This paper will examine the question of how M&A activities influence a company’s stock price and earnings per share (EPS), especially if the bootstrap effect occurs?
In 2016, the global mergers and acquisitions (M&A) activities decreased by about 18 percent compared to 2015. Altogether, 17,369 deals with a value of 3.2 trillion (tn.) US-Dollars (USD) were performed. There are numerous reasons to invest and divest in inorganic growth. Organic growth has its limitations, thus acquiring competitors, growing vertically or horizontally as well as accessing new markets are strong motivators to do so. Growing a business is often linked with going public. The decision to be part of the stock market and to perform M&A influences an enterprise’s value for various reasons.
To approach these questions, the first chapter gives a general overview of reasons, motivators, risks and benefits of M&A. Thereafter, the influence of M&A on a company’s shareholder value and EPS is examined. Then, the bootstrap effect is explained and subsequently illustrated by an exemplary M&A transaction. Afterwards the risks and benefits of bootstrapping and M&A are analysed to consider its usefulness and influence on the share price and EPS.
Table of Contents
1 Introduction
2 Mergers & acquisitions at a glance
3 Mergers & acquisitions’ influence on the share price
3.1 Influence of takeover announcements
3.2 Shareholder value approach
3.3 Calculation of the shareholder value
4 The bootstrap effect
4.1 Account of the bootstrap effect
4.2 Appliance of the bootstrap effect
4.3 Consequences for mergers and acquisitions
5 Conclusion
Objectives and Topics
This paper examines how M&A activities influence a company’s stock price and earnings per share (EPS), with a specific focus on the mechanics and potential misleading nature of the so-called "bootstrap effect."
- Theoretical foundations of Mergers & Acquisitions and their primary motives.
- Analysis of the influence of takeover announcements on share prices.
- Deep dive into the Shareholder Value approach as a strategic management tool.
- Explanation of the bootstrap effect, its mathematical application, and its implications.
- Critique of using short-term accounting metrics like EPS versus long-term shareholder value creation.
Excerpt from the book
4 The bootstrap effect
M&A transactions can cause earnings growth without creating economic value. This accounting trick is based on the EPS and price-earnings ratio (P/E) and is referred to as the Bootstrap Effect (or bootstrapping, bootstrap or chain letter game).
There are two conditions, which must be met leading to the occurrence of the effect. First, the transactions payment must be a stock swap, where the acquiring company pays with shares instead of cash or other forms of payment. Second, the acquiring company must have a higher P/E than the target company. Therefore, a high growth company acquires a low growth company, actually resulting in a decrease in growth rate for the combined entity.
This transaction can increase the EPS, but should not increase the share price neither it should increase the short-term earnings due to a correction through a lower future earnings growth. If the market is fooled or investors are misled by potential synergies, they expect the same P/E for the post-merger company as for the acquirer. The accounting with the premerger P/E leads to a higher market valuation of the post-merger company.
Efficient markets will regulate this and bootstrapping is not possible, but this takes a certain period. Thus, the acquiring company has a benefit out of merging with low performing companies to increase EPS until the market realises that no economic value is created. Therefore, it is not possible to evaluate the benefits of the merger by focusing on the acquiring firm’s earnings. This tactic was used in the 1960’s merger wave, which was characterised by conglomerate mergers and rarely occurs in today’s transactions.
Summary of Chapters
1 Introduction: This chapter provides an overview of global M&A activity and outlines the research objective regarding the influence of M&A on share prices and EPS.
2 Mergers & acquisitions at a glance: This section details the forms and reasons for M&A, focusing on synergy expectations and the motivation behind inorganic growth.
3 Mergers & acquisitions’ influence on the share price: This chapter investigates managerial motivations for takeovers and analyzes how market announcements and the shareholder value approach affect company valuation.
4 The bootstrap effect: This core section explains how stock swaps can artificially inflate EPS and provides an exemplary calculation to illustrate the lack of real economic value creation.
5 Conclusion: The final chapter summarizes that while M&A impacts stock prices, management should focus on long-term shareholder value rather than short-term EPS manipulation.
Keywords
Mergers and Acquisitions, M&A, Stock Price, Shareholder Value, Bootstrap Effect, Earnings per Share, EPS, Price-Earnings Ratio, P/E, Synergies, Corporate Finance, Stock Swap, Market Valuation, Business Strategy, Economic Value.
Frequently Asked Questions
What is the core focus of this research paper?
The paper examines the impact of M&A activities on stock prices and earnings per share, specifically investigating the phenomenon of the "bootstrap effect" and how it misleads market valuation.
What are the central thematic areas covered?
Key topics include M&A classification, the mechanics of shareholder value creation, the influence of takeover announcements, and the critical evaluation of accounting metrics versus real economic performance.
What is the primary research question?
The study asks how M&A activities influence a company’s stock price and EPS, particularly in scenarios where the bootstrap effect occurs.
Which scientific method is utilized in this paper?
The paper relies on a literature review of corporate finance theories and provides a mathematical demonstration of the bootstrap effect using an exemplary calculation to contrast static accounting figures with discounted cash flow analysis.
What does the main body of the work address?
The main body covers the theoretical framework of M&A, the shareholder value approach developed by Rappaport, the definition and conditions of the bootstrap effect, and a practical application of these concepts in transaction analysis.
Which keywords best describe this study?
The most relevant keywords include M&A, Shareholder Value, Bootstrap Effect, EPS, P/E Ratio, Synergies, and Corporate Finance.
How is the bootstrap effect defined within the text?
The bootstrap effect is defined as an accounting phenomenon where M&A transactions lead to earnings growth without the creation of genuine economic value, often fueled by stock swaps and P/E ratio disparities.
Why is the "Shareholder Value Approach" considered superior to standard accounting?
According to the author, the shareholder value approach is superior because it uses discounted cash flow analysis to account for the time value of money and future risks, whereas EPS and similar metrics are prone to short-term manipulation.
Are there real-life examples of the bootstrap effect mentioned?
The author notes that while the criteria are difficult to verify in contemporary data, historical context from the 1960s is provided, and recent major deals like Bayer-Monsanto were analyzed but declined for meeting specific bootstrap criteria.
- Arbeit zitieren
- Florian Beyer (Autor:in), 2017, What is the Bootstrap Effect? Merger & Acquisition-Activities and their Influence on Stock Prices, München, GRIN Verlag, https://www.grin.com/document/536597
