March 15 , 2002
DEREGULATION OF ANY INDUSTRY OFTEN LEADS TO consolidation and merger, which frequently bolsters the involved companies' stock prices.
In the SBC/Pacific Telesis merger, intervenors argued before the California Public Utilities Commission that the change in the value of Pacific Telesis' stock was a measure of the merger's "benefits" to shareholders. They said the PUC should force the merged company to rebate half those benefits to ratepayers.
Analysts use stock market information in an "event study" to measure the economic impact of a particular event. This method is based on the "efficient markets hypothesis," which states that all publicly available investment information is incorporated into stock prices. Event study analysis "values" an event based on the interactions of many self-interested, objective and rational economic agents. The analysis would render agents less prone to individual bias and questionable assumptions that may creep into other methods, such as discounted cash flow analysis or the use of multiples.
While event studies can prove powerful, several factors complicate the issue. For example, it is sometimes unclear when relevant information became available; merger news can leak out before a formal announcement is made. Also, the impact of a merger announcement may be diluted by doubts that it will survive regulatory review. Increased competition may make it more difficult for investors to assess a merger's impact.
The SBC-Pacific Telesis merger illustrates some of the errors that may arise in misapplication of an event study. The price of Pacific Telesis stock did spike the day the merger was announced, producing a $2.6-billion increase in market value (see figure). That is the figure intervenors used to measure ratepayers' share of merger benefits. However, this gain was largely offset by a loss in value of SBC shares. The effect on the combined value of the companies was a 2.0 percent increase in value, compared with a 1.3 percent increase in the value of the S&P 500 that same day.
We undertook a rigorous analysis of the movements in the stock prices of Pacific Telesis and SBC immediately following the merger announcement, and found that there was no statistically significant increase in the combined value of the two companies. Although Pacific Telesis shareholders clearly did benefit, the benefit appears to have been at the expense of SBC shareholders. Stock price information alone did not provide a basis for determining a rebate to ratepayers.
The new firm's capitalization as of close of business April 29 was 68 percent higher than the capitalization of the combined firms at the close of trading on the day the merger was announced, slightly more than the increase in the S&P 500 Index in the same period. With so many extraneous events affecting the firm in this period, it is difficult to draw any inference regarding the benefits of the merger.
It is our expectation that as regulators adopt more market-based approaches, regulatory determinations based on market phenomena - including the movement of financial markets - will become more prevalent, and event study analysis will be an increasingly important tool. But, as this example demonstrates, it should be used