2.3.1 What can be regarded as a merger?
There are different kinds of transactions that could be called a merger, for instance subsidiary mergers or consolidations – but this investigation only deals with mergers after which the acquiring company survive in a legal manner, whereas the target firm becomes a part of the acquirer. The task to distinguish between a merger that fulfills this requirement and other forms of collusive behavior is sometimes tricky. During the pre-World-War I period and afterwards, several forms of non-tacit collusion existed,25 Tilly (1982) stressed
22 Armitage (1995) provided an excellent overview regarding the modifications and often used basic models.
23 See Fama (1970), p. 383.
24 See Masulis (1980).
25 See also Feldenkirchen (1988).
the importance of pooling agreements (`Interessengemeinschaften´) that cannot be regarded as mergers. Nevertheless, such pooling agreements can be the starting point for a further integration of companies and, consequently, can lead to an actual merger. Besides being the potentially first step toward full unification, `pooled´ companies can together acquire a competitor. As an illustration, table 2.1 summarizes the newspaper articles that dealt with the merger of `Höchst´ and `Kalle & Co. AG´; thereby, the pooling agreement with
`Leopold Casella & Co´ played a crucial role in financing the acquisition.
Table 2.1: The case of `Höchst´ and `Kalle & Co. AG´
Information provided by the year book `Handbuch der deutschen
`Kalle & Co. AG´ by issuing new shares. Already prior to this announcement rumors spread about an impending increase in nominal capital of `Höchster and also stresses that the management of the target firm should stay in charge after the acquisition of `Kalle & Co. AG´”
13th April 1908 Morning issue, insert IV
“`Höchster Farbwerke´ convenes a shareholder gathering to decide about the issue of new shares and the acquisition. The gathering the increase of nominal capital by 10.5 million Mark. The nominal capital now reaches 36 million Mark.” acquisition of `Kalle & Co. AG´.
A part of the acquired shares that represent 4 million Mark in nominal capital will be passed on to `Leopold Cassella & Co.
GmbH´ with which a pooling agreement exists”
12th May 1908 Evening issue, page 11
“Shareholder gathering of `Kalle
& Co. AG´ approves the offer”
“To deepen the relation between
`Höchster Farbwerke´ and `Kalle
& Co. AG´ an agreement was signed in 1908 to acquire shares from former principal shareholders. This acquisition was undertaken together with
`Leopold Cassella & Co. GmbH´
and reached a volume of 4,000,000 Mark (nominal capital). The `Höchster Farbwerke´ now own shares with a nominal capital of 3,200,000 Mark, whereas `Leopold Cassella
& Co. GmbH´ own 800,000 Mark in nominal capital”
Source: The indicated issues of the `Berliner Börsenzeitung´ and the `Handbuch der deutschen Aktiengesellschaften´, issue for the years 1913-1914, volume I, page 1600-1602.
2.3.2 What can we learn from this case study?
I combine the information provided in the daily newspaper `Berliner Börsenzeitung´ and the year book `Handbuch der deutschen Aktiengesellschaften´26 to get as much detail as possible about the initiated mergers. By reading the daily newspaper carefully, it is possible to capture the whole process of a merger that starts with the initial announcement and ends with the approval of the shareholders. In spite of the work intensity,27 the `Berliner Börsenzeitung´ offers an excellent up to date information regarding events during the pre-World-War I period. For instance, the major results of the shareholder gathering of
`Höchster Farbwerke´ that took place on 9th May 1908 were reported in the evening issue of the same day. Having in mind the long process and the many hurdles a merger has to overcome nowadays, the extremely short time span between the announcement, the call for the shareholder gatherings, and the approvals is astonishing. This high speed of decisions is a common feature of all of my detected mergers. Moreover, hostile takeovers or the replacement of the management were highly unusual in the pre-World-War I period.
Typically, the newspaper announcements also contain information whether the management is allowed to stay in office or not. Generally, the quality and the high detail provided by the daily newspaper is remarkable. Accordingly, the daily information enables to precisely determine the announcement day, which is crucial for measuring the market response triggered by newly available information.
2.3.3 Drawing a sample
Caused by the time intensive and meticulous work inherent with reading daily newspapers, I had to restrict the time period. Accordingly, I included all mergers announced between 1st January 1908 and 31st June 1908 into my initial sample. Encouraged by Tilly’s (1982) statements about drawing samples in historical time periods, this method is a widely accepted procedure.28 The advantage is that all events are considered regardless if a firm is listed on the stock exchange respectively is very small. As a first step, I collect all relevant information and observe 101 announcements. However, to conduct an event-study, share prices have to be observed. This prerequisite together with the requirement that a sufficient amount of trades occurred reduce the number of included companies dramatically. Thus, I
26 The `Handbook of the German Companies´ contains firm specific information on earnings, dividend payments as well as special activities, for instance, stock splits. Of course, the handbook does not contain any details about announcement days in daily newspapers.
27 Note that the `Berliner Börsenzeitung´ had in these years a morning and an evening issue every working day; this makes the reading very time consuming. Even worse, the newspaper was also issued on Sundays.
28 Tilly (1982) argued that choosing a specific time interval during which as much information is accumulated as possible is an appropriate method of sampling in economic history.
end up with forty-five cross sectional observations. Nevertheless, this sample size is in line with other event-studies, or simulation experiments executed by Brown and Warner (1980, 1985). Therefore, if one bases the analysis on daily returns, the econometric power of an event-study is very large.29 Despite the high analytical quality, I should discuss the `historical power´ of my investigation, which is done in a subsequent section.
Moreover, it is crucial to determine precisely the day of the announcement to avoid false measurement; therefore, actuality and objectivity of the information source are important criterions. For the American market, the day of publication in the Wall Street Journal is usually used as event day. In Germany in the year 1908, the newspaper that satisfies these criterions best is the `Berliner Börsenzeitung´ because it possessed a great importance for investors and – thanks to telegram announcements – a high actuality. Therefore, the date of the first publication in the `Berliner Börsenzeitung´ is defined as the event day. Besides the determination of event days, more data are needed.
The `Berliner Börsenzeitung´ delivers stock prices of the Berlin stock exchange as well as other regional exchanges on a daily basis. This is an important improvement in comparison to using monthly or weekly stock returns,30 which is too rough and leads to considerable methodical problems, for instance, cross correlation is more likely to occur.31
For the cross-sectional models additional information on stock characteristics like firm size is needed. A reliable source for company specific information is the `Handbuch der deutschen Aktiengesellschaften´. This year book also contains information on merger activities; however, only the year of an acquisition is usually reported.
After determining the event day, I turn to specify the event period that begins fifteen days before the announcement and ends fifteen days thereafter. In a later section, I justify this choice. Moreover, to estimate the normal returns, I collect fifty daily returns for each stock of my sample from the period January and February 1907. This estimation period is far enough away from the merger announcement and, hence, is not affected by the events, which is a prerequisite for estimating normal returns. Note that the estimated normal returns reflect the stock price movement without the merger event.
29 See Morse (1984).
30 See, for example, `Berliner Börsen-Courier´ and `Neuman’s Kurs-Tabellen der Berliner Fonds-Börse´ that provide monthly data.
31 Bernard (1987) found this result by running simulation experiments.
2.3.4 Why should I choose the year 1908 as investigation period?
Despite the high empirical power of my event-study, economic historians may wonder why I choose the year 1908 for my analysis. Henceforth, this decision needs a justification. Because only short time intervals can be analyzed, one should choose an interesting period for discussing the merger paradox. Note that my aim is to test whether the merger paradox exists and, accordingly, whether acquiring companies gain from mergers. Consequently, my null hypothesis states that the merger paradox can be observed. The rejection of the null hypothesis is more difficult in periods in which risky investments and, hence, mergers are punished by the market. If the market is bearish, such a punishment seems to be more likely.
Besides this argument, one can also point to the fact that in the year 1907, which serves as estimation period, higher normal returns should result.32 Accordingly, in the downturn of the market in 1908, it should be more difficult to observe positive abnormal returns and, thus, to reject the `merger paradox´. Figure 2.1 depict the `Donnerindex´ to illustrate the basic trend in the market.33 Although this index is often criticized for its composition, it should just give a first impression regarding the general market situation. In chapter five, I will construct my own market index and can overcome typical pitfalls of the
`Donnerindex´.
In addition, working with daily returns typically yields estimated normal returns that are not significantly different from zero. The following section provides my empirical findings for the normal returns and corresponding confidence intervals. In addition, chapter four deepens the discussion further and tests whether changes regarding the length or the location of my estimation period matter.
32 Note that I used January and February 1907 as estimation period during which the `Donnerindex´ reached values between 122.36 and 121.03. Thereafter, a pronounced decline set in, and the market lost more than 10%
till the beginning of my event period; however, this decrease was not included in my estimation period.
Furthermore, my fourth chapter provides evidence that switching the estimation period (using March and April 1907) or extending the period does not affect my results.
33 For instance, Grabas (1992) listed the `Donnerindex´ for this period in her data appendix; thus, I use this information to depict the market index in figure 2.1.
Figure 2.1: The `Donnerindex´ on a monthly basis 1895 to 1913
The event-period, 1st January to 30th June 1908, reaches a relatively low share price level compared to the previous estimation period, January to February 1907. On average, the estimation period exhibits 10% higher share prices in comparison to the event-period.