CHAPTER 3: RESEARCH OBJECTIVES AND METHODOLOGY
3.1 Scope of the research study
Based on the literature review, the scope for this research study has been
considered as follows:
 Study of post-merger operating performance for different types of
mergers, for a longer time period of reference, for different industries, for
different sizes of merging and merged firms
 Study of how results from mergers (in terms of operating performance)
have varied over different periods in history
 Study of stock price returns in the long run following mergers /
acquisitions, for merging firms
The present research study has been aimed at taking a more broad-based and
comprehensive coverage of the mergers and acquisition activity in Indian
industry, by considering a long time-period of 12 years, in the post-reforms
period, i.e. from 1991-2003. In particular, the present study has aimed to study
the post-merger performance of merging firms by using a much larger sample
size, to ensure statistical significance of the observations / data analysed. The
gaps in research, as identified by the literature survey, are being addressed as
explained below:
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3.1.1 Study of post-merger operating performance
Further, while previous research has aimed at studying all mergers as
homogeneous sample, the present research study has tried to study mergers
from multiple perspectives, like (a) comparing operating performance by
merger types, (b) analysing mergers between same group companies, (c) study
of mergers in different business sectors, (d) comparison of post-merger
operating performance at different periods of time, and (e) analysis of mergers
based on the relative size of the merging and merged companies.
3.1.2 Study of stock price returns
Further, the study would also try to look at the performance of the merging
firms, by way of measurement of post-merger cumulative stock returns, over
the 5-year period following mergers.
3.2 Research Objectives
The objectives of the present research study include the following:
1) Test whether mergers enhance the operational performance of acquiring
firms in India, and if the results corroborate with results from other
similar studies globally
2) Test and observe which types of mergers could be more beneficial to
acquiring firms in terms of improving their operating performance
3) To examine whether mergers between same group companies have
proved beneficial to the merging firms in enhancing their operating
performance
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4) To examine if there are any significant advantages from mergers, for
companies in some industries, as compared to other industries, for
improving operating performance
5) To verify whether the effect of mergers on operating performance of
acquiring firms in India was different during different time-periods over
the years, and identify any significant variations in trends
6) Test whether the relative sizes of the acquiring and acquired firms, has a
bearing on the post-merger operating performance of the acquiring firm
3.3 Research Hypotheses
To test the research objectives, the following hypotheses have been formulated
for the study:
 H1: In general, mergers have improved operating performance of acquiring
firms
 H2: Horizontal Mergers are more effective in improving operating
performance of firms than Vertical Mergers
 H3: Vertical Mergers are more effective in improving operating performance
of firms than Conglomerate Mergers
 H4: Horizontal Mergers are more effective in improving operating
performance of firms than Conglomerate Mergers
 H5: Mergers occurring between same group companies do not have any
impact on operating performance of acquiring companies following mergers
 H6: Type of industry does not affect change in operating performance of
acquiring companies following mergers
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 H7: The specific time in history of merger occurrence does not have any
bearing on the operating performance of acquiring companies following
mergers
 H8: Relative size of the acquiring and acquired firms, does not have a
bearing on the post-merger operating performance
3.4 Research Methodology
From the review of past research papers on mergers, considering the
limitations in event-studies of mergers, the present study was started with the
premise that such studies might not give a completely correct picture of the
impact of mergers, as several other factors could influence stock prices before
and after mergers, and it is difficult to segregate the effects which could be due
only to mergers.
Given this premise, the study felt that the use of pre-merger and post-merger
accounting data on operating performance (especially, through financial ratios)
is a better and safer path to test directly for changes in operating performance
that result from mergers. Prior research studies have adopted different
methodologies, and thus far, there has been no particular representative
methodology on M&As, that was supposed to reveal a successful operating
performance. Methodologies have varied in the form of analysis of various
financial ratios, cash flow based measures, and evaluation of strategic rationale
for merger decisions, like surveys of managers involved in mergers.
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In a finite sample period, the population of all firms in an industry would change
since there would be new entry of firms into and exit of firms from the industry,
following mergers. The process of restructuring of firms through mergers
makes it difficult to construct a sample of firms that can be analysed with longrun data to isolate the merger. Hence medium-term data for merging firms has
been considered by the study for analysing pre and post-merger performance,
so as to capture the merger-related effects. This approach has also been used
by several other research studies on operating performance following mergers,
in various countries in Europe and Asia – some researchers have used threeyear data in the pre- and post- merger periods, and some have used five-year
data (pre-merger and post-merger). Thus this approach was considered as an
accepted methodology, for the purpose of this study. The present study has
therefore decided to use a set of financial ratios, for comparing the pre- and
post-merger operating performance of acquiring firms, (i) for 3 years before and
3 years after the effective year of merger and (ii) 3 years before and 5 years
after the effective year of merger. The merger completion year was denoted as
year 0. For the years prior to a merger, the operating ratios of the acquiring firm
alone are considered. Post the merger, the operating ratios for the acquiring
(combined) firm are taken. The mean financial ratios were tested for significant
differences using “t-test”, to determine whether mergers have caused an
improvement or deterioration of the acquiring firm’s operating performance.
One deviation of the methodology of the present study from the earlier research
studies was that the operating ratios are not based on the aggregation of data
of acquiring and acquiring firms - the data pertaining only to the acquiring
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company in the pre-merger period has been considered. One reason for such
approach is because some of the acquired firms belong to the private firm
category, and therefore the published accounting data is not available for
combining the pre-merger performances of the merging and merged
companies. There has also been very little published information about some of
the acquired companies (particularly so in case of unlisted firms that were
acquired by their group companies that were listed and publicly traded). The
methodology has also drawn from Lubatkin’s [11] observations on merger
studies that recommended a large sample size to get meaningful results from
post-merger performance studies. This present research study therefore has
attempted to use a large sample of merging firms over a 12-year period, to
overcome any systemic biases in the sampling methodology
Changes in an acquiring firm’s operating financial performance could be due to
consequences of merger (ex: enhanced monopoly power, real cost savings,
managerial economies), factors unique to its industry (ex: changing demand or
resource costs), or changing general economic conditions (ex: recession or
boost in economy). The ratios selected for this study are aggregated across
industries and time periods, to negate the influence of external factors, and
therefore an attempt has been made to test the change in operating
performance due to mergers, as closely as possible
Only mergers where equity stock of acquiring firm has been issued to acquired
firm (target) shareholders as consideration for the acquisition / merger have
been considered for the study. Instances where there have been only cash
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acquisitions, are excluded from this study, to ensure comparability of results
across the sample
Also eliminated from the study are merger cases where sick (BIFR) companies
were taken over by profitable companies for getting tax credits, since operating
performance post the merger would be deflated due to write-offs of
depreciation and losses, thereby reducing tax liability for acquiring firm
3.4.1 Financial Ratios analysed by the study
The study has evaluated the pre- and post-merger corporate performance of
companies engaged in merger activity during the post- economic reforms
period in India for the mergers in Indian industry during 1991-2003. Operating
performance of acquiring firms before and after mergers was compared using
financial measures that are related to a firm’s operating efficiency performance.
Profitability, Returns and Capital Structure Ratios have been used for
evaluating the pre-merger and post-merger operating performance. Average
Pre-merger and Post-merger Performance of acquiring companies was
compared using the following Financial Ratios: Operating Profit Margin, Gross
Profit Margin, Net Profit Margin, Return on Net worth and Return on Capital
Employed. Further, Debt-equity Ratio during pre-merger and post-merger
periods was also compared to see if there has been a significant difference in
the leverage of the acquiring firm, which could possibly explain the change in
profitability or returns to the company on invested capital.
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The ratios are as explained by the formulae below:
o Operating Profit Margin PBDIT/ Net Sales
o Gross Profit Margin
PBIT / Net Sales
o Net Profit Margin
PAT / Net Sales
o Return on Capital Employed PBIT / Capital Employed
o Return on Net worth
o Debt – Equity Ratio
PAT / Net worth
Book value of Debt / Book value of Equity
Since the present study was investigating whether corporate acquisitions
create synergistic gains as suggested by the normative literature, the financial
ratios selected reflect operating efficiency manifestations. Also, the study
deviates from other such studies, in the sense that the results of the acquiring
and acquired firms are not aggregated while measuring the pre-merger
performance
3.4.2 Definition of the Financial Ratios
PBDIT: Profit Before Depreciation, Interest and Tax. This was chosen to reflect
the profits from operations, excluding the effect of financing like interest, and
the impact of capital expenditure, like depreciation set off.
PBIT: Profit Before Interest and Tax. This was chosen to reflect the profits from
operations, after adjusting for the impact of capital expenditure, in the form of
depreciation write off
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PAT: Profit After Tax. This was chosen to reflect the net profits from business,
after accounting for all operating, administrative and interest costs
Net Sales: This is arrived at by deducting from Gross revenues, any effect of
statutory deductions like excise and sales tax, which do not accrue to the
company, but have to be paid to the government. Net Sales reflect the actual
sales proceeds received by the company from its business
Net Worth: This is arrived at summing up the book value of equity capital, free
reserves and surplus, in the company’s balance sheet, which represent the
shareholders’ wealth in the company
Capital Employed: This represent the total asset base, or the total capital
which is available for using in the business
3.4.3 Variables used for categorising the sub-samples
The following variables were used for categorising the various sub-samples
needed for analysis in the present study:
1. Industry Classification – This variable will help in distinguishing
whether a merger is horizontal, vertical or a conglomerate type
2. Promoter Group details: If there is a common promoter group, or
common management team, for the acquiring and acquired firms, then
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such identity will help in determining if the merger was between
companies of same group
3. Time-periods of merger occurrence: The entire period of the study,
viz. 1991 to 2003, was broken down into three sub-periods: 1991-95,
1996-99, and 2000-03
4. Relative sizes of the two merging companies: The relative size of the
merged company, with that of the merging firm is measured as the ratio
of “book value of equity issued to acquired firm shareholders” to “book
value of equity of the acquiring / merging firm prior to merger”. Since the
amount of equity shares issued to the acquired firm shareholders is
based on the market value of the two companies’ shares, it is
considered as a good proxy of the relative sizes of operations of the two
companies, as perceived by the equity market and the investing public.
For the purpose of this study, all those mergers where this ratio is less
than 0.10, have been removed from the final sample for analysis 1
1
This was because where the relative size of the merged company was less than 10% of the
acquiring / merging firm (by market capitalisation), it was felt that there cannot be any
significant impact, as any changes in performance of the merging company could be of its own
accord rather than because of the merger
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3.4.4 Tests to be performed as part of the research study
3.4.4.1 Testing for changes in operating performance of acquiring firms, for the
entire sample
The significance of the difference between operating ratios for the pre and postmerger periods for the sample firms was tested using “paired two sample t-test:
for means”. The nature of the observations was such that the observations on
each pair of firms in the sample are not independent. Since the acquiring firm
retains its identity before and after merger, it was considered an appropriate
test to measure merger induced profitability changes. Differences between the
mean ratios were tested for statistical significance, at confidence level of 0.05.
3.4.4.2 Testing for changes in operating performance of acquiring firms by
merger type
“T-test: paired two sample for means” was used to compare the significance of
the difference between operating ratios for the pre and post-merger periods for
each of the merger types, i.e. horizontal, vertical and conglomerate types. The
nature of the observations was such that the observations on each pair of firms
in the sample are not independent. Since the acquiring firm retains its identity
before and after merger, it was considered an appropriate test to measure
merger induced profitability changes
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3.4.4.3 Comparing Performance of acquiring firms (by merger type) for
differences
The comparison of differences in performance ratios for different combination
(for example, horizontal vs. vertical mergers) of mergers was done through
“Two-paired sample t-Test”, since the sample sizes are different for different
types of mergers in the overall sample
3.4.4.4 Testing for changes in operating performance of acquiring firms in
different industries
From the distribution of the mergers, a few large industry clusters would be
identified, and tested if there are any industry specific trends. Average premerger and post-merger performance ratios would be measured and tested to
see if there was any change in operating performance due to mergers in
specific industries, using paired “t” test
3.4.4.5 Testing for changes in operating performance of acquiring firms merging
with group companies
From the entire sample distribution of the mergers, the list of firms which are
merging with other group companies or those merging with subsidiary
companies would be identified. Average pre-merger and post-merger
performance ratios would be measured and tested to see if there was any
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change in operating performance due to mergers of group companies, using
two sample paired “t” test
3.4.4.6 Testing for changes in post-merger operating performance of acquiring
firms in different time-periods
The sample list of firms engaged in mergers, would be divided into blocks of
time periods (1991-95, 1996-99 and 2000-03), and tested if there are any
specific trends in mergers occurring in the three different time-periods. Average
pre-merger and post-merger performance ratios would be measured and tested
using paired “t” test.
3.4.4.7 Testing for changes in operating Performance of acquiring firms for
different relative sizes
Relative size of merging and merged firms was measured in terms of the
“Issue Ratio”, i.e., ratio of “the amount of equity issued to the acquired firm
shareholders” to “outstanding equity of the acquiring firm before merger”. Since
the issue of equity shares (swap ratio) is usually based on the market values of
the two firms, this was taken as a proxy for the relative size of the two firms, in
terms of market capitalisation. For the purpose of this study, the sample firms
were segregated into four categories:

Issue Ratio between 0.11 to 0.40

Issue Ratio between 0.41 to 0.70

Issue Ratio between 0.71 to 1.00

Issue Ratio above 1.00
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3.4.4.8 Measuring post-merger stock price returns for acquiring firms
To verify if the decline in operating performance following mergers was also
reflected in the stock price returns of the sample firms, stock price returns for 1,
2, 3, 4 and 5 years after merger would be analysed for the stocks of the
acquiring firms. The stocks were categorised into 3 groups based on the
effective year of the merger: period 1991-95, period 1996-99, and period 200003 for the purpose of the analysis
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