Horizontal mergers, efficiency and capacity utilization: A DEA approach

Date of Completion

January 2004

Keywords

Economics, General

Degree

Ph.D.

Abstract

This dissertation examines the relationship between horizontal mergers, technical efficiency and capacity utilization using the empirical evidence from the U.S. manufacturing industries during 1990s. In particular, three main questions about horizontal mergers are addressed: (1) do horizontal mergers enhance firm-level technical efficiency? (2) What is the relationship between firm-level technical efficiency and stock market reactions to merger announcement? (3) What is the role of capacity utilization in horizontal mergers? The empirical methodology consists primarily of Data Envelopment Analysis (DEA), which is employed to measure firm-specific efficiency and capacity utilization rate. DEA is also supplemented by econometric analysis as relevant. ^ First, the nonparametric DEA methodology supplemented by bootstrap is employed to investigate the pre-merger efficiency distributions across acquiring firms and targets, and also the post-merger efficiency gains for the combined entities. Additionally, the two-way fixed effect analysis is used to assess the overall merger effects on the change of efficiency. It is found that the overall short-run merger effects on efficiency change tend to be negative when compared with firms without mergers. ^ Second, the relationship between the technical efficiency of the participating firms and the stock market response to the horizontal merger announcements is examined. Technical inefficiency captures a firm's managerial inability to produce the maximum output from a given bundle of inputs. Stock market abnormal returns around the merger announcement date provide the investor's re-evaluation of the future performance of the participating firms based on the newly announced information; hence they represent the gains from mergers. Cross-sectional regression analysis is employed to explore the sources of the merger gains. In order to avoid the problems of nonnormality and heteroskedasticity in the regression analysis, the wild bootstrap method is employed in the estimation and inference. The results indicate that the market responds more favorably to a merger when the acquiring firm has lower pre-merger efficiency. Apparently, it regards the merger activity as a beneficial rearrangement between these two firms. ^ Finally, we address the question of why some firms became bidders and some targets with particular focus on the role of capacity utilization in the mergers activities. Horizontal mergers can be viewed as an external expansion for the acquiring firms to gain more capacity in the short run. For this, we extend the DEA model of Färe, Grosskopf and Kokkelenberg by imposing a short-run variable cost constraint in estimating the firm-level rate of capacity utilization. A subsequent logit regression reveals that firms with high capacity utilization rates are more likely to become acquirers in the market. ^

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