Price/earnings differential as a pure conglomerate merger motive, 1954-1969
Conn, Robert Lawrence
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This study analyzes the importance of price/earnings differences between firms as a motive for conglomerate merger. The motive of increased short run wealth in the form of higher earnings per share and/or price per share is scrutinized from theoretical and empirical viewpoints. The primary hypothesis evaluated is whether price/earnings differences between acquiring and acquired firms comprise an important motivation for merger. The major conclusion is that price/earnings differentials are an important explanatory variable in the motivation for conglomerate merger. Chapters I and II contain a theoretical discussion of the necessary conditions for achieving wealth increases via merger for equity owners in acquiring and/or acquired firms. The effect of price/earnings differentials on the attainment of specific merger goals-increases in earnings per share and/or price per share-is examined within an exchange ratio model. In Chapter III prior empirical evidence on price/earnings differentials is reviewed. Existing data on merging firms suggest that price/ earnings differences may be more significant for conglomerate than nonconglomerate mergers. But the data are for limited, different time periods and conclusions must be tentative. Chapter IV contains the primary quantitative tests of the price/ earnings differential theory. The mean price/earnings ratios are calculated for the firms involved in major pure conglomerate mergers, as defined by the Federal Trade Commission, during 1954-1969. The relations of merger frequency per firm and time periods to the price/ earnings differences of merging firms are also investigated. For the mergers sampled the acquiring firms' mean price/earnings ratio significantly exceeds that of the acquired firms. Similarly, a significant positive relation is found between merger frequency per firm and the price/earnings differential, especially for the highly active 1966-69 merger period. These results, along with others, indicate that the price/earnings differential theory of mergers merits serious consideration in any discussion of motives for conglomerate mergers. A secondary empirical effort of the study is made in Chapter V to compare the pre merger profitability of acquiring and acquired firms for approximately the same sample of mergers evaluated for price/ earnings differences. Specifically, the popular "failing firm" hypotheses-either acquirer or acquired-are found to have little empirical support.