Value creation in information-based industries through convergence: A study of U.S. mergers and acquisitions between 1993 and 2005

Abstract

According to the International Engineering Consortium (IEC), the realignment and consolidations currently underway in information-based industries is likely to result in the five traditional information industries (photography, publishing, computing, telecommunications and entertainment) converging into three new sectors: information content providers, information highways, and information appliances. We investigated the impact of mergers and acquisitions on value creation both within and across these sectors by estimating the stock market's response to acquiring firms around the announcement date of their merger. Using data on 2421 mergers and acquisitions between 1993 and 2005 and employing the well-established event study methodology, we found that most acquirers received a target within the same sector or industry and that the related acquisition strategies brought synergistic gains resulting in positive wealth change for the acquiring firm's shareholders. The few firms that pursued an unrelated diversification strategy that lowered operating risk experienced no significant change in shareholder wealth. Our results contrasted with the zero or negative wealth change found for acquiring firms in general (as reported in the finance literature) but were consistent with the positive wealth change for acquirers in the telecommunications industry found in recent studies.

Introduction

Mergers and acquisitions (M&As) are an important mechanism for external growth. As Jensen [16] notes, mergers and acquisition are “a response to new technologies or market conditions which require strategic change in a company's direction or use of resources.” They serve an important role in the efficient redeployment of capital as poorly performing enterprises are often removed in the process. An extensive body of research shows that target firm shareholders are the winners while the acquiring firm shareholders gain little or nothing [2], [15]. Acquiring firms have also tended to perform poorly in the years following the acquisition compared to their non-acquiring counterparts [20]. Both the short- and long-term performance for the acquiring firm was affected by the prevailing market conditions at the time of the merger and whether the acquiring firm was an early-mover. Market power, synergy, managerial hubris, strategic realignment, among others, were a few of the commonly cited reasons why firms pursued an acquisition strategy. The 1990s represented the fourth important takeover wave of the 20th century and technology was a major factor.

This sector has grown at a phenomenal rate. Its importance stems from its integration with almost every other sector of the economy. Information-based industries today constitute a significant part of all major economies of the world. However, rapid technological innovation, many small new players, easy access to and use of new technologies, intense competition, changing regulations, and shifting standards have created uncertainty among consumers, investors and other stakeholders.

Wilcox et al. [31] argued that, “[T]he pervasive and ubiquity of the Internet and continued development of common standards provides tremendous opportunities to smaller entrepreneurial firms to contribute value.” In addition, firms that previously belonged to distinct industries have become competitors or partners.

Grover and Vaswani [13] identified increased market access, economies of scale and control of key technologies as primary motives behind the pace of consolidation currently underway in the telecommunications industry. The International Engineering Consortium (IEC) [14] stated that the traditional information-based industries, organized by form, were realigning along sectors defined by function. This realignment, and the consolidation resulting from it, should result in synergistic gains through better utilization of resources and strengths, thereby creating more value for consumers, shareholders, and other stakeholders. It predicted that the realignment of firms in the five traditional information industries (photography, publishing, computing, telecommunications and entertainment) would result in the creation of three new information sectors (information content providers, information appliances and information highways). The mergers of AOL and Time Warne, Seagram and Vivendi, and Ebay and Skype were examples of this trend. For example, the merger of AOL–Time Warner was from two sectors: the information highway and the information content, respectively. Borés et al. [4] suggested that such mergers were important, because owning the rights to content could affect the success of a firm, since the delivery technologies would be more competitive and eliminate substitutes.

The primary focus of our study was to investigate the impact of M&As on firm value in the three emerging IEC defined information sectors. We did this by examining the impact of M&A decisions on the wealth of the acquiring firm shareholders. We analyzed the M&As to determine which types of strategies were more appropriate and how the market valued such decisions.

Several recent studies have focused on acquisitions in technology sectors. Using a sample of M&As from the telephone and cable industries, Li [19] found that firms with slower revenue growth were more likely to diversify. Cloodt et al. [8] studied the impact of M&As on the performance of acquiring firms innovation, concluding that they should acquire targets that were neither too similar nor unrelated to their knowledge base. Kohers and Kohers [17] found that acquiring firms in the technology sector underperformed control firms based on industry membership, size, and book-to-market ratio of equity. Several researchers have found that successful integration is the key to post-merger success [12], [26], [28]. The studies by Wilcox et al. and Grover and Vaswani addressed issues similar to ours; they examined the short-run stock market response to acquiring firm shareholders and found that M&As involving narrow diversification created more value than those with broad diversification. The results were stronger for smaller firms. However, they did not provide any evidence on the effect of the type of alliances on firm value, even though their valuation impact varied. Furthermore, the sample sizes in these studies was small.

We build on existing evidence by having further investigated the valuation impact of M&As both within and across the three new information sectors and the five traditional information industries using a sample of 2421 acquirers during the period 1993–2005. We examined the stock returns around the announcement date for the shareholders of the firms in the information sectors defined by IEC.

Specifically, we addressed the following questions: (1) Do acquiring firms create more value for their shareholders if they acquire a target firm in the same IEC defined information sector rather than a different sector? (2) What impact does the similarity of the firms have, if the M&A is within the same IEC information sector? (3) Does the valuation impact of M&As in the information sectors vary across the three sectors?

While our focus was on the new IEC information sectors, we also provided evidence on M&As for the five traditional information industries.