptcy Costs 87
4.1.2f Price /Earning Magic 88
4.1.3 The Efficiency Theories of Merger 90
4.1.4 The Undervaluation Hypothesis 94

4.2 MANAGEMENT WEALTH-MAXIMISATION HYPOTHESIS 96

4.3 STRATEGIC MOTIVES 104

4.3.1 Environmental Uncertainty 105

4.3.2 Merger as a Search Motive 107
4.4 MERGERS AND MACROECONOMIC EVENTS 110
4.5 SUMMARY AND CONCLUSIONS 117
CHAPTER FIVE PRIOR STUDIES ON ACQUIRED FIRMS'
CHARACTERISTICS .......................122

5.0 INTRODUCTION 122

5.1 STUDIES BASED ON U.K. ACQUISITIONS 122

5.1.1 Newbould Study 123

5.1.2 Singh Study 124

5.1.3 Buckley Study 125

5.1.4 Kuehn Study 125

5.2 NON U.K. STUDIES 127

5.2.1 Simkowitz and Monroe Study 127

5.2.2 Stevens Study 128

5.2.3 Harris et al. Study 129

5.2.4 Dietrich and Sorensen Study 131

5.2.5 Palepu Study 132

5.2.6 Belkaoui Study 133

5.2.7 Rege Study 134

5.3 SUMMARY AND CONCLUSIONS 135
iii
CHAPTER SIX RESEARCH METHODOLOGY AND DESIGN.139

6.0 INTRODUCTION 139

6.1 RESEARCH PROBLEM 140

6.2 HYPOTHESES SETTING 142

6.2.1 The Inefficient Management Hypothesis 142

6.2.2 The Undervaluation Hypothesis 143

6.2.3 Price-earning Ratio 145

6.2.4 Financial Synergy Hypothesis 146

6.2.5 Growth Resources Imbalance Hypothesis 147

6.2.6 Size Hypothesis 149

6.3 RESEARCH DESIGN 150

6.3.1 Types of Research Design 150

6.3.2 Time Horizon 154

6.3.3 Sample Design 154

6.3.4 Selection of Variables 159

6.3.5 Data Collection 160

6.4 DATA ANALYSIS 164
6.4.1 STATISTICAL METHODOLOGY 165
6.4.1.1 Multivariate Discriminant Analysis 166
6.4.1.la Distribution of the Variables 169
6.4.1.1b Group Dispersions 172
6.4.1.2 LOGIT ANALYSIS 173
6.5 SUMMARY AND CONCLUSIONS 175
CHAPTER SEVEN COMPARISON OF THE CHARACTERISTICS OF
ACQUIRED AND NON-ACQUIRED
............
FIRMS: UNIVARIATE ANALYSIS 177

7.0 INTRODUCTION 177
7.1 STUDIES OF FINANCIAL RATIOS DISTRIBUTION 178
7.2 DESCRIPTIVE STATISTICS AND HYPOTHESES TESTING 185
7.2.1 Descriptive Statistics and Univariate
Analysis: The Inefficient Management

Hypothesis 185
iv
7.2.2 Descriptive Statistics and Univariate
Analysis: The Assets Undervaluation
Hypothesis 198
7.2.3 Descriptive Statistics and Univariate
Analysis: Price- Earning Magic Hypothesis 200
7.2.4 Descriptive Statistics and tlnivariate
Analysis: Financial Synergy Hypothesis 202
7.2.5 Descriptive Statistics and tJnivariate
Analysis: Size Hypothesis 208
7.2.6 Descriptive Statistics and Univariate
Analysis: Funds Flow Measures 210

7.3 SUMMARY AND CONCLUSIONS 216
CHAPTER EIGHT EMPIRICAL RESULTS:
DISCRIMINANT ANALYSIS ................. 218

8.0 INTRODUCTION 218

8.1 METHODOLOGICAL STEPS IN SANPLE SELECTION 219
PART 1
8.2 DISCRIMINANT ANALYSIS PROCEDURES

AND ASSUNPTIONS 221
8.3 FINAL PREDICTOR VARIABLES SELECTION

TECHNIQUES 222
8.4 MULTIVARIATEDISCRIMINANT ANALYSIS FOR

THE DATA 225

8.4.1 Statistics for the First Set of Models 226
8.4.2 Statistics for the Second Set of Models 230

8.5 SELECTION OF THE BEST MODEL 235

8.6 STATISTICS FOR THE THIRD SET OF MODELS 238

8.7 STATISTICS FOR THE FOURTH SET OF MODELS 239

8.8 SUMMARY AND CONCLUSIONS 241
PART 11 EMPIRICAL RESULTS: LOGIT ANALYSIS

8.9 LOGIT ANALYSIS 243
V