long-term post-merger performance of firms in india

8/3/2019 Long-Term Post-Merger Performance of Firms in India

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VIKALPA VOLUME 33 NO 2 APRIL JUNE 2008 47

R E S E A R C H

Long-term Post-mergerPerformance of Firms in India

K Ramakrishnan

includes research articles thatfocus on the analysis and

resolution of managerial andacademic issues based on

analytical and empirical orcase research

KEY WORDS

Mergers

Long-term OperatingPerformance

Post-merger PerformanceEfficiency

Mergers are important corporate strategy actions that, among other things, aid the firm in exter-nal growth and provide it competitive advantage. This area has spawned a vast amount ofliterature over the past half a century, especially in the developed economies of the world. India

too has been seeing a growth in the number of mergers over the past one-and-a-half decadessince economic liberalization and financial reforms were introduced in 1991. Studies on thepost-merger long-term performance of firms in both the developed and the developing marketshave not been able to come to a definite and convincing conclusion about whether mergers havehelped or hindered firm performance. Our literature review shows that mergers do not appearto be resulting in favourable financial performance of firms in the long-term in the marketswhere they are a fairly recent phenomenon.

The economic liberalization and reforms initiated in 1991 in India have served to triggercorporate restructuring through M&As. The removal of industrial licensing, lifting of monopolyprovisions under the MRTP Act, easing of foreign investment, encouraging the import of rawmaterials, capital goods, and technology have increased the competition in Indian industry.Firms are free to fix their capacity, technology, location, etc., to enhance their efficiency. Theamendment of the MRTPA has made it possible for group companies to consolidate through

mergers eliminating duplication of resources and bringing down costs. M&A has now becomea viable strategy for growth in India.Immediately after liberalization, Indian industry added capacity since it expected a rapidly

expanding market due to the perceived latent demands of the vast middle class. But the lowerincome groups could not participate in the consumer goods market. The economy began toslow down from 1996. This squeezed the profit margins of local firms that now had excesscapacities. Industry saw a spate of restructuring in the form of shedding non-core activities infavour of core competencies and expansion through M&As, in a bid for survival. According tomarket reformers, growth is the result of efficient utilization of resources on the supply side. Ina free market economy, utilization becomes more efficient due to competition. It is thus hypoth-esized that -- Mergers in India have resulted in improved long-term post-merger firm operatingperformance through enhanced efficiency.

Statistically analysed cash flow accounting measures were used to study whether firm per-formance improved in the long-term post-merger. This research, on a sample of 87 domestic

mergers, validates the hypothesis: Efficiency appears to have improved post-merger lending synergistic benefits to the merged

entities. Synergistic benefits appear to have accrued due to the transformation of the hitherto un-

competitive, fragmented nature of Indian firms before merger, into consolidated and opera-tionally more viable business units. This improved operating cash flow return is on accountof improvements in the post-merger operating margins of the firms, though not of the effi-cient utilization of the assets to generate higher sales.What this study thus indicates is that in the long run, mergers appear to have been finan-

cially beneficial for firms in the Indian industry. It also renews confidence in the Indian manage-rial fraternity to adopt M&As as fruitful instruments of corporate strategy for growth.

Executive

Summary


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Mergers are important corporate strategy ac-

tions that, among other things, aid the firms

in external growth and provide competitive

advantage. This area has spawned a vast amount of lit-

erature over the past half a century, especially in the

developed economies of the world. India too has been

seeing a growth in the number of mergers over the past

one-and-a-half decades since economic liberalization

and financial reforms were introduced in 1991. While

domestic firms have resorted to merger activity for con-

solidation of their positions in order to face higher com-

petition, multinational companies (MNC) have used it

as a tool to enhance corporate control in India (Basant,

2000).

A merger means any transaction that forms one eco-

nomic unit from two or more previous ones (Weston,

Chung and Hoag, 2000). The term performance used

in the remainder of this paper, for brevity and conven-ience, refers to the long-term post-merger operating

performance.

LITERATURE REVIEW

The presence of diverse and varied merger motives

serves to highlight the inherent contradictions in any

discourse on the performance of merged firms. Almost

every aspect of successful performance stands a chance

of contraindication by a negative outcome associated

with the merger under scrutiny. For instance, a mergersupposedly intended to deliver economies of scale

through a much larger size of the merged entity, may

come under the scrutiny of market regulators who might

apprehend breach of antitrust laws due to the newer,

bigger firm now possessing excess market power.

The performance of merging firms has hence, for

long, been an area of study, research and debate. In spite

of a substantial volume of literature, this debate about

whether mergers are wealth-creating or wealth-reduc-

ing events for the firms that undertake them is an ongo-

ing one. Several papers published by scholars in thefields of financial economics, industrial organization

economics and strategic management have attempted

to shed light on this topic. It is important to understand

whether mergers of firms have led to a better perform-

ance, since only such an improvement can justify the

use of mergers as an important tool of corporate strat-

egy.

But why is it important to measure the performance

of merged firms? Measuring the performance of merged

firms helps in developing strategic plans and in evalu-

ating the extent of achievement of the objectives of the

organization. If mergers do not lead to the combined

firms being better off post-merger as compared to be-

fore the merger, resorting to them cannot be justified.

An important related issue is the motive guiding the

merger. Assessing only financial performance may not

be an accurate yardstick to determine whether a merged

firm is better off. For, the motivation for the merger

might have been related to social and community gains

and not only to improved financial performance.

Even though I have earlier mentioned the presence

of diverse motives for mergers, I am of the opinion that

it is imperative for us to ascertain how mergers have

performed financially. Successful performance, at the

primarily financial level, at least, justifies the utilization

of mergers as an appropriate means of implementing

corporate-level strategy. Else, resorting to this tool maynot be very effective. Managers might then also need to

consider alternatives such as strategic alliances or the

setting up of greenfield ventures instead of concentrat-

ing on mergers. Of course, if the motives guiding the

merger were not purely driven by enhanced financial

success, our understanding of only the financial perform-

ance would be an inadequate measure of the overall per-

formance of mergers.

From this backdrop thus emerges one main question

that invites research in the Indian context and, that is

How have merging firms performed in the long term in

India?

As mentioned above, the debates inherent to merg-

ers due to the presence of conflicting motives and claims

about their impact ensure that the measurement of post-

merger performance still holds potential for further de-

velopment. This is especially true for emerging markets

which are grossly under-represented in scholarly litera-

ture in this area. Theories that have been generated in

the context of the developed Western markets may not

be applicable to or appropriate for the emerging econo-mies (Hoskisson, et. al., 2000). Unlike the developed

world, the emerging economies have only recently

opened up (or are still in the process of doing so) to the

global markets. They are still at various stages of achiev-

ing complete market-orientation. Privatization of state-

owned enterprises is taking place. Domestic markets are

now becoming more competitive. But such a transition

is not smooth. There are various environmental, finan-

cial, and other constraints. Acquisitions and mergers are

LONG-TERM POST-MERGER PERFORMANCE OF FIRMS IN INDIA


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a means to enter and grow in such emerging economies.

It would thus be interesting to gauge the results of merg-

ers in the emerging markets, as it would help to further

our understanding of the working of this instrument of

corporate strategy in a different context as compared to

the developed world.

The performance of merging firms has been assessed

using various measures and methods. The traditional

studies have used financial measures such as profits and

accounting returns. Market-based financial measures

such as stock returns have also been extensively used.

A significant portion of the studies published till date

on this topic of merger performance deals only with

announcement period abnormal stock price returns to

both the bidder and target firms, using a window com-

prising of a few days before and after the first date of

announcement of the merger. An increasing number of

studies are now attempting to understand the long-termperformance of the firm over a few years post-merger,

as such studies with longer horizons may provide us

with better insights on whether mergers are serving the

intended purpose. The rationale behind studying a

longer time horizon post-merger, and not just the im-

mediate period surrounding merger announcement, is

that stock price movements around the latter period are

only indicative of the capital markets expectations of

the mergers performance. They are speculative in char-

acter and by no means stand for the actual performance

of the merger. This real or actual performance is re-

flected in, among other things, the financial reports of

the combination for a few years after the merger. A care-

ful analysis of these financial statements is indicative of

the true level of post-merger performance. The term

post-merger here means subsequent to the consumma-

tion of the merger that has been previously announced.

The effective date for this has generally been taken as

the date of delisting of the merged firm from public ex-

changes, or the announcement in the business press of

board/management approval of the merger.The different ways of measuring performance of

mergers can lead to disparate and contradictory find-

ings on whether any merger has lead to the firms being

better off. In keeping with my argument about the pri-

macy of financial performance, in this paper, I would be

concentrating on the use of accounting data to measure

the performance of merging firms. It is an educative ex-

ercise to review the literature on the performance of

merging firms, as it will provide us with pointers on

how far we have arrived in this important area of cor-

porate strategy. The next few sub-sections link the dis-

cussion to the Indian context of mergers and put forward

my hypothesis that is intended to concretize the scope

set forth as part of the research question mentioned

above.

Research on Performance of Mergers

Numerous scholars have carried out research on the

performance of the merged firm. The focus of this re-

search has been on whether performance, after the

merger, has been announced/completed, has been en-

hanced or has deteriorated as compared to before the

event, and what the magnitude of this change is. Sev-

eral key papers from the areas of financial economics

and strategic management that have empirically meas-

ured performance, have been reviewed and studied. The

salient features of these studies are highlighted here inan attempt to provide a snapshot of the developments

in this area of research. This literature review does not

claim to be an exhaustive one. Some relevant academic

articles may have inadvertently got left out. But the ef-

fort has been to make this study as comprehensive as

possible by including the significant papers to provide

us with some directions.

As already indicated, two primary means have been

utilized by researchers to operationalize the perform-

ance of merged firms a) Accounting measures based

on objective data such as cash flow returns and other

financial ratios, b) Share price returns, again based on

objective data, that are related to the capital market. In

this paper, the discussion of literature and methodology

of the research are restricted to the accounting meas-

ures of post-merger performance.

Merger Performance Studied using Accounting Measures

One of the trend-setting studies in this genre of measur-

ing the success of mergers is by Ravenscraft and Scherer

(1989). They tested the hypothesis that other variablesmaintained equal, if mergers result in economies of scale

or scope, the post-merger profits should be higher than

the pre-merger profits and/or their industry averages.

Their study of 2,732 lines of business for the years 1975-

77 did not find any improvement in the post-merger

operating performance. In fact, with no control for the

merger accounting methods (purchase vs pooling), there

was a significant negative impact of 13.34 per cent on

the post-merger profitability. One important shortcom-


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ing of the Ravenscraft and Scherer study was the non-

alignment of the post-acquisition period with the acqui-

sition event, leading to non-validity of the results.

Traditional stock price performance studies have

been unable to determine whether mergers lead to long-

term economic gains, resulting in a gap in our under-

standing of post-merger firm performance. Healy,

Palepu and Ruback (1992) addressed this issue of

whether mergers improved performance, and if they did

so, what the sources of economic gain were. They also

tried to improve upon the methodology of the earlier

work by Ravenscraft and Scherer (1989). A sample of

the 50 largest mergers of public industrial firms in the

US, completed between 1979 and mid-1984, were used.

Cash flow measures were used to study the post-merger

performance. According to them, cash flows are repre-

sentative of the actual economic benefits generated by

the assets. Pre-tax operating cash flow returns on assetswere used to measure the improvements in operating

performance. Their definition of operating cash flow was

sales, minus cost of goods sold and selling and adminis-

trative expenses, plus depreciation and goodwill ex-

penses. This measure was deflated by the market value

of assets (market value of equity plus book value of net

debt) to make it comparable across time and firms. This

measure was unaffected by depreciation, goodwill, in-

terest expense and income, and taxes. The aggregate

industry-adjusted pre-merger and post-merger perform-

ance measures were calculated, five years prior to and

subsequent to the merger, and then these two were com-

pared to study the change in post-merger performance.

The firm-specific, economy, and industry factors that

might influence post-merger performance, were thus

controlled for. An increase in the post-merger operat-

ing cash flow returns vis--vis the firms industries was

observed. The increase was 2.8 per cent per year, after

controlling for the pre-merger performance. The im-

provements in operating cash flows after merger were

due to enhancement of asset productivity post-merger.Healy, Palepu and Ruback also correlated their post-

merger cash flow performance and merger-announce-

ment related stock market performance and found a

significant positive correlation between these two meas-

ures indicating that the stock market correctly revalues

the merging firms at announcement in expectation of

the improvements in operating performance in the fu-

ture. Since this study sampled the 50 largest acquisitions

in the US, its results may not be generalizable across the

entire gamut of mergers which might present quite a

mix of organizations in terms of size and motives for

mergers. This is especially true for the Indian context

where most of the acquisitions are relatively small.

Healy, Palepu and Ruback (1992) stated that the eco-

nomic gains from a takeover are most likely to be de-

tected when the target firm is large. This leaves the

question of why small mergers, like the ones in India,

also take place, still unanswered, since economic feasi-

bility would be an important driver for such an activity.

It thus becomes necessary to study such small mergers

too in a bid to understand whether they lead to economic

gains.

Another study in the same genre is by Cornett and

Tehranian (1992) who studied the post-acquisition per-

formance of 30 large banks in the United States. These

acquisitions took place between 1982 and 1987. Each of

these acquisitions had a purchase price exceeding $ 100million. They measured economic performance related

to the mergers in a manner similar to Healy, Pa1epu and

Ruback (1992). Operating cash flows divided by the

market value of assets were used for performance evalu-

ation. The pre-merger performance was computed for

years 1 to 3 before the merger, whereas post-merger

performance was studied over the years +1 to +3 after

the merger. Comparing the latter with the former is in-

dicative of the impact of the merger on firm perform-

ance. The industry mean data was subtracted from the

raw sample-firm data to provide the industry-adjusted

performance, prior to the comparison between the pre-

and post-merger figures. This was done to ensure that

the influence of economy-wide or industry factors on

the performance data calculated was avoided. The mean

annual industry-adjusted cash flow return before the

merger was 0.2 per cent for the entire sample and 1 per

cent post-merger. This means that, before the merger,

the sample banks underperformed as compared to their

industry by 0.2 per cent, but outperformed by 1 per cent

post-merger. There was a significant (at the 1% level)increase of 1.2 per cent in performance post-merger as

compared to before the merger. This study pertained

specifically to the US banking industry and hence its

results may not be generalizable across other industries.

Also, like in the Healy, Palepu and Rubacks (1992) pa-

per, selecting only the largest mergers may lead to re-

sults that cannot be generalized across all sizes of

mergers, such as the ones taking place in India. Never-

theless, the methodology adopted here serves as a guid-



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ing post for future studies of the same kind.

Switzer (1996), using the methodology followed by

Healy, Palepu and Ruback (1992), focused on analysing

the post-merger changes in operating performance. Her

contention was that the latter study covered the merger

mania period in the US and not mergers in general. It

thus made sense, according to Switzer, to take up a

longer period of mergers in the US, in order to be cer-

tain about the applicability of the results of such a study

to periods not witness to a merger wave. The study was

of 324 acquisitions occurring between 1967 and 1987 in

the US, using the cash flow-based measure of operating

performance as in Healy, Palepu and Ruback (1992). It

concluded that mergers led to synergistic gains and bet-

ter performance in the long-term, the median improve-

ment over five years post-merger being a significant 1.97

per cent..

A study in the United States that also focused onmerging firms operating performance after corporate

acquisitions was by Ghosh (2001). The sample consisted

of 315 pairs of target and acquiring firms for which merg-

ers were completed between 1981 and 1995. The per-

formance measure used was operating cash flows, both

pre- and post-merger, defined as sales minus cost of

goods sold, minus selling and administrative expenses,

plus depreciation and goodwill amortization expenses.

The study compared the pre- and post-acquisition per-

formance of merging firms using control firms as bench-

marks, instead of using industry-median benchmarks

as used in Healy, Palepu and Ruback (1992). Ghosh con-

tended that using industry-median benchmarks could

lead to non-random measurement errors since firms

undertake acquisitions following a period of superior

performance. The control firms were matched on the

basis of similar operating cash flow performance and

total asset size before the acquisition. Both size and pre-

acquisition performance were thus accounted for. Us-

ing a methodology similar to Healy, Palepu and Ruback

(1992), the study found that the cash flows of mergingfirms increased significantly by 2.4 per cent every year.

The median increase in cash flows post-merger by 0.26

per cent per year was statistically insignificant, when

the sample firms were compared with matched firms.

This paper assumed that only large-sized and well-per-

forming firms generally go in for mergers. This assump-

tion may not be valid in the Indian M&A context where

we have even small and under-performing firms adopt-

ing the merger route to growth and to satisfy other mo-

tives. Moreover, it may be difficult to get control firms

that are well-matched to the sample under study due to

the highly fragmented and volatile nature of the Indian

industry in many sectors. Hence, the use of an industry-

median benchmark would better serve the purpose for

Indian data.

Ramaswamy and Waegelein (2003) studied the post-

merger financial performance of 162 merging firms that

occurred during 1975-1990 in the US. They used indus-

try-adjusted operating cash flow returns on market value

of assets as the measure of performance, which was simi-

lar to the one used by Healy, Palepu and Ruback (1992).

Even their methodology was the same as in the latter,

except that they used only firms that had not gone in for

any merger during the study period as part of their con-

trol sample, since they felt that only that would make

the data incorruptible and the results more robust. The

study found a significant increase of 12.7 per cent in firmperformance after the merger had taken place.

Research on takeovers in the UK has not been able to

come to any definitive conclusion about the operating

gains from such activity. Manson et. al. (2000) studied

44 takeovers in the UK completed between January 1,

1985 and December 31, 1987, wherein the total market

value of each of the acquired firms was over 5 million,

in a re-examination of the issue of whether UK takeo-

vers resulted in operating gains for the merging firms.

They used the cash-flow based measure of operating

performance as also the research methodology inno-

vated and introduced by Healy, Palepu and Ruback

(1992) and Cornett and Tehranian (1992). Regressing

post-takeover operating performance on pre-takeover

operating performance using eight variants of the meas-

ure, they found that takeovers had led to operating gains

ranging from 2 per cent to 14 per cent per year post-

merger. This study also provided evidence for non-op-

erating gains resulting from takeovers.

A replication study that attempted to determine

whether post-merger synergy is created leading to im-proved corporate operating performance was by Sharma

and Ho (2002). Since literature on merger motivations

indicates that acquisitions lead to gains, they hypoth-

esize that operating performance post-acquisition is

greater than in the pre-acquisition period. They studied

36 Australian acquisitions occurring between 1986 and

1991, using matched firms to control for industry and

economy-wide factors. This match is on the basis of in-

dustry and size of the assets. Data three years prior and


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subsequent to the merger were used for the analysis.

Financial ratios, both accrual (return-on-assets (ROA),

return-on-equity (ROE), profit margin and earnings-per-

share (EPS)) and cash flow (ROA, return-on-sales (ROS),

ROE, number of ordinary shares) pertaining to operat-

ing efficiency and returns to shareholders were used

since the study investigated synergistic gains from merg-

ers. Operating cash flow before tax was used as the main

post-merger performance measure. No significant post-

acquisition improvement in corporate operating per-

formance was observed. The study used both earnings

and cash flow measures of operating performance to rule

out the possibility of the result being an artifact of meas-

urement. But it suffered from the problem of lack of

generalizability of the results since it studied only the

manufacturing sector in Australia.

Rahman and Limmack (2004) analysed the operat-

ing performance of 94 listed acquiring and 113 privatetarget companies in Malaysia that were involved in ac-

quisitions between January 1, 1988 and December 31,

1992. They attempted to find out whether operating ef-

ficiency improvements took place after mergers. Their

hypothesis was that such gains, if any, would be more

due to sources such as synergy, rather than through dis-

ciplining of inefficient management. They carried out

analysis of the ratio of operating cash flow to operating

assets of the companies pertaining to two years before

and five years after the merger. Industry-matched con-

trol companies were used in their analysis. Improve-

ments in operating cash flows after the merger were to

the tune of 3.75 per cent per year post-merger. Also, the

combined firms appeared to be using resources more

efficiently post-merger. The improvement in performance

did not come at the cost of long-term investments. Also,

the takeovers did not seem to be disciplinary in nature.

The results of the study, consisting of a sample of only

privately-owned targets and control group companies,

may not be generalizable to publicly-held organizations.

Tsung-Ming and Hoshino (2000) attempted to findout whether value was created in Taiwanese mergers

through tapping of economies of scale. Their sample

consisted of 20 firms that acquired other firms between

1987 and 1992. Both stock market-based and account-

ing-based measures were used to assess shareholder

wealth gains and improvements in corporate perform-

ance post-merger. Accounting measures were used to

determine the profitability, financial health, and growth

of the acquirers post-merger. Profitability was assessed

using ROA and ROE. The financial health was meas-

ured using financial leverage, liquidity, and operating

expenses. Growth was measured as the sales growth.

Industry medians were computed for each year corre-

sponding to the merging firms. The industry median

pertained to all the publicly-listed firms of the same in-

dustry as per the sample and year. These control firm

values/industry medians were then subtracted from the

pre- and post-merger values obtained for each firm.

These pre- and post-acquisition adjusted values were

compared to arrive at the performance of the merged

firm. They found no profitability improvements post-

merger for the acquirers. In fact, there was deteriora-

tion in some profitability indicators. To gauge the

financial health of the acquirers post-acquisition, finan-

cial leverage was calculated as the long-term liabilities

to total assets. The debt-equity ratio was also calculated

as total liabilities divided by equity. Current ratio com-puted as current assets divided by current liabilities was

used.Also, operating expenses ratio was calculated asoperating expenses divided by sales. There was no sig-

nificant difference in the pre- and post-merger values

for leverage and debt equity while the current ratio fell

significantly in the first year after the merger while not

being significantly different in the later years. They cal-

culated sales growth as (sales of current year/sales of

previous year) 1). The acquirers significantly under-

performed on this measure post-merger. The study had

taken into account only the acquiring company. Most of

the targets were privately-owned companies. In most

cases, the merger was a result of government interven-

tion since the healthy acquirer was forced into taking

over the distressed and financially weak acquired firm.

This might have led to the deterioration in the condition

of the acquiring firm leading to a downturn in profit-

ability post-merger. The results of this study are hence

not generalizable.

Pawaskar (2001) studied 36 mergers that had taken

place in India between 1992 and 1995. Using accrualmeasures of accounting spread over three years before

and after the merger, the study found that the profit-

ability of the merged firms was impacted negatively due

to the merger, i.e., corporate performance did not im-

prove significantly post-merger. A majority of the merg-

ers studied in this paper were between companies

belonging to the same business group, carried out as

part of corporate restructuring. This might make the

result quite specific and not generalizable. In addition,



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the study used matched companies as controls for both

the acquiring and acquired companies. But, when a

majority of the mergers studied are within-business

group mergers, it is imperative that even the control pairs

be from similar groups. This would ensure similarity in

terms of their situation within the industrial and eco-

nomic context, as also a modicum of overlap in the

merger motivations. Since, this had not been considered

in the paper, along with the fact that getting such con-

trol companies may be well nigh impossible, the study

had serious limitations in terms of validity and genera-

lizability of the results.

Out of the eleven studies reviewed here (summarized

in Table 1), that use accounting measures to study post-

merger performance, we find that six of them have indi-

cated improved performance. The rest show that

mergers have made the combined firms worse off. Since

almost one-half of the studies show deterioration in post-merger performance, and especially due to the fact that

three of these five studies are from Australia and Asia,

it is not very clear whether mergers, overall, have led to

betterment. At least mergers do not appear to be result-

ing in favourable financial performance in the long term

in these markets where they are a fairly recent pheno-

menon.

The accounting measures used in these studies are

based on objective data obtained from financial state-

ments of the firms being studied. According to Bromiley

(1986), in many cases, accounting performance measures

are better than market-based measures because they are

used more frequently by managers to make strategic

decisions. Long-term accounting-based performance

measures also accurately represent the realization of

synergies as these effects are obtained only over a pe-

riod of time post-merger (Harrison, et. al.,1991).But, ac-

counting data possess certain limitations. They are not

perfect in measuring economic performance. Traditional

accounting measures, such as return on book assets, are

affected by the method of merger accounting (purchaseor pooling) followed, and the method of financing of

the merger (cash, debt or equity). Hence, using such

measures, we cannot compare the merged firm over time

and with other firms. Cash flow measures can help over-

come these limitations as already described above.

The Indian Context

M&As need to be regulated in order to prevent unfair

practices, market dominance or concentration of eco-

nomic power. Regulation can ensure a level playing field

and thriving competition. The Monopolies and Restric-

tive Trade Practices Act (MRTPA), 1969, has been a major

institutional mechanism to regulate M&A activity in

India. According to this Act, the Union Government

could prevent an acquisition if it apprehended concen-

tration of economic power that would be detrimental to

the common good. Amendments to it were made in 1984

and 1991 (Singh, 2000). There are four parts to this Act

that deal with (i) Monopolistic practices, (ii) Restric-

tive trade practices, (iii) Unfair trade practices, and (iv)

Controlling concentration of economic power. The

MRTP Act is designed to ensure that the operation of

the economic system does not result in the concentra-

tion of economic power to the common detriment, and

to prohibit such monopolistic and restrictive trade prac-

tices as are prejudicial to public interest(Rao, 1998).

Industrial markets tend to be highly concentrated de-spite there being anti-monopoly policies such as the

MRTP Act or the industrial licensing policy. High con-

centration leads to higher prices being charged and also

the absence of any motivation for improvements in tech-

nology. A large number of big firms used these policies

for deterring and preventing the entry of new competi-

tors into the industries where they dominated. Hence,

changes were made in the MRTPA in the New Indus-

trial Policy. The New Industrial Policy Statement (NIPS)

repealed certain specific provisions of the MRTP Act

(namely, the sections 21, 22 and 23) which dealt with:

(a) the growth of an existing undertaking; (b) the estab-

lishment of a new undertaking; and (c) the merger, amal-

gamation and takeover of firms (Mani, 1995). The

emphasis is now on controlling and regulating monopo-

listic, restrictive, and unfair trade practices rather than

making it necessary for the monopoly houses to obtain

prior approval of central government for expansion, es-

tablishment of new undertakings, merger, amalgama-

tion and takeover, and appointment of certain directors.

The thrust of the policy is more on controlling unfair orrestrictive business practices (Ray, 1992).This dilution

of the MRTPA has increased competition from the

smaller firms, now no longer under the purview of the

Act. Both firm-level investments and growth have been

unfettered (Basant, 2000).

Indian Industry before 1991

M&As were not a common occurrence in India before

the reforms of 1991. M&As and corporate takeovers were


8/1854

Table 1: A Summary of Studies that have used Accounting Measures to Ascertain Post-merger Performance

Study Sample Size Sample Country Accounting Statistics Findings

Experimental Control Period Measure Used

Ravenscraft 251 for pre- Industry 1950- US Operating income Univariate; Acquired firms earn positive abnormaland Scherer merger profita- 1977 over end of year Regression returns compared to their control(1989) bility; 2,732 for assets; Operating group during the pre-merger period

post-merger income over sales; but not in the post-merger period.performance Cash flow over sales

Healy, 50 Industry 1979- US Operating cash Univariate; Merged firms show significant impro-Palepu and 1984 flow returns on Regression vements in operating performance,Ruback assets; Stock especially for related firms. The(1992) returns at post-merger increase in operating

acquisition cash flow is strongly positivelyannouncement linked to the abnormal stock returns

at acquisition announcement.

Cornett and 30 Industry 1982- US Operating cash Univariate; Merged firms show significantTehranian 1987 flow returns on Regression improvements in operating perfor-(1992) assets; Stock mance. The post-merger increase in

returns at operating cash flow is stronglyacquisition positively linked to the abnormal stockannouncement returns at acquisition announcement.

Switzer 324 Industry 1967- US Operating cash Univariate; Merged firms show significant impro-(1996) 1987 flow returns on Regression vements in operating performance.

assets; Stock The post-merger increase in operatingreturns at cash flow is strongly positively linkedacquisition to the abnormal stock returns at acqui-announcement sition announcement. Factors such

as the offer size, relatedness andbidder leverage dont affect the results.

Ghosh 315 Industry; 1981- US Operating cash Univariate; Merged firms show significant impro-(2001) Matched 1995 flow returns on Regression vements in operating performance

assets and on using the Healy, Palepu and Rubacksales (1992) methodology, but not when

the control group is made up ofmatched firms. Cash acquisitionspositively impact cash flowswhereas stock acquisitions lead topoorer performance. Acquisitions

fail to achieve synergy gains. Announ-cement-related abnormal share pricereturns are not correlated with cashflow returns.

Ramaswamy 162 Industry 1975- US Operating cash Univariate; Merged firms show significant impro-and 1990 flow returns on Regression vements in operating performance.Waegelein assets Unrelated mergers and larger relative(2003) size are positively associated with

post-merger performance.

Manson et al 44 Industry 1985- UK Operating cash Regression Both operating and non-(2000) 1987 flow returns on operating gains exist for UK

total market value takeovers.

Sharma and 36 Matched 1986- Australia Earnings and cash Univariate; Operating performance does notHo (2002) 1991 flow Regression improve post-merger. Factors such as

relatedness, form of financing, sizeof the acquisition do not affect post-merger performance.

Rahman and 94 Matched 1988- Malaysia Operating cash Univariate; Operating performanceLimmack 1992 flow returns on Regression improves post-merger.(2004) assets

Tsung-Ming 20 Industry 1987- Taiwan Accrual measures; Univariate; Stock market reaction to acquisitionand Hoshino 1992 Share price returns Regression announcement is positive. There are(2000) no improvements in post-merger

performance. The stock marketreaction is not correlated to post-merger performance.

Pawaskar 36 Matched 1992- India Operating cash Univariate; Post-merger profitability does not(2001) 1995 flow returns Regression increase.

on assets



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very rare (Rao, 1998). For over a quarter century, pro-

duction capacities in India were restrained under the

MRTP Act. This kept Indian firms small and globally

uncompetitive. The market economy was virtually stran-

gulated due to the economic power of the government

such as industrial licensing and other regulations. In-

dustrial licensing and other controls led to severe entry

and exit barriers and encouraged rent-seeking and lob-

bying. The industrial policy pre-1991, instead of promot-

ing competition, lead to inefficiencies. Bureaucracy

determined plant capacity, product-mix, and location.

Trade in scarce materials became more lucrative than

efficient manufacturing. Licensing and product reser-

vation for small-scale sector inhibited firms from reap-

ing economies of scale (Ray, 1992; Basant, 2000). During

the regime of controls, capacity expansion was gener-

ally not possible. So, product diversification rather than

specialization became the preferred option for firms(Siddharthan and Lal, 2003).

In 1985-86, the government prescribed the minimum

economic scale capacity scheme in about 72 industries.

This acted as a capital barrier to entry especially in in-

dustries where economies of scale were not significant.

Many sectors of Indian industry were fragmented due

to these restrictions on capacity through industrial li-

censing and reservation for small and public sector or-

ganizations. Licensing was used as a tool to break-up

the small domestic market among producers so that eco-

nomic power could be curtailed. This led to total capa-

city being fragmented into uneconomic plant sizes. Thus

industrial licensing and the MRTP policies restricted the

setting up of adequately large plants that could provide

scale economies (Patibandla, 1992; Venkiteswaran, 1993;

Khanna, 1999). Direct controls over investment, produc-

tion, prices, imports, foreign capital and even exports

played havoc with efficiency and, therefore, with growth

(Patel, 1992). Inefficient management was not threatened

by loss of control (Rao, 1998). The policies of industrial

licensing, protective foreign trade, control of among oth-ers, entry into industry, capacity expansion, technology,

output mix and import content, concentration of eco-

nomic power, and regulation of foreign investment in

India, grossly underemphasized the importance of ef-

ficient use of resources, particularly labour and capital.

A protected domestic market did not encourage private

enterprises to improve either their efficiency or prod-

uct-quality (Neogi and Ghosh, 1998).

To sum up, according to Venkiteswaran (1993), some

of the reasons for mergers and acquisitions not being in

vogue before the economic liberalization in 1991 were:

a) Ownership pattern of Indian industry: Most companies

were tightly held by promoters and government-

owned financial institutions. They resisted any at-

tempts at takeovers.

b) Exercise of voting power by the public financial institu-tions: Voting by stakeholding public financial insti-

tutions was guided more by reasons of power and

pelf than by any objective criteria to enhance share-

holder wealth.

c) Tight regulatory environment: MRTPA, Foreign Ex-

change Regulation Act (FERA), and other such regu-

lations looked at any attempt to grow through M&As

as a precursor to the dawn of a monopoly. Hence,

such a regulatory environment made it difficult to

use M&As as a corporate-level strategy.

d) High entry and exit barriers: Several mandatory gov-

ernment approvals such as licensing requirements

and clearances served as high entry barriers to in-

dulging in M&As. Similarly, legislations making it

almost impossible to redeploy surplus or under-per-

forming assets or labour served as high exit barriers

that dissuaded companies from using M&As.

M&As in India after the Reforms

The economic liberalization and reforms initiated in 1991

in India have served to trigger corporate restructuringthrough M&As. The complex system of industrial licens-

ing has been abolished as per the New Industrial Policy

Statement (NIPS). The economic reforms, through the

relaxation of controls and regulations on production,

trade and investment, were aimed at increasing compe-

tition, improving efficiency and growth (Chaudhuri,

2002). the reforms have the potential of altering the

structure of Indian industries, subjecting them to com-

petition from both internal and external sources and

thereby making them more efficient Mani (1995). The

removal of industrial licensing, lifting of monopoly pro-visions under the MRTP Act, easing of foreign invest-

ment, import of raw materials, capital goods, and

technology have increased the competition in Indian

industry. Firms are free to fix their capacity, technology,

location, etc., to enhance their efficiency (Rao, 1998;

Basant, 2000). The amendment of the MRTPA has made

it possible for group companies to consolidate through

mergers eliminating duplication of resources and in

bringing down costs (Mehta and Samanta, 1997). M&A


10/1856

has become a viable strategy for growth in India due to

a) easing of regulation, b) restructuring of family-owned

conglomerates, c) sale of state-owned companies, d)

overcapacity, and e) deregulation of fragmented indus-

tries (Anandan, et. al., 1998).

Immediately after liberalization, the Indian industry

added capacity since it expected a rapidly expanding

market due to the perceived latent demands of the vast

middle class. But the lower income groups could not

participate in the consumer goods market (Chandra and

Shukla, 1994). The economy began to slow down from

1996 after an average gross domestic product (GDP)

growth rate of 6.5 per cent for five successive years from

1991-92. This squeezed the profit margins of local firms

that now had excess capacities. The industry saw a spate

of restructuring in the form of shedding non-core ac-

tivities in favour of core competencies and expansion

through M&As, in a bid for survival. M&As were re-sorted to in order to expand in size to face the MNC

onslaught (Nayar, 1998). Due to the ease of foreign firms

also participating in M&As in India, inefficient firms are

more likely to be the targets of takeovers (Rao, 1998).

According to the market reformers, growth is the result

of efficient utilization of resources on the supply side.

In a free market economy, utilization becomes more ef-

ficient due to competition (Patibandla and Mallikarjun,

1996; Ahuja, 1999). It is thus my hypothesis that:

H0: Mergers in India have resulted in im-proved long-term post-merger firm operating

performance through enhanced efficiency.

The next section outlines the research methodology

that was adopted to test the hypothesis.

RESEARCH METHODOLOGY

There appears to be little published research work on

M&As in India and we are yet to understand whether

mergers here have led to long-term financial benefits to

the merging firms. The raison de etre of Indian mergerscan be questioned if financial performance does not show

any improvement in the long run. It is imperative for us

to have a reasonable understanding of whether M&As

in India at least make financial sense. Hence, I am at-

tempting to understand, through this paper, whether

Indian mergers have been successful where success is

regarded as the long-term, post-merger financial success.

This research is designed to collect essentially objec-

tive data on Indian mergers and to carry out quantita-

tive, statistical analyses with a view to understanding

financial performance in the long run, post-merger.

Sample

The data for this study has been extracted from second-

ary sources. The main sources are Prowess database

of Centre for Monitoring Indian Economy (CMIE),Capitaline, ISI Emerging Markets, India Business Insight,

and web sites of Securities and Exchange Board of India

(SEBI), Bombay Stock Exchange (BSE), and National

Stock Exchange (NSE). Mergers and acquisitions are

fairly recent in India and have been resorted to by

corporates mainly after the economic liberalization and

financial reforms of 1991 were initiated. They were al-

most negligible in the early 1990s and hence there is a

dearth of data pertaining to this early period of Indian

M&As.

We initially identified 414 mergers between 1993 and

2005. Mergers taking place in the financial sector were

dropped due to differing accounting standards applica-

ble to them that make comparison with other firms dif-

ficult. Only the period January 1996 to March 2002 was

considered for selection of merger pairs of target and

bidder firms. All mergers in India occurring between

January 1, 1996 and March 31, 2002 were identified. This

period has been chosen, as it is relatively recent. It also

helps obtain three years of financial data for companies

both before and after the merger, for the purpose of theanalyses.

Only domestic mergers taking place in India were

selected. Cross-border mergers, i.e., in which either the

bidder or the target was based outside India, were

dropped. This was done to ensure homogeneity of the

economic and industrial environment so that

generalizability of the results could be achieved for In-

dian M&As. Firms for which three years of data, both

prior to and after the merger, were not available, were

dropped from the list. Pairs, for which data was una-

vailable for both the target and the bidder, and for whichcomplete information was not obtainable, were also

dropped.

The final sample size used for analyses was thus 87

pairs of mergers consisting of 174 firms (87 each of tar-

gets and bidders). The distribution of mergers across the

years is presented in Table 2.

The average relative size of the target to the bidder

firm is 0.59, where size is measured as the total assets of

the firm. This high relative size indicates that the target



11/18


might be playing an important role in determining the

extent of post-merger success of the entity.

Data Analyses Method

For about two decades, from the early 1970s to the early

1990s, wealth effects of M&A activities were gaugedusing standard event study methodologies that calcu-

lated cumulative abnormal share price returns over a

window period around the date of the announcement

of the acquisition bid. However, such stock price returns

around the time of merger / acquisition announcement

are not indicative of the long-term performance post-

merger of the combination. Such studies only reflect

market expectations from the event and not the actual

economic gains or losses that actually result over a pe-

riod of time. Also, the real sources of such economic gains

cannot be identified using share price returns (Cornettand Tehranian, 1992; Healy, Palepu and Ruback, 1992;

Rahman and Limmack, 2004).

This study thus uses long-term pre- and post-merger

financial data to assess firm operating performance. A

sufficiently long period is needed to analyse and under-

stand the impact of a merger since efficiency improves

over a long time horizon and not within short periods

(Ghosh, 2001; Healy, Palepu and Ruback,1992; Manson,

et al., 2000; Rahman and Limmack, 2004). Hence, we use

data three years prior to and subsequent to the merger

in line with Franks, Harris, and Titman (1991), Ghosh

(2001), Magenheim and Mueller (1988), and Rau and

Vermaelen (1998). Year 0, i.e., the year of the merger is

excluded from our analyses since its inclusion may cause

distortions due to changes in financial reporting caused

due to adjustments in accounting necessitated due to

the merger (Healy, Palepu and Ruback, 1992).

Pre-tax operating cash flow returns scaled by the op-

erating assets of the sample firms are used to measure

the change in performance post-merger (Cornett

and Tehranian, 1992; Ghosh, 2001; Healy, Palepu and

Ruback, 1992; Rahman and Limmack, 2004). Actual eco-

nomic gains from assets are captured by cash flow meas-

ures. The change in operating performance attributable

to the merger is the comparison of the post- and pre-

merger operating cash flows scaled by the operating

assets. The pre-merger calculation done for both the tar-

get and the bidder for the period (-3 to -1) years, is the

sum of their operating cash flows for each year scaled

by the sum of their operating assets at the beginning of

the relevant year. This provides an idea of their perform-

ance if they had not merged and had continued as sepa-

rate entities.

Every firm operates in a particular industry and is

affected by the rules and regulations applicable, as also

the economic factors impinging on that specific indus-

try. It is thus necessary to take into account the effects ofthe economy and industry in which each firm operates,

in order to make the comparison possible across firms

(Cornett and Tehranian, 1992; Ghosh, 2001; Healy,

Palepu and Ruback, 1992; Rahman and Limmack, 2004).

This factoring out of the external environmental impact

makes the comparisons across firms and industries

meaningful. The raw operating performance figures

obtained using the procedure outlined in the previous

paragraph are thus adjusted for industry and economic

effects by subtracting the median industry operating

performance.

Paired samples t-test is carried out to assess the dif-

ference in performance between AIACFI, POST and

AIACFI,PRE,whereAIACF denotes the aggregate indus-

try-adjusted cash flows and the subscripts POST and PRE

refer to the period after and before the merger, the sub-

script I referring to the pair of merging firms. The paired

samples t-test compares the means of two variables from

the same group. It determines whether the difference

between the means of the two variables is significantly

different from zero. In our case, the two variables arethe aggregate industry-adjusted operating performance

of each pair of merged firms both before and after the

merger. Merger can be considered as an intervention that

takes place in our set of sample firms. The paired sam-

ples t-test thus determines whether there is a significant

change in the before/after merger performance and

allows us to attribute the result to the merger.

The following cross-sectional linear regression model

is also estimated:

Table 2: Distribution of Sample Mergers across Years

Year Number of Mergers Studied

1996 1

1997 11

1998 17

1999 8

2000 82001 26

2002 16

Total 87


12/1858

AIACF I,POST= + .AIACF I,PRE + I

This equation predicts the aggregate post-merger op-

erating performance of the merged entities using data

pertaining to the aggregate pre-merger performance. The

y-intercept represents the change in annual control-

adjusted performance due to the merger and is inde-

pendent of the pre-merger performance as its value isobtained when the value of AIACFI,PRE is 0. The slope

represents the correlation between the cash flow re-

turns in the years prior to and subsequent to the merger.

It depicts how much each unit change of AIACF I, PREchanges the value of AIACFI,POST. Iis theerror term,

i.e., the random disturbances from the regression line.

The .AIACFI,PRE value is the effect of pre-merger per-

formance on post-merger returns (Cornett and

Tehranian, 1992; Ghosh, 2001; Healy, Palepu and

Ruback, 1992; Rahman and Limmack, 2004).

EMPIRICAL RESULTS

As already stated, the hypothesis is that mergers in In-

dia have resulted in improved long-term post-merger

firm operating performance. The paired samples t-test

for comparison of means provides a test statistic of 1.873

that is found significant at the 10 per cent confidence

level, as shown in Table 3.

Table 3: Paired Samples t-test for Before/After Merger

Performance Comparison

Value Statistic Significance (2-tailed)

Mean 0.028 1.873 (t-statistic) 0.064*

*Significant at 10% level.

This indicates that the positive mean difference of

0.028 betweenAIACFI,POSTandAIACFI,PREis not due to

chance, and that merger has led to a significant improve-

ment in firm performance. This validates our hypoth-

esis that mergers in India have resulted in improved

long-term post-merger firm operating performance. This

result is the same as found by Cornett and Tehranian

(1992), Ghosh (2001), Healy et al. (1992), Manson et. al.

(2000), and Rahman and Limmack (2004), but is contrary

to the findings of negative post-merger returns found

by Clark and Ofek (1994), and Ravenscraft and Scherer

(1987), among others.

Paired samples t-test is also carried out comparing

the aggregate industry-adjusted cash flow of each of the

three post-merger years against each of the three pre-

merger years. The results are depicted in Table 4.

Table 4: Paired Samples t-test of Aggregate IACFI

between Specific Years Before/After Merger

Pair (years before/ Mean t-statistic Significanceafter merger) (2-tailed)

(-3,+1) 0.07 1.79 0.078 *

(-3,+2) 0.10 2.46 0.016 **

(-3,+3) 0.12 2.19 0.032 **

(-2,+1) -0.01 -0.53 0.595

(-2,+2) 0.01 0.47 0.643

(-2,+3) 0.02 0.66 0.514

(-1,+1) -0.02 -0.87 0.385

(-1,+2) 0.01 0.30 0.763

(-1,+3) 0.01 0.35 0.729

** Significant at 5% level.* Significant at 10% level.

The firm performance appears to have improved sig-nificantly in each of the three post-merger years in com-

parison to the third year before the merger. The

improvement seems to be higher as the years progress

post-merger the average IACFI in the first year after

the merger is 0.07 (significant at the 10% level), increas-

ing to 0.10 (significant at the 5% level), and 0.12 (signifi-

cant at the 5% level) in post-merger years two and three.

The change in post-merger performance in each of the

three subsequent years compared to two years and one

year before the merger is not significant.

The paired samples t-test just described is one of the

techniques for determining any significant change in

firm performance, post-merger. A cross-sectional regres-

sion model is developed, after controlling for the effect

of the pre-merger average industry-adjusted cash flow

on the post-merger performance. This helps in deter-

mining whether post-merger firm performance im-

proves irrespective of the possible impact of the

performance before the merger. This second technique

has thus been adopted to act as a confirmatory tool for

the previous findings.This model takes the form:

AIACF I,POST = 0.043 + 0.678.AIACF I,PRE(3.034)*** (8.628) ***

R2 = 0.467, F = 74.446***, N= 87, t-statistic in parentheses

***Significant at 1% level, using a 2-tailed test.

The F-ratio, with a value of 74.446, is significant in

this model, which indicates that the regression is sig-



13/18


nificant. Further an R2 value of 0.467 shows that about

47 per cent of the variation in the dependent variable is

explained by the independent variable. We find that both

the intercept andAIACFI,PREare significant at the 1 per

cent level. This shows that the pre-merger firm perform-

ance has a positive effect (0.678) on the post-merger re-

turns, i.e., for every unit change in this explanatory

variable, the dependent variable AIACFI,POSTincreases

by 0.678 units. Even after controlling for the effects of

pre-merger performance (AIACFI, PRE), the firms still

show increasing cash flow returns post-merger, at an

annual rate of 4.3 per cent, depicted by the intercept

value of 0.043. This means that firm performance after

the merger has improved significantly irrespective of

the impact of the pre-merger performance.

SOURCES OF ECONOMIC GAIN ON MERGER

We now decompose our measure of operating perform-

ance into its constituents, in order to ascertain the source

of the better long-term post-merger returns. Operating

cash flow scaled by the operating assets is the product

of the operating margin and the sales turnover. Thus,

CF/A = (CF/S) x (S/A)

Here, CF = Operating cash flow

S = Net sales

A = Operating assets

CF/A = My operating cash flow performancemeasure

CF/S = Operating margin

S/A = Sales turnover

The operating margin depicts the cash flow return

obtained through each rupee of sales. The sales turno-

ver ratio provides me the unit sales generated through

investment in every rupee of assets, i.e., it connotes the

efficiency with which assets are utilized to generate sales.

The performance of the merging firms on each of these

measures is studied next.

Post-merger Long-term Operating MarginPerformance

This section examines the operating margin perform-

ance of the combined firms after the merger. The attempt

is to determine whether this performance is better as

compared to the pre-merger performance of these same

firms that had not merged.

Two pairs of merging firmsSun Pharmaceuticals

and M J Pharmaceuticals, and Usha Ispat and Usha

Udyogare dropped from this analysis, since on ana-

lysing for outliers, it was found that the values pertain-

ing to these pairs lie beyond three standard deviations.

Data on three pairs of merging firms could not be ob-

tained. The new sample size is thus 82 pairs of merging

firms.

From Table 5, it is found that the aggregate post- and

pre-merger industry-adjusted operating margins

(AIAOMI,POSTand AIAOMI,PRE) are 5.17 per cent and -

1.82 per cent across the sample of 82 merging pairs of

firms. The average operating margin appears to have

increased after the merger.

We find that the firms have not been faring signifi-

cantly differently from the industry before the merger.

Except for the year -2 before the merger, the industry-

adjusted operating margins are insignificant in everyyear pre-merger, with the aggregate across the three

years also being insignificant. But, we find that the in-

dustry-adjusted operating margin is significantly posi-

tive every year after the merger, except in year +3 where

it is positive though not significant, and the aggregate

across the three years post-merger is also significantly

positive.

We have used paired t-test to ascertain whether there

is an improvement in firm operating margins, post-

merger.

Table 5: Comparative Pre- and Post-merger Industry-adjusted Operating Margin Performance ofthe Combined Firms, N=82

Year Relative to Merger Industry-adjusted AverageOperating Margin of the

Combined Firm (%)

-3 -9.70 (-0.505)

-2 18.53 (1.868) *

-1 -14.69 (-0.719)

Aggregate pre- merger -1.82 (-0.23)performance for years -3 to -1

+1 5.91 (3.829) ***

+2 6.78 (2.967) ***

+3 2.82 (1.447)

Aggregate post-merger 5.17 (4.672) ***

performance for years +1 to +3

t-values in parentheses***Significant at 1% level, using a two-tailed test.* Significant at 10% level, using a two-tailed test.


14/1860

Table 6: Do Operating Margins Change Post-merger?(N=82)

Test Used Test Statistic

Paired t-test for equality of the means of the t= -0.901aggregate industry-adjusted operating marginpost- and pre-merger

The test statistic, -0.901, is insignificant as shown inTable 6.

Even though the test for equality of means shows an

insignificant t-statistic, we see from Table 5, that the in-

dustry-adjusted aggregate operating margin in the pre-

merger period is insignificant, whereas it is significant

in the post-merger period. This indicates an absolute

improvement in the operating margin performance of

the merging firms in the post-merger period compared

to their industries, though statistically, this performance

does not appear to be significantly better than in the pre-

merger period.

We have constructed a cross-sectional regression

model controlling for the effect of the aggregate indus-

try-adjusted operating margin pre-merger (AIAOMI,PRE)

on the aggregate industry-adjusted operating margin

post-merger (AIAOMI,POST). This helps in determining

whether post-merger firm operating margin perform-

ance improves irrespective of the possible impact of the

performance before the merger.

The model takes the form:

AIAOM I,POST = 0.052 + 0.027.AIAOM I,PRE

(4.773)*** (1.741) *

R2 = 0.037, F = 3.032*, N= 82, t-values in parentheses

*** Significant at the 1% level, using a two-tailed test.* Significant at the 10% level, using a two-tailed test.

We find that both the intercept and the aggregate

industry-adjusted operating margin pre-merger

(AIAOMI,PRE) are significant. This shows that for every

unit change in the pre-merger firm operating margin per-

formance, the dependent variable, the aggregate indus-try-adjusted operating margin post-merger (AIAOMI,

POST), increases by 0.027 units. Thus, it indicates persist-

ence of pre-merger operating margin performance in the

post-merger period considered.

Even after controlling for the effect of the aggregate

industry-adjusted operating margin pre-merger

(AIAOM I,PRE) , the firms still show increasing operat-

ing margin post-merger, at an annual rate of 5.2 per cent,

depicted by the intercept value of 0.052. This means that

firm operating margin after the merger is significantly

positive irrespective of the impact of the pre-merger per-

formance. It is not zero or negative.

Since we have scaled the operating cash flow meas-

ure by the net sales of the merging firm, the significant

post-merger operating margin reported above, indicates

that the merged firms appear to have generated higher

operating cash flows per unit net sales, after the merger.

This is especially obvious since the pre-merger firm raw

operating margin performance is not better than the

corresponding industry performance. This means that

the merger has led to better operating margins. The bet-

ter operating margin might reflect the lowering of fixed

costs due to the merger, which in turn might indicate

the growth in the economies of scale. My earlier obser-

vation that the industry in India has been fragmented

for historical reasons, with economic liberalization lead-ing firms on a quest to derive higher economies of scale

through M&A activity, thus appears to be vindicated

through this improvement in post-merger firm operat-

ing margins.

Post-merger Long-term Sales Turnover Performance

We now study, in a similar manner, the sales turnover

performance of the combined firms after the merger

takes place.

One pair of merging firmsIndia Foils and LightMetal Industrieshas been dropped from this analysis,

since on analysing for outliers, the values pertaining to

this pair was found to lie beyond three standard devia-

tions. Even data on three pairs of merging firms could

not be obtained. The new sample size is thus 83 pairs of

merging firms.

From Table 7, we find that the aggregate post-and pre-merger industry-adjusted sales turnovers

(AIASTI,POSTandAIASTI,PRE) are 25.91 per cent and 19.33

per cent across the sample of 83 pairs of merging firms.

The average sales turnover appears to have increasedafter the merger.

We find that the merging firms have not been faring

significantly differently from the industry before the

merger. The industry-adjusted sales turnovers are in-

significant in every year pre-merger, with the aggregate

across the three pre-merger years also being insignifi-

cant. But, we find that the industry-adjusted sales turno-

ver is significantly positive every year after the merger,



15/18


except in year +2, and the aggregate across the three

years post-merger is also significantly positive.

We have used paired t-test, as before, to ascertain

whether there is an improvement in the firm sales turno-

ver performance, post-merger.

Table 8: Does Sales Turnover Change Post-merger?(N=83)

Test Used Test Statistic

Paired t-test for equality of the means of the t= -0.665aggregate industry-adjusted sales turnoverpost- and pre-merger

The test statistic, -0.665, is insignificant as shown in

Table 8. This indicates that the mean difference between

the aggregate industry-adjusted sales turnover post-

merger (AIAST I, POST)and the aggregate industry-ad-

justed sales turnover pre-merger (AIASTI,PRE)is due to

chance, and it cannot be inferred that merger has led to

a significant improvement in firm sales turnovers.

A cross-sectional regression model has also been con-structed, controlling for the effect of the aggregate in-

dustry-adjusted sales turnover pre-merger (AIASTI,PRE)

on the aggregate industry-adjusted sales turnover post-

merger (AIAST I, POST). This helps in determining

whether post-merger firm performance improves irre-

spective of the possible impact of the performance be-

fore the merger.

The model takes the form:

AIASTI,POST = 0.120 + 0.720.AIASTI, PRE(1.257) (8.163) ***

R2= 0.451, F = 66.634***, N= 83, t-values in parentheses

***Significant at 1% level, using a two-tailed test.

We find that the aggregate industry-adjusted sales

turnover pre-merger (AIASTI,

PRE

) is significant. This

shows that for every unit change in the pre-merger firm

sales turnover performance, the dependent variable, the

aggregate industry-adjusted sales turnover post-merger

(AIASTI,POST), increases by 0.72 units. Thus, it indicates

persistence of pre-merger sales turnover performance

in the post-merger period considered.

However, the intercept, 0.120, is not significant. This

means that we cannot infer that firm sales turnover af-

ter the merger is significantly different from pre-merger

levels. We cannot thus conclude that mergers have led

to a higher sales turnover, which indicates that it is ratherunlikely that merged firms have generated higher in-

cremental sales utilizing their assets more efficiently.

The analyses indicate the possible increase in mar-

ket power due to mergers in India. This is supported by

the finding of a significant increase in the operating mar-

gins after the merger, though the effect on the output

has not been studied in order to be able to make con-

firmatory comments. However, the efficiency of utiliza-

tion of assets to generate higher sales does not appear to

have increased as shown by the insignificant change in

sales turnover post-merger.

CONCLUSION

The objective of this paper was to test the hypothesis

that mergers in India have helped firms perform better

in the long-term. A comprehensive understanding and

an analysis of the Indian industrial and economic con-

text, juxtaposed with studies carried out in the other

markets, assisted in my arriving at this hypothesis, as is

evident from the section on the review of extant empiri-

cal literature. My hypothesis that mergers in India haveresulted in improved long-term post-merger firm oper-

ating performance stands validated through this study.

We are in a position to conclude that, on an average,

merging firms in India appear to have performed better

financially after the merger, as compared to their per-

formance in the pre-merger period. This improvement

in performance can be attributed to the merger. En-

hanced efficiency of utilization of their assets by the

Table 7: Comparative Pre- and Post-merger Industry-adjusted Sales Turnover Performance of theCombined Firms, N=83

Year Relative to Merger Industry-adjusted AverageSales Turnover for theCombined Firm (%)

-3 27.94 (1.562)

-2 16.94 (1.252)

-1 15.3 (1.397)

Aggregate Pre- merger 19.33 (1.645)Performance for years -3 to -1

+1 29.04 (2.122) **

+2 20.17 (1.412)

+3 28.52 (2.256) **

Aggregate Post-merger 25.91 (2.057) **

Performance for Years +1 to +3

t-values in parentheses*** Significant at 1% level, using a two-tailed test.** Significant at 5% level, using a two-tailed test.


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merged firms appears to have led to the generation of

higher operating cash flows. Synergistic benefits appear

to have accrued to the merged entities due to the trans-

formation of the uncompetitive, fragmented nature of

Indian firms before merger, into consolidated and op-

erationally more viable business units. What this study

thus indicates is that in the long run, mergers appear to

have been financially beneficial for firms in Indian in-

dustry.

On studying the long-term post-merger performance

of firms by the two constituents of the measure of per-

formance (operating cash flow scaled by the assets)

operating margin and sales turnover we are able to

obtain some insights into the sources of economic gains.

The long-term post-merger operating margin of firms,

on an average, appears to have improved. This means

that higher incremental operating cash flows are being

generated per unit net sales by the firms after the merger.

This means that higher profits (before accounting for

depreciation, interest, and taxes) are now being gener-

ated through the net sales. This might also indicate size

effects, i.e., the economies of scale obtained by the

merged firms due to which the fixed costs appear to have

been lowered. On the other hand, there does not appear

to be any change in the sales turnover of the firms, on

an average, after the merger. We cannot therefore con-

clude that the net sales per unit of asset invested have

increased after the merger, i.e., the increase in the effi-

ciency of utilization of assets to generate higher net sales

cannot be inferred from our findings. To sum up, this

study renews or reaffirms confidence in the Indian mana-

gerial fraternity to adopt M&As as fruitful instruments

of corporate strategy for growth.

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K Ramakrishnan is an Assistant Professor in the StrategicManagement Group at the Indian Institute of Management,Lucknow, India. He teaches the core Strategic Managementcourse and also offers an elective course on Mergers and

Acquisitions. His other areas of research interest are StrategicDecision Making, Strategic Alliances, and Applications of theResource Based View to Strategy.

e-mail: [email protected]


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long-term post-merger performance of firms in india

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