earnings per share increase after the acquisition, whereas
acquiring a company with a P/E ratio of 40 will lower
earnings per share.
Whyareaccretiveacquisitions viewedmorefavorablythan
dilutiveacquisitions?Usingtherationalethatsomeacquirers
employ,themarketpricepersharefortheacquirershouldgo
upinanaccretiveacquisitionbecausetheearningspershare
arehigher.Thispresupposesthatthemarketdoesnotchange
the P/E ratio for the company after the acquisition. That
makesnosensesincethetargetcompanypresumablyhada
lowerP/Eratioforgoodreasons—highriskandlowgrowth,
forinstance.Ifthemarketisreasonablyforward-looking,the
P/Eratio fortheacquirer shoulddropaftertheacquisition.
Will the drop be proportionately higheror lower than the
increaseinearningspershare?Thatwilldependonwhether
thepricepaidforthetargetcompanyexceedsorislowerthan
thevalueofthetarget.Inotherwords,theP/Eratioforthe
target,byitself,shouldbeirrelevanttotheprocessasshould
the question of whether earnings are accretive or dilutive.
Notwithstandingthispointofview,somefirmswillcontinue
to put earnings accretion front and center while doing
acquisitions. They are betting that markets will not see
throughappearancesandwillrewardthemwithhigherstock
prices.Intheshortterm,theirbetsmayverywellpay off.
Andrade(1999)examined 224 transactionsbetween 1975 and
1994 andfoundthatstockpricesforacquirerswithaccretive
acquisitions continued to go up for 18 months after the
acquisitionand thatthey goup more forfirms with large
percentages of unsophisticated investors.
17 However,thechangeinstockpriceismuchsmallerthan
wouldbeexpectedgivencompletelynaiveinvestors.Inother