Impact of mergers on stock values, bond values, debt capacity, and the transfer of wealth

This study examines the impact of 49 industrial mergers from 1970 through 1984 on the returns to bondholders and stockholders of the merging firms. Monthly results indicate that bondholders of the acquired firm group gain significantly in the announcement month, suggesting a diversification effect for acquired firm bondholders. Acquiring firm bondholders suffer significant losses in the preannouncement month supporting the incentive effects hypothesis for the acquiring firm bondholders. Regarding returns to stockholders, results indicate that acquired firm stockholders gain significantly in the announcement month while acquiring firm stockholders lose insignificantly in the same month.

Further analysis indicates that abnormal returns to bondholders are greater for firms with high variance, high leverage premerger. Correlation measures between acquired firm bondholder abnormal returns and the correlation of earnings before interest, taxes and depreciation are significantly negative; this provides additional evidence for diversification effect to acquired firm bondholders.

Studies on debt capacity indicate that the actual postmerger debt ratios are significantly higher than the potential debt capacity ratios after the merger according to a model based on premerger correlation of the cashflows and debt levels of the merging firms. Further results indicate that increasing the debt levels may in fact neutralize the abnormal returns accruing to bondholders.

A study of total value--sum of stocks and bonds for the combined preannouncement and announcement months--indicates support for total value maximization hypothesis. Thus, mergers do seem to create value.

Daily results show that acquired firm bondholders as well as the stockholders reap significant positive abnormal returns on the day of announcement. Both the bondholders and stockholders of acquiring group suffer nonsignificant losses on the day of announcement.