Impact of Mergers and Acquisitions on the stock price behavior of Merger and Acquirer Companies in Oil and Gas Industry

 

Rashmi R¹, Dr. N Suresh¹, Sheetal R Lokande²

¹Assistant Professor, Faculty of Management and Commerce, MS Ramaiah University of Applied Sciences, Bengaluru, Karnataka, India–560054.

²MBA Student, Faculty of Management and Commerce, MS Ramaiah University of Applied Sciences, Bengaluru, Karnataka, India–560054.

 

ABSTRACT:

Mergers and Acquisitions is a corporate strategy that fetches synergy benefits, accelerate growth, improves performance quality, acquire technology, skills, and eliminate the excess capacity of the business. Oil & Gas Industryis of great importance for developing countries. This industry supports many industries together like transportation, aviation, manufacturing, other ancillary sectors. To study the share price behavior and the impact three analysis and methods are used and those are Market study, Event – study method by computing Cumulative Abnormal Returns (CAR), and Developing GARCH model. To analyze the impact of mergers and acquisitions on the CAR, the Cumulative Abnormal Return (CAR) is computed for the merger and acquiring companies using two event windows and they are – 31 days (-15, 0, +15) and 7 Days (-3, 0, +3). The expected return on the stock for each day was calculated using the CAPM model. To analyze the stock price behavior, Autoregressive Conditional Heteroskedasticity (ARCH) model is used. Results and outcome revealed that there werea remarkable effect and unremarkable effect on the abnormal return of mergers and acquisitions in the selected companies in the Oil & Gas industry.

 

 

 

 

INTRODUCTION:

Oil & Gas Industry is of great importance for developing countries. This industry supports many industries together like transportation, aviation, manufacturing, and other ancillary sectors.The Oil & Gas industry is growing rapidly and playing an important role in the development of the economy.The demand-supply gap is very high.As a game-changing corporate strategy, mergers and acquisitions happen on a large scale globally and almost in all the industries. There are equal chances of being successful and unsuccessful when mergers and acquisition are pursued by the companies. Motives for M&As can be different but companies strive hard to make it a successful move.

 

 

In today’s competitive market, every company’s objective would be to earn profits and create shareholder wealth. A company can achieve growth by introducing new products and services or by innovating the existing products.

 

The internal growth of a company can be achieved by producing new products or innovating existing products. Whereas, external growth can be achieved by entering into mergers and acquisitions.

 

LITERATURE REVIEW:

Mergers and acquisitions in the Pharmaceutical and Biotech Industries examine the determinants and impacts of the merger and acquisition event in the pharmaceutical and biotechnology industry from the year 1998 to 2001. Patent expirations and gaps in the firm’s product pipeline are the reason for the merger concerning the large firms whereas, for the small firms, mergers are primarily an exit strategy. The propensity score is used to estimate the impacts of mergers based on observed characteristics. The study’s outcome revealed that the merged large firms experienced a change in enterprise value, sales, employees, slower growth in operating profit, research and development, compared to companies that had not taken part in merger activity. The authors say that the merger may be a response to the trouble and not the solution for it (Danson et al., 2007). A study on the impact of the pre and post bank merger announcement on stock price movements examines the pre and post Bank merger effect on the stock prices. This study has considered the recent Bank mergers from the year 2010 till 2018. This study has considered both the private and public Banks. The data considered and collected consisted of the closing prices of banks 7 days pre and 7 days post–merger announcement. According to the authors outcome of the study revealed that there was a significant impacton the post-merger event and the pre-merger event did not get affected that much (Reddy et al., 2019). Focussed on the financial brand’s value of mergers and acquisitions. The study examines the drivers of the financial value of brands when the ownership of the brand is not changed (Bahadir et al., 2008)

 

METHODOLOGY:

This study’s main concern is to analyze stock price behavior and the impact of pre and post mergers and acquisitions (M&A) in the Oil & Gasindustry. In the present research, to study the share price behavior and the impact three analysis and methods are used and those areMarket study, Event – study method by computing Cumulative Abnormal Returns (CAR), and Developing GARCH model. The following steps are involved:

·                To analyze the impact on the share price by calculating Cumulative Abnormal Returns (CAR) on the shares of merger and acquirer companies using 31 days (-15, 0, +15) and 7 Days (-3, 0, +3) event period.

·      Developing the GARCH model with distribution in mean equations and the Dummy variables as variance equations are used to analyze and check the effect of mergers and acquisitions.

 

RESULTS AND DISCUSSIONS:

The current study’s focus is on the impact on the share price of the Mergers and Acquisitions of selected companies in the Oil & Gas industry between the years 2000 to 2020, worldwide. The study’s secondary data sample was formed in the following criteria:

·       The date of mergers and acquisitions from January 2000 to March 2010 are chosen for the study.

·       Completed and on-going mergers and acquisitions are considered.

·       All the companies’ share prices and returnsthat are chosen for this research are in and converted to (INR) Indian Rupees and considered for the calculations.

·       CAR for 31 days window (-15, 0, +15) and 7 days windows (-3, 0, +3) are computed.

·       Market prices considered are the market index of the respective companies.

·       All the chosen companies’ Share price returns are computed converting to the respective company’s currency to Indian rupee (INR) for easy analysis and better understanding purpose.

 

Cumulative Abnormal Return:

To analyze the impact of mergers and acquisitions on the respective companies’ share prices, an event study method is used wherein 31 days window that is (-15, 0, +15) days mergers and acquisitions event period including the date on which companies pursued mergers and acquisitions is chosen and studied. A short 7 days window that is (-3, 0, +3) days are analyzed too. Both the mentioned event study helps us to know the impact of the mergers and acquisitions on the share prices was there or not (significant or insignificant impact) The daily expected return on the stock is calculated by using CAPM Model, which includes beta and alpha (intercept). The CAPM equation is as follows:

 

E(Rf) = Rf+ β (Rm - Rf)

 

Where,

E(Rf) = Expected return of the stock on t day

Rf = Risk-free return of the security for t day

Rm = Market return for t day

β = slope of stock return and market return or the volatility measure of stock return with the market return

For the Abnormal return calculation, the following equation is used:

 

 

ARt = Rt – E(Rt)

Where,

ARt = Abnormal return of the stock on t day

Rt = actual or the normal return of the stock on t day

t = particular day of the event

 

CAR Test of 31 days event window [-15, 0, -15]:

The Cumulative Abnormal Returnsfor 31 days [-15, 0, +15] event window is graphically represented as follows:

 

Conoco Phillips’s acquisition of Burlington Resources:

On the date day of the acquisition event there was a downfall in CAR but later it increased and did not have any downfall till day +15. The 31 days cumulative abnormal return shows that there has been an increase in the CAR immediately the date of acquisition. There is a positive impact on the shareholders’ return on ConocoPhillips’s shares (Fig. 1).

 

Indian Oil Corporation Limited and Indo Burma Petroleum Merger:

The 31 days cumulative abnormal return shows, on the day of acquisition event the CAR has increased. And there has been an increase in the CAR immediately the date of acquisition too. But later, that is from the day +2 the CARs were decreased. There was a negative impact of the merger event on abnormal returns, nothing but on the shareholders’ wealth. Concerned to the cumulative abnormal returns, pre-merger event period was better than the post-merger event period (Fig. 2)

 

Reliance Industries Limited and Indian Petroleum Corporation Limited Merger:

The 31 days cumulative abnormal return shows that, on the day of acquisition event and +1 day, the CAR has increased. But later, that is from the day +2 till day +13, the CARs were decreased. There was a negative impact of the merger event on abnormal returns. From day +13 CAR has uptrend. Concerned withthe cumulative abnormal returns, pre-merger event period was slightly better than the post-merger event period (Fig. 3).

 

Oil and Natural Gas Corporation (ONGC):

The 31 days cumulative abnormal return shows that there has been an increase in the CAR immediately the date of acquisition. From day zero (0) that means the day of the event till the days in the post–acquisition event, the CAR has been increasing. On the post 8^thday, there is a slight downfall in CAR. But overall, there is a positive impact on the shareholders’ return on ONGC’s shares. The acquisition event has created a significant impact on the CAR (Fig. 4).

 

CAR Test of 7 days event window [-3, 0, -3]:

The Cumulative Abnormal Returns for 7 days [-3, 0, +3] event window is graphically represented as follows:

 

ConocoPhillips’s acquisition of Burlington Resources:

The 7 days cumulative abnormal return shows that there is a decrease in the CAR on the day of the merger event, which is on 0^th day.The 7 days CAR event windowdepicts that the CAR was better and there was a positive impact in the post-acquisition event period than the day of the event (Fig. 5).

 

Indian Oil Corporation and Indo Burma Petroleum Merger:

The 7 days cumulative abnormal return shows that there is an increase in the CAR immediately on and after the day of the merger event. on the +2 and +3, the CAR was low(Fig. 6).

 

Reliance Industries Limited and Indian Petroleum Corporation Limited Merger:

The 7 days cumulative abnormal return shows that there is an increase in the CAR immediately after the day of the merger event. on the +2 and +3, the CAR was low. -1- and 0-day’s CAR is more or less the same (Fig. 7).

 

Oil and Natural Gas Corporation (ONGC):

The 7 days cumulative abnormal return shows that there is an increase in the CAR immediately after the date of the merger event. The 7 days CAR event windowdepicts that the CAR was much better in the post-acquisition event period than the pre-acquisition event days (Fig. 8).

 

 

Fig. No. 1: 31 Days CAR of ConocoPhillips, CAR – 31 days Window	Fig. No. 2: 31 Days CAR ofIndian Oil Corporation Limited, CAR – 31 days Window
Fig. No. 3: 31 Days CAR ofReliance Industries Limited, CAR – 31 days Window	Fig. No. 4: 31 Days CAR ofOil and Natural Gas Corporation (ONGC), CAR – 31 days Window
7 Days CAR Event Windows Fig. No. 5: 7 Days CAR of Conoco Phillips, CAR – 7 days Window	Fig. No. 6: 7 Days CAR ofIndian Oil Corporation Limited, CAR – 7 days Window
Fig. No. 7: 7 Days CAR of Reliance Industries Limited, CAR – 7 days Window	Fig. No. 8: 7 Days CAR of Oil and Natural Gas Corporation (ONGC), CAR – 7 days Window

 

FINDINGS:

Both the event study windows that are 31 days [-15, 0, +15] and 7 days [-3, 0, +3] show that there is and has been a significant impact of the mergers and acquisitions on the abnormal returns of the shareholders. The share prices and the cumulative abnormal returns increased immediately preceding the date of merger and acquisition, whereas in a few cases it decreased. Thus, there is seems to be a positive impact in mostcases and negative in a few cases.

There is wealth creation of the shareholders as it is reflectedfrom the abnormal returns of stocks of mergers and acquiring companies.

 

GARCH Model:

The ARCH model can be fitted when the error variance in a time series follows an Autoregressive pattern or model and so does the (GARCH) Generalised Autoregressive Conditional Heteroskedasticity Model (Manasa and Narayanarao, 2018).

 

The estimation output consists of the sample of estimation, the methods used in computing the initial variance, coefficient of standard errors, mean equation, andthe variance equation.

 

The result or the Output of GARCH (1,1) model from the ARCH estimation is divide into two sections, the upper part provides the standard output for the mean equationwhereas the lower part and is labeled as variance equation, which includes the coefficients, standard errors, p-value coefficients, and z statistics.

To fit the ARCH / GARCH model we have to run the regression model and check on the residuals if they are stationary or not. And before developing and using the GARCH model for the stock returns, Heteroskedasticity Test is done and tested to check whether the volatility in the stock returns exists or not. If and when volatility exists the GARCH model can be applied.

 

Developing the GARCH (1,1) Model:

In the development of the ARCH / GARCH Model, it generally consists of two equations which are, Mean equation and other Variance equation. (Manohar et al., 2018). And is represented by:

 

Mean Equation is: C = C1*C+e

 

Variance Equation:

GARCH = C (2) + C (3) *RESID (-1) ^2 + C (4) *GARCH (-1) + C (5) *DUMMY+eWhere,

C = Daily return of the Company

 

GARCH = Residual Variance (error term which is derived from Eq. 1), In other words, it is the current day’s stock return.

 

RESID (-1) ^2 = Previous period’s residual square obtained from Eq. 1, also known as the Lag / previous day’s return information regarding the volatility. It is called the ARCH term.

 

GARCH (-1) = Lag / previous day’s Variance residual or the Volatility of stock return. The term is known as GARCH.

 

 DUMMY = Variable to represent the effect of mergers and acquisitions.

 

To analyze the stock and the index which affect on the volatility, an exogenous Dummy variable (D) is considered in the variance equation. If the dummy variable found is at ≤ 0.05 level of significance, that means the stock has an effect on the volatility of the spot market and has an impact. The model can be said right when the residuals satisfy for no serial correlation during the serial correlation tests.

GARCH (1,1) Model of selected companies:

Table. No. 1: Result of the GARCH model of ConocoPhillips (COP)

*Indicates Statistical significance at 5% level

Table. No. 2: Result of the GARCH model of Indian Oil Corporation Limited (IOCL)

*Indicates Statistical significance at 5% level

 

Table. No. 3: Result of the GARCH model of Reliance Industries Limited (RIL)

*Indicates Statistical significance at 5% level

 

 

 

 

 

 

Table. No. 4: Result of the GARCH model of Oil and Natural Gas Corporation (ONGC)

*Indicates Statistical significance at 5% level

 

Interpretation of GARCH (1,1) Model of Conoco Phillips (COP):

According toTable No. 1, the Dummy term’s probability is (0.0177) which is less than 0.05 (5%) - it is found that the probability of Dummy is significant. With the coefficient of (0.910730), the GARCH term is also significant. It means that the lag/previous day ConocoPhillips return’s volatility can influence the current day’s volatility of return (Table. 1).

 

Interpretation of GARCH (1,1) Model ofIndian Oil Corporation Limited (IOCL):

According to Table No. 2, the probability of Dummy variable is (0.000) which is less than 5% (0.05) that means that it is significant and the impact is present. The GARCH’S coefficient is (-0.009634) depicts that it is significant too. It means that the lag/previous day IOCLreturn’s volatility can influence the current day’s volatility of return (Table. 2).

 

Interpretation of GARCH (1,1) Model of Reliance Industries Limited (RIL):

According toTable No. 3, the probability of Dummy variable is (0.000) which is less than 5% (0.05) that means that it is significant and the impact is present. The GARCH’Scoefficient is (0.858696) depicts that it is significant too. It means that the lag/previous day RIL return’s volatility can influence the current day’s volatility of return (Table. 3).

Interpretation of GARCH (1,1) Model of Oil and Natural Gas Corporation (ONGC):

According to Table No.4, the probability of the Dummy variable is (0.0011) which is less than 5% (0.05) that means that it is significant and the impact is present. The GARCH’S coefficient is (0.163271) depicts that it is significant too. It means that the lag/previous day ONGC return’s volatility can influence the current day’s volatility of return (Table. 4).

 

CONCLUSION:

Modelling and Forecasting of the volatility of stock returns on share prices and share markets have become a vital field of empirical study and research in finance. This is becausevolatility is considered as an important aspect and concept in many economic and financial applications. Present research’s main aim is to explore the stock price behavior and impact of mergers and acquisitions. The stock price behavior and impact of mergers and acquisitions are analyzed by calculating Cumulative Abnormal Returns (CAR) (event – study method) and the returns have been modeled by using (GARCH) Generalised AutoregressiveConditional Heteroskedastic Model, that captures the volatility clustering and impact.

 

Base on the observed results and outcome, the following are the conclusions.

·       According to the CAR, there was a remarkable as well as an unremarkable effect on the abnormal return of mergers and acquisitions. The results of the GARCH model showed there was positive as well as negative impact in the pre and post-merger and acquisition events. The results of the ARCH LM test conducted point out the significant presence of the ARCH effect in the residuals and volatility clustering effect. All models were found satisfactory in all the residual and diagnostic tests.

 

·       Positive and Negative impact of Mergers and Acquisitions –ConocoPhillips and Oil and Natural Gas Corporation companies’ acquisition and merger witnessed a positive impact on the share prices, returns and the Cumulative returns were high too.

·       On the other hand, Reliance Industries Limited and Indian Oil Corporation Limited companies’ acquisition and merger events witnesseda negative impact on the share prices, returns and the Cumulative returns were low too.

·       Results also reveal that the chosen companies in the automobile industry depict that the mergers and acquisitions have led to significant impact and in some cases insignificant impact on gaining abnormal returns for the shareholders and on the wealth creation of mergers and acquiring companies. The ARCH effect isfound on almost all the chosen companies’ stocks and the volatility in the GARCH model. The stock’s future returns are significant in the case of all the chosen companies.

 

ACKNOWLEDGEMENT:

For the successful completion of this study and outcome, a lot of guidance, support, and assistance from the nexus of people were required. We could complete and accomplish the target of this research only because of their guidance and them.

 

I wish to express my sincere respect and Thanks to our amiable Project Mentor Mrs. Rashmi R, Assistant Professor, Faculty of Commerce of M.S. Ramaiah University of Applied Sciences for her support, advice, insightful comments, valuable suggestions, and her willingness to give her time so generously is very much appreciated.

 

I would like to extend my gratitude to Dr. H.S. Srivatsa, Dean, Faculty of Management and Commerce, of M.S Ramaiah University of Applied Science for providing me the opportunity and support for our project.I owe my gratitude to all my Parents, Family, and friends for their wonderful support, advice, and encouragement.Last but not the least, I am grateful to the Almighty God for abundant blessings and unfailing love for us.

 

 

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