Firm size, market conditions and takeover likelihood

Abstract

Purpose The firm size hypothesis – takeover likelihood (TALI) decreases with target firm size (SIZE) – has enjoyed little traction in the TALI modelling literature; hence, this paper aims to redevelop this hypothesis while taking account of prevailing market conditions – capital liquidity and market performance. Design/methodology/approach The study uses a logit modelling framework to model TALI. Model performance is assessed using receiver operating characteristic (ROC) curve analysis. The empirical analysis is based on a UK sample of 34,661 firm-year observations drawn from 3,105 firms and 1,396 M&A deals over a 30-year period (1987-2016). Findings While acquirers generally seek smaller targets because of transaction cost constraints, the paper shows that the documented negative relation between SIZE and TALI arises from sampling bias. Over a full sample, mid-sized firms are most at risk of takeovers. Additionally, market conditions moderate the SIZE–TALI relationship, with acquirers more inclined to pursue comparatively larger targets when financing costs are low and market growth or sentiment is high. The results are generally robust to endogeneity. Research limitations/implications Sample truncation on the basis of SIZE leads to empirical misspecification of the TALI–SIZE relation. In an unbiased sample, an inverse U-shaped specification between TALI and SIZE sufficiently models the underlying relation and leads to improvements in the predictive ability of TALI models. Originality/value This study advances a new firm size hypothesis which is consistent with classic M&A theories. The study also evidences market conditions as a moderator of the acquirer’s choice of target SIZE. A new model specification which recognises the non-linear relation between TALI and SIZE and accounts for the moderating effect of market conditions on the SIZE-TALI relationship leads to improvements in the performance of TALI prediction models.

MandA Likelihood: Impact of Firm Characteristics

“…Past studies show that there are two streams about the impact of firm characteristics on M&A, whether it is immediately or there is a lag time. In the first stream, they assume that firms level determinants in year t will affect M&A in year t+1 [17,41,42]. However, in the second stream, they assume that firms level determinants in year t will affect M&A in year t [16,18,23,35].…”

Fifty years of research on takeover target prediction: a historical perspective

“…Besides the two main theoretical perspectives explaining the choice of merger targets, other studies have advanced agency cost of free cash flow (Jensen, 1986; Powell, 1997), transaction cost (Tunyi, 2019) and information asymmetry (Ambrose and Megginson, 1992) perspectives which can inform the selection of takeover targets. These perspectives can, however, be subsumed or deemed as extensions of the market for corporate control theory.…”

A qualitative analysis to identify takeover target criteria

“…Stevens, 1973;Palepu, 1986;Ambrose and Megginson, 1992;Cudd and Duggal, 2000;Espahbodi and Espahbodi, 2003;Cremers et al, 2009;Pasiouras et al, 2011;De and Jindra, 2012) and the United Kingdom (e.g. Singh, 1975;Barnes, 1998Barnes, , 1999Barnes, , 2000Powell, 1997Powell, , 2001Powell, , 2004Powell and Yawson, 2007;Cocco and Volpin, 2013;Tunyi, 2019). Furthermore, empirical studies have been published for Canada (e.g.…”

“…Concerning the size variable, although the majority of studies agree on the characterization of target firms as being smaller in size (Hasbrouk, 1985;Palepu, 1986;Ambrose and Megginson, 1992;Cudd and Duggal 2000;Alcalde and Espitia, 2003;Nguyen, 2005;Brar et al, 2009;Cremers et al, 2009;Boubaker and Hamza, 2014), other authors have found that targets tend to be larger (Eddey, 1991;Berger and Ofek, 1996;Powell, 1997;Tsagkanos et al (2006Tsagkanos et al ( , 2012; Ouzounis et al, 2008). Tunyi (2019) deduced that takeover likelihood is an inverse U-shaped function of firm size. We have also noted opposite results concerning other variables tested in previous studies (profit margin, liquidity and ownership structure).…”

“…58 T-122 NT Size (À), liquidity (À), growth-resource imbalance (þ), P/E (À), ownership structure (low concentration) (þ) and transaction volume of shares (þ) Holm en et al (2014) 1985-2005 Sweden 208 firms Antitakeover measures (À), Tobin's Q (À) and leverage (À) Meghouar (2016) 2001-2007 France 48 T-48 NT Liquidity (À), growth-resource imbalance (þ) and value creation (À) Tunyi (2019) 1987- 2016The UK 1,396 M&A deals Size (inverse U-shaped) and market conditions (þ)…”