Accounting, financial, and market variables: Predictors of acquisition targets

The major purpose of this study was to determine which accounting, financial, and market variables are predictors of acquisition target companies. A secondary purpose was to determine if these variables represent the underlying dimensions of liquidity, profitability, size, leverage, activity, growth, price-earnings, stock market characteristics, market valuation, and dividend policy.During the five year period of 1981-1985 the largest number of business mergers in American history were consummated providing the large population from which a representative sample could be drawn. It was hypothesized that accounting, financial, and market variables have information content which can be used to predict acquisition target companies. Data for a sample of horizontal and vertical mergers were drawn from the COMPUSTAT research tapes for the years 1981-1985. This sample was pair matched with a comparison group by industry and asset size to control for extraneous variables.Confirmatory factor analysis using the LISREL program supported the selection of those variables commonly used by accountants and researchers to represent liquidity, profitability, leverage and market valuation. Multicollinearity problems revealed that many variables represent several dimensions and need more study.Logit binary regression analysis was performed using the entire sample, and then separately on the horizontal and vertical samples to determine if the equation is the same for different types of acquisitions. A small sample of firms was drawn from those acquired or merged in 1986 and 1987 and used to validate the models.Analysis of horizontal acquisitions provided the best results with 78.21 percent correct predictions. The variables long-term debt to total assets, long-term debt to market value, market value to book value, asset growth, and sales growth were significant and supported the conclusion that the current wave of horizontal merger activity is related to the undervaluation of assets due to the high inflation of the seventies and the conservative approach taken by accountants when valuing assets in the financial statements.