Returns to Shareholders
from Mergers: The Case of
A K Mishra
Rashmi Goel
A K Mishra is Associate Professor, Finance and
Accounting, Indian Institute of Management,
Lucknow. mishra@iiml.ac.in
Rashmi Goel is Senior Research Associate,
Finance and Accounting, Indian Institute of
Management, Lucknow. rashmi@iiml.ac.in
IIMB Management Review, September 2005
RIL and RPL Merger
V
alue theory views a firm as an economic unit whose objective is the
maximisation of profits or, more generally, the maximisation of the
present value of the firm. The traditional theory of firm postulates
that only those firms which maximise corporate performance will survive
and those that do not will either be taken over or eliminated1. With firms
striving to survive in the competitive business environment, mergers and
acquisitions (M&A) are among the most efficient strategies for companies to
grow and for driving shareholder value. In recent years, mergers have gained
momentum due to liberalisation of the capital market and globalisation of
competition.
The Reliance Group has followed the merger strategy over the years, floating
a new company to diversify into a specific area, and merging it back into the
parent when it comes of age. The Reliance Industries Limited (RIL) and
Reliance Petroleum Limited (RPL) merger was in line with the same strategy
and followed global industry trends, for achieving scale and size and to pursue
future growth opportunities. Through the merger, RIL aimed to attain
leadership in the industry peer group, not only in terms of asset base, revenues,
production volumes and market share, but also in terms of maximisation of
total shareholder returns.
Literature Survey
Mergers and acquisition deals on an average have the potential to enhance
shareholder value2. While there are many popular ways to measure the value
created by mergers, the short-run stock performance of the bidder, the target
and the combined entity is the most widely used method. The short-run
stock performance is widely viewed as the most reliable evidence of value
creation because in an efficient capital market, stock prices quickly adjust to
new information and incorporate any changes in value that the mergers are
expected to bring3. Rather than considering actual stock returns occurring
69

On an average, a merger is
not a wealth creating exercise
but transfers wealth from bidders
to target shareholders. Many
studies conclude that the target
company’s stock price on an
average tends to go up from 10
days before the announcement to
10 days after. The bidding firm will
experience no excess stock
returns.
over a few days, studies4 focus on abnormal returns. In other
words it means that actual returns are reduced by the returns
investors could have earned by investing in the market as a
whole.
On an average, a merger is not a wealth creating exercise but
transfers wealth from bidders to target shareholders. Many
studies conclude that the target company’s stock price on an
average tends to go up from 10 days before the
announcement to 10 days after5. Mandelkar6 relates these
positive excess returns of the target shareholders to the ‘unique
resources’ held by the target firm in a given perfectly
competitive acquisition market. He argues that if the takeover
takes place in a perfectly competitive market, acquisition will
result in zero net present value projects. That is, the expected
return from an acquisition will be the same as from any other
investment production activity with similar risk. The bidding
firm will experience no excess stock returns. However, if the
target firm has some unique resources, it will earn positive
excess return while the bidder firm will earn normal return
i.e. no excess return.
However, the pre-acquisition share price of the bidder
company depends upon the perception of investors about
whether the acquisition is beneficial or not. The post-
acquisition share price of the bidder company generally
depends upon the success or otherwise of the acquisition7.
Merger announcements on an average result in zero or
negative excess returns to the bidders8. The probable reasons
identified are:
Size of the firm: The Size Maximisation theory states that
managers maximise, or at least pursue as one of their goals,
70 Returns to Shareholders from Mergers: The Case of RIL and RPL Merger
the growth in physical size of their corporation rather than
its profits or stockholder welfare. In this process they may
engage in activities which have negative net present value.
Unless the merger market is a veritable sea of synergistic
opportunities, a growth-maximising management can be
expected to push its acquisition programme beyond the point
that maximises stockholder welfare9.
Risk and return parity: Firth10 relates the post-merger
negative announcement effect on bidding firm shareholders
with risk and return parity. He argues that during the period
immediately following the merger announcement (t=>1),
presumably the investors of the bidding firm consider that
the costs in administering the merger (e.g. the risk involved
with the merger) exceed the benefits derived (profitability).
This results in negative excess returns to the bidding firm
shareholders.
Fixed-exchange ratio:
ratio Negative returns to bidding firm
shareholders are also normally observed in the case of fixed-
exchange ratio caused due to price pressure associated with
the merger, and arbitrage short selling around merger
announcements. Dodd, and Asquith11 identify the possibility
of leakage of merger information during 20 days prior to the
announcement of the offer. However, shareholders seem to
revise their expectations about the merger synergy in the
process and subsequently experience opposite trends due to
the overshooting of the share prices12.
Positive excess returns to the target shareholders and zero or
negative excess returns to the bidders also raises the issue of
net gains arising from the merger transaction. To resolve this
issue, excess return for the combined firm becomes an
important indicator. However, studies seem to conclude
different reasons for zero, negative or positive combined
excess return to the combined entity post merger.
• The Hubris hypothesis predicts that acquisition
announcements have zero combined excess return, as
acquisition would be only a transfer of wealth from bidder’s
shareholders to target’s shareholders13.
• The Free cash flow hypothesis predicts that the combined
excess return to the merged firm is negative. Managers,
instead of paying out the excess cash, use it to invest in
negative net present value projects14.
• The Managerialism hypothesis also predicts negative returns
to the combined firm as managers knowingly overpay in
takeovers. Managers embark on acquisitions to maximise
their own utility at the expense of the shareholders of the
acquiring firm. This has been observed as a motive for
 takeovers in the US, when firms have the incentive and the
discretion to engage in acquisitions aimed at empire
building or risk reduction15.
• The Synergy hypothesis predicts that an acquisition
announcement has positive combined excess returns.
Synergy is realised when the value of the combined firm is
greater than the sum of the values of the individual firms.
The target firms capture the lion’s share of the gains as
compared to bidder firms. Moreover, the degree of
competition among the bidding firms reduces the average
gain to the bidders to a level equal to zero16.
The above studies are based on the assumption that the capital
market is an efficient one. In an efficient capital market, any
new information relating to a firm is expected to be
immediately incorporated into the share prices of the firm. If
the market is certain about the scope, timing and success of
the merger, then the value of synergy gains expected to be
generated is immediately incorporated into the share prices
of both the acquiring firm and the target firm when the merger
deal is announced. However, if the market is doubtful about
the success of the merger, it will react as and when it receives
any new information related to the merger. The market will
create merger value if the new information affirms the success
of the merger, but will destroy merger value if the information
is negative17.
RIL-RPL Merger: Background
On 1st March, 2002, Reliance Industries (RIL) and Reliance
Petroleum (RPL) got together to form a giant in the energy
and petrochemicals sector. The exchange ratio was 1:11, that
is, RPL shareholders would receive 1 share of RIL for every
11 RPL shares held by them18. Consequently, the post merger
paid up share capital of RIL increased by Rs. 343 crores (3.43
billion) leading to a 32% increase in RIL’s equity from Rs.1,053
crores (10.53 billion) to Rs. 1,396 crores (13.96 billion) after
the allotment of shares completed on 23rd October 200219.
Before the merger, both RIL and RPL had a dominant presence
in the Indian market. RIL was a market leader in the country’s
polyester and petrochemicals businesses with market shares
in excess of 50%. It straddled every sphere of the downstream
area of the petrochemical business. RPL’s refinery at Jamnagar
was Asia’s largest refinery at 27million tons per annum. It
was highly cost-efficient and ensured higher refining margins
than most of RPL’s peers.
The Reliance Group had many logical reasons to support the
merger deal.
IIMB Management Review, September 2005
Reliance Industries (RIL) and Reliance
Petroleum (RPL) got together to
form a giant in the energy and
petrochemicals sector. The exchange
ratio was 1:11; that is, RPL
shareholders would receive 1 share
of RIL for every 11 RPL shares
held. Consequently, the post merger
paid up share capital of RIL
increased by Rs. 343 crores
leading to a 32% increase in RIL’s
equity.
Establishing Retail Network
RPL held a substantial edge over its domestic competitors
like IOC, HPCL and BPCL in terms of cost efficiency and
profitability. However, these companies had the advantage
of large retail networks. RPL used to sell half its produce to
these oil PSUs and the balance was either exported or sold to
RIL. With the dismantling of the administered price
mechanism (APM) from April 1, 2002 for the petroleum
sector, most of the price and distribution controls in the sector
were lifted and companies were allowed to enter petroleum
retailing. Further, there was also a proposal to disinvest HPCL
and BPCL from the government. RPL made plans to enter
retail marketing of transportation fuels, enabling it to deliver
a complete value proposition to customers, achieve
downstream integration and enhance overall return on
capital.
For this the company needed assured outlets for its products.
It had two options — either acquire already established set
ups or set up its own retail network. An established marketing
network, like that of BPCL and HPCL, would have enabled it
to make greater sales in the domestic retail market (where
the margins are higher than in exports) at more favourable
terms. However, in the post liberalised economy RIL would
have to pay high bid prices due to stiff competition from
global oil giants such as Shell, Exxon-Mobil and Chevron along
with its domestic competitor IOC. The second option of
building a network of retail outlets across the country, and
the logistics of supplying to them was a cumbersome and
time consuming job. The estimated cost was over Rs. 5000
crores (50 billion) and it would take at least four years to
establish a significant marketing presence in the country.
71
To finance the above expansion a strong balance-sheet entity
Exhibit 1 RIL-RPL Merged Entity: Details
like RIL with its wide equity base, was required to partner a
cash flow generating entity like RPL. The RIL-RPL merger Particulars RIL RPL Merged Entity

was thus logical. If RPL alone were to invest Rs. 5000 crore Sales 24,520 33,996 51,016*
(50 billion), its debt-equity ratio in fiscal 2003 would have
Net profit 2,856 1,692 4,548
been strained at over 1:1.5. However, it was estimated that
Equity 1,053 5,202 1,396
the merged entity might mobilise around Rs. 11000 crore
(110 billion) on a debt equity ratio of 1:1. Further, since RIL Net worth 14,765 8,727 23,492
commanded a better credit rating, fresh debts could be raised Book value (Rs) 140.2 16.8 168.3
on better terms. Hence, such a merger was aimed at tapping
EPS (Rs) 27.1 3.3 32.6
the emerging opportunities in a deregulated petroleum sector
along with providing financial strength to each other. Source : Outlook Money Magazine; March 31, 2002
Notes : All figures in Rs crores unless stated; nine-month figures have
been annualised; * The sales figure has been reduced by inter-
Financial Sustainability company sales of Rs 7,500 crores.

RIL had ambitious plans to diversify into the telecom, biotech
and power sectors for which it required enormous amounts
of ready cash for investment. For e.g. its telecom venture,
Reliance Infocom estimated investments of about Rs 25000
crores (250 billion) over the next few years. After the merger,
the strong cash flows generated from RPL’s business could
be channelled towards meeting the cash requirements of
these potential ventures.
Risk Diversification
In the global energy business, standalone refineries do not
make business sense. Refining margins are thin and any
business model that relies on oil refining alone cannot be
profitable in the long run. It makes economic sense only when
the entire chain of the oil business — from exploration to
refining to marketing and distribution is integrated. Before
the merger, RIL was engaged in the upstream oil exploration
and production (E&P) business as well as in petrochemicals
whereas RPL was confined to refining. RIL’s gross margin
was mainly affected by the price of naphtha, the feedstock
for its cracker. With globalisation, the growth and profitability
of a firm was increasingly governed by the price of the end
product. Merging with RPL would insulate RIL against the
volatility in naphtha prices and reduce volatility in its earnings.
Moreover, RPL would benefit from a significant improvement
in its business portfolio and acquire a wider spectrum of
businesses – oil exploration and production, petrochemicals
and telecommunication.
Other Benefits
The RIL- RPL merger was expected to result in considerable
savings in sales tax and income tax, improvement in the quality
of earning reported in annual accounts, increase in the balance
sheet size and reduction in volatility in the earnings of the
two businesses, along with other peripheral benefits. Before
the merger, RPL was selling a significant part of its output
(estimated at Rs 7,500 crores [75 billion] for the year 2002)
to RIL and was paying sales tax on such transactions, which
would be saved after the merger. Further, the merger was
likely to bring in the tax cover by way of depreciation on
RPL’s Rs.14404 crore (144 billion) refinery at Jamnagar20.
The RIL-RPL merger was significantly large21 and the merged
entity catapulted RIL into being the second largest Indian
company after HLL in terms of market capitalisation, and
IOC in terms of revenue, the third most widely held company
in the world with more than 35 lakh shareholders and the
largest private sector company by sales, profits, net worth,
assets and exports, all of which earned it a place in the Fortune
500 list. Exhibit 1 gives details about the merged entity.
RIL-RPL Merger: A Study
Given the cost advantages and growth prospects, while the
RIL-RPL merger made logical sense, its financial impact on
shareholder value remained to be seen. A study was
undertaken to investigate shareholder value creation in the
RIL-RPL merger deal. On the basis of the short term
performance of the merger, the study examines whether
shareholders of merging firms will gain or lose from the
merger.
The following hypotheses were tested:
H1: Whether positive or negative cumulative excess returns
accrued to RIL (bidder) or RPL (target) shareholders and the
reasons thereof.
H2: Whether there is zero or negative combined excess return
in the merged firm (RIL-RPL combined) and the reasons
thereof.

72 Returns to Shareholders from Mergers: The Case of RIL and RPL Merger

In order to test the hypotheses the study
required: announcement date, excess
shareholder returns, cumulative excess
returns and excess returns of combined
firm.
Announcement date (t=0) is the date on
which the information about a merger bid
first appeared in the financial dailies.
Keeping t=0 as the date of announcement
of merger, date t=(-1) represents a day
before the merger and the day t=(+1)
represents the day after the merger. In this
case, RIL announced its plan to merge with
its group company RPL on March 1, 2002.
Hence March 1, 2002 is taken as t=0 in this
study. The daily share prices of RIL and
RPL from the period May 14, 2001 to Jan
31, 2002 were collected from CMIE
software — PROWESS.
Excess shareholder return measures the
stock market’s initial reaction to a merger
bid and division of any gains from any new
information which becomes available to the
market. Daily share price changes were
tracked to compute daily excess returns
(XRit) for the security i as on a particular
day (t) by employing market model (1)22.
XRit = Rit- E (Rit) (1)
where,
Data and Methodology
t = day measured relative to an event, where CER is the cumulated excess return
XRit = excess return on security i for day t, from day –K through day T.
Rit = return on security i during t,
E(Rit) = expected rate of return on security
Excess returns of the combined firm
i that it would ordinarily earn for a
(equation 4) were calculated for assessing
given level of market performance
for day t. This is measured using the market expectations from the merger
the market model denoted by the of the two companies. It is a weighted sum
23
equation (2) . of bidder and target firms’ excess return.
E(Rit) = αi + βiRmt (2)
The study deduced the market
XR (b,t) * MVb + XR (t,t) * MVt
performance by taking the BSE Sensex as XR (bt,t) = (4)
the market benchmark. Values of α and β MVb + MVt
were estimated by regressing R jt
(dependent variable) on Rmt (independent
where MVb and MVt are market values (i.e.
variable) for the 18024 day period ranging
from the period May 14, 2001 to Jan 31, market capitalisation) of the bidder and
2002. The period of 20 days25 prior to the target respectively as at the day before
announcement was excluded from the the announcement date (t=-1). XR (b,t) is the
estimation period to ensure that the
excess returns of bidder firm as on day t
parameter estimates were not contaminated
with the announcement of the merger and XR (t,t) is the excess return of the target
process. Market model parameters were firm as on day t.
calculated based on these 180 data points.
Cumulative excess returns (CER) in the However, the above model relies heavily
days surrounding the merger (equation 3) on market value weights. To counter the
were needed to examine whether
possibility of overvaluation of the market
shareholders of merging firms gained from
value of shares of target or bidder26, two
the merger.
different measures were used to weight the
T
CER = ∑ XRit (3) combined returns – market value of the firm
t = -K and book value of the firm.

Empirical Results
Returns to Bidder Firm RIL and Target Firm RPL
Exhibit 2 presents the CER (cumulative excess returns) of
RIL and RPL accumulated according to equation (3) for the
period (-20 to +20), i.e., from 20 days before the merger to
20 days after the merger27. From the table it is clear that the
entire time window is displaying negative CERs for RIL with
the mean of -4.89%. In relative terms, the CER declined during
the 20 days prior to the merger by 4.48% and rose by 1.75%
(R(t=20) - R(t =-1)) from the date of merger through the next 20
days. On the date of announcement of merger (t=0), RIL
experienced 0.81% positive excess returns reflecting that the
shareholders expected benefits from the merger. However, if
CER is re-evaluated after omitting this positive announcement
day excess return, CER for the period (-20 to -1) declined by
-5.28% and then rose marginally by 0.94% during the 20 days
after the merger. CER, hence, effectively (-20 to +20) stayed
negative.
For RPL the CER declined during the 20 days prior to the
merger by 3.97% and rose to 0.39% till 20 days after the
merger. On the announcement date, RPL experienced 4.98%
negative returns. This high negative return supports the fact
that the shareholders were not satisfied by the swap ratio
declared by RIL28. Further, there was uncertainty about the
rights of RPL ADR shareholders in the merged entity. If CER
is considered after excluding the announcement day’s return,
it is found that CER for the period (-20 to -1) rises by 1.01%
and then there is additional increase by 4.36% during the 20
days after the merger. Thus, on ignoring 0 day CER, it is found

IIMB Management Review, September 2005 73

 Exhibit 2 Daily and Cumulative Excess Returns of Reliance Industries During Period (-20 to +20)

RIL RPL
Day Date BSE RIL Rit Rmt E(Rit) XRit CER RPL Rit Rmt E(Rit) XRit CER
(t) Sensex Price (%) (%) Price (%) (%)

-20 1-Feb-02 3333.9 299.95 0.001 0.007 0.008 -0.67% -0.67% 28.75 0.054 0.007 0.007 4.68% 4.68%
-19 4-Feb-02 3317.0 302.55 0.009 -0.005 -0.007 1.53% 0.86% 28.10 -0.023 -0.005 -0.010 -1.33% 3.35%
-18 5-Feb-02 3311.7 293.85 -0.029 -0.002 -0.002 -2.67% -1.81% 26.90 -0.044 -0.002 -0.005 -3.89% -0.53%
-17 6-Feb-02 3427.4 291.35 -0.009 0.034 0.041 -4.98% -6.79% 28.45 0.056 0.034 0.044 1.20% 0.66%
-16 7-Feb-02 3436.9 305.80 0.048 0.003 0.003 4.55% -2.24% 28.45 0.000 0.003 0.001 -0.12% 0.55%
-15 8-Feb-02 3493.9 311.75 0.019 0.016 0.020 -0.02% -2.26% 28.40 -0.002 0.016 0.020 -2.15% -1.60%
-14 11-Feb-02 3515.5 308.30 -0.011 0.006 0.007 -1.81% -4.07% 29.20 0.028 0.006 0.006 2.21% 0.61%
-13 12-Feb-02 3497.7 309.25 0.003 -0.005 -0.007 0.98% -3.09% 30.15 0.032 -0.005 -0.010 4.15% 4.76%
-12 13-Feb-02 3519.9 309.80 0.002 0.006 0.007 -0.54% -3.63% 30.85 0.023 0.006 0.006 1.70% 6.46%
-11 14-Feb-02 3557.1 311.40 0.005 0.011 0.012 -0.71% -4.35% 31.15 0.010 0.011 0.012 -0.20% 6.26%
-10 15-Feb-02 3602.0 315.50 0.013 0.013 0.015 -0.17% -4.52% 31.00 -0.005 0.013 0.014 -1.93% 4.33%
-9 18-Feb-02 3633.9 318.80 0.010 0.009 0.010 0.02% -4.50% 30.80 -0.006 0.009 0.009 -1.58% 2.75%
-8 19-Feb-02 3597.6 320.80 0.006 -0.010 -0.013 1.90% -2.60% 29.85 -0.031 -0.010 -0.016 -1.51% 1.24%
-7 20-Feb-02 3558.2 317.35 -0.011 -0.011 -0.014 0.31% -2.29% 29.40 -0.015 -0.011 -0.018 0.24% 1.48%
-6 21-Feb-02 3570.5 313.75 -0.011 0.003 0.004 -1.51% -3.79% 29.95 0.019 0.003 0.002 1.65% 3.13%
-5 22-Feb-02 3604.1 314.80 0.003 0.009 0.011 -0.76% -4.55% 30.00 0.002 0.009 0.010 -0.84% 2.29%
-4 25-Feb-02 3613.5 314.75 0.000 0.003 0.003 -0.28% -4.83% 29.90 -0.003 0.003 0.001 -0.43% 1.86%
-3 26-Feb-02 3712.7 321.75 0.022 0.027 0.032 -1.05% -5.88% 30.40 0.017 0.027 0.034 -1.76% 0.10%
-2 27-Feb-02 3705.7 324.75 0.009 -0.002 -0.003 1.21% -4.67% 30.10 -0.010 -0.002 -0.005 -0.47% -0.37%
-1 28-Feb-02 3562.3 307.45 -0.055 -0.039 -0.049 -0.62% -5.28% 28.85 -0.042 -0.039 -0.056 1.38% 1.01%
0 1-Mar-02 3678.8 322.15 0.047 0.032 0.039 0.81% -4.48% 28.60 -0.009 0.032 0.041 -4.98% -3.97%
1 4-Mar-02 3642.6 312.95 -0.029 -0.010 -0.013 -1.64% -6.12% 28.95 0.012 -0.010 -0.016 2.82% -1.15%
2 5-Mar-02 3641.1 313.55 0.002 0.000 -0.001 0.29% -5.83% 28.25 -0.024 0.000 -0.003 -2.13% -3.28%
3 6-Mar-02 3614.4 307.30 -0.020 -0.007 -0.009 -1.07% -6.89% 27.70 -0.020 -0.007 -0.013 -0.70% -3.98%
4 7-Mar-02 3690.3 312.10 0.015 0.021 0.025 -0.93% -7.82% 28.10 0.014 0.021 0.026 -1.13% -5.11%
5 8-Mar-02 3656.8 306.85 -0.017 -0.009 -0.012 -0.53% -8.35% 27.50 -0.022 -0.009 -0.015 -0.66% -5.76%
6 11-Mar-02 3604.0 298.20 -0.029 -0.015 -0.018 -1.04% -9.39% 26.95 -0.020 -0.015 -0.022 0.22% -5.54%
7 12-Mar-02 3535.8 292.00 -0.021 -0.019 -0.024 0.28% -9.11% 26.40 -0.021 -0.019 -0.029 0.80% -4.75%
8 13-Mar-02 3569.6 293.45 0.005 0.010 0.011 -0.61% -9.73% 26.65 0.009 0.010 0.010 -0.09% -4.84%
9 14-Mar-02 3580.8 297.55 0.014 0.003 0.003 1.06% -8.67% 26.75 0.004 0.003 0.002 0.21% -4.63%
10 15-Mar-02 3617.7 308.25 0.035 0.010 0.012 2.34% -6.33% 27.55 0.029 0.010 0.011 1.82% -2.81%
11 18-Mar-02 3613.3 306.55 -0.006 -0.001 -0.002 -0.35% -6.68% 27.30 -0.009 -0.001 -0.004 -0.48% -3.29%
12 19-Mar-02 3560.3 299.65 -0.023 -0.015 -0.019 -0.43% -7.11% 26.80 -0.018 -0.015 -0.023 0.42% -2.87%
13 20-Mar-02 3581.3 303.85 0.014 0.006 0.007 0.73% -6.38% 27.00 0.007 0.006 0.005 0.21% -2.66%
14 21-Mar-02 3536.3 303.55 -0.001 -0.013 -0.016 1.50% -4.89% 26.75 -0.009 -0.013 -0.020 1.05% -1.61%
15 22-Mar-02 3516.1 304.05 0.002 -0.006 -0.007 0.91% -3.97% 26.45 -0.011 -0.006 -0.010 -0.09% -1.70%
16 26-Mar-02 3466.3 300.20 -0.013 -0.014 -0.018 0.52% -3.46% 26.25 -0.008 -0.014 -0.022 1.44% -0.26%
17 27-Mar-02 3459.1 300.35 0.000 -0.002 -0.003 0.36% -3.10% 26.10 -0.006 -0.002 -0.005 -0.03% -0.28%
18 28-Mar-02 3469.4 300.70 0.001 0.003 0.003 -0.19% -3.30% 25.85 -0.010 0.003 0.001 -1.10% -1.39%
19 1-Apr-02 3500.2 300.95 0.001 0.009 0.010 -0.94% -4.24% 26.45 0.023 0.009 0.009 1.35% -0.03%
20 2-Apr-02 3505.8 303.50 0.008 0.002 0.001 0.70% -3.54% 26.55 0.004 0.002 0.000 0.42% 0.39%
Mean -4.89% -0.40%

that CER stays at positive for RPL shareholders during 20 days Overall, it can be concluded that the period under review
prior to and 20 days after the announcement of merger deal. supports the theories that postulate negative returns to the

74 Returns to Shareholders from Mergers: The Case of RIL and RPL Merger
 Exhibit 3 Cumulative Excess Returns

0.0800
0.0600
0.0400
0.0200
0.0000
Returns

-0.0200

8
-20
-18

-16

-14

-12

-10

-8

-6

-4

-2

10

12

14

16

18

20
-0.0400
-0.0600
-0.0800
-0.1000
-0.1200

Day (t)
RIL RPL

bidder shareholders and positive return to the target
shareholders (Exhibit 3).
The result supports the Size Maximisation theory by which
most of the gains accrue to the target’s shareholders29. It is
also compatible with the unique resources of the target in the
competitive market30.
Announcement Effect
In order to further analyse the announcement effect, the forty
days period from day -20 to +20 was partitioned into various
sub-periods. Then the proportion of the total build-up in CER
during this period as accounted by the various sub-periods
was computed.
Announcement Effect and RIL
Exhibit 4 shows a mixed trend during the 40 days (from -20
to +20) around the announcement of merger. During 20 days
through 11 days prior to the announcement of offer the CER
declined more than the total decline during the time period
of -20 to +20 days. It accounted for about 122% of the total
decline. The trend of negative returns continued for the next
ten days but on the day of merger (t=0) it yielded positive
return of 22.88% of total decline. Moreover, there was a
sudden drop in the share prices of RIL by 52.26% during the
next 10 days after the announcement of offer. However, the
scrip gained 79% rise during 11 through 20 days after the
announcement of merger.
This is consistent with our hypothesis. When RIL and RPL
merger was announced, RIL shareholders presumably
expected that the proposed merger would lead to lower
returns given the more risky business of RPL. This was due to
the fact that pre merger beta (βRPL) of RPL was 1.36 as
compared to RIL beta (βRIL) of 1.22. Further, the pre merger

Exhibit 4 CER – Announcement Effect for Reliance Industries Limited

Sub-period -20 -10 0 +1 +11 +21 -20 0 0 -20 -20
to to to to to to to to to to
-11 -1 +10 +20 +40 0 +20 +40 +20 +40

CER -4.35 -0.94 0.81 -1.85 2.79 -1.54 -4.48 1.75 0.21 -3.54 -5.07

Announcement -97.10% -20.98% 18.08%

Effect (-20 to 0)

Announcement 46.29% -105.71% 159.43%

Effect (0 to +20)

Announcement -122.88% -26.55% 22.88% -52.26% 78.81%

Effect (-20 to +20)

IIMB Management Review, September 2005 75

 Exhibit 5 CER – Announcement Effect for Reliance Petroleum Limited
Sub-period -20 -10 0 +1 +11 +21 -20 0 0 -20
to to to to to to to to to
-11 -1 +10 +20 +40 0 +20 +40 +20

CER 6.26 -5.25 -4.98 1.16 3.20 5.69 -3.97 -0.62 5.07 0.39

Announcement 157.68% -132.24% -125.44%

Effect (-20 to 0)

Announcement -803.23%
Effect (0 to +20)

Announcement
Effect (-20 to +20)

profit margin of RPL was 4.12% as compared to RIL profit deal.

margin of 7.28%31. Hence, the news about merger would
have been a worrying factor for RIL shareholders as this
merger could lead to lower returns and high degree of riskier
business32.
Announcement Effect and RPL
Exhibit 5 shows Reliance Petroleum experienced high positive
returns during 20 days through 11 days prior to merger
announcement deal (t= -20 to -11). It was followed by the
high negative returns during the next 11 days and after that
the share prices resumed an upward trend. Hence, on the
whole RPL shareholders experienced positive returns during
the entire time window of -20 to +20. This further supports
our hypothesis (H1).
Comparing the trends of RIL and RPL (Exhibit 6), it is found
that:
• RIL experienced negative returns during the period t= -20
to +10 days except on the date of announcement of the
• RPL experienced high positive returns during the period
t=-20 to -11 days and again during t= +1 to +20 days.
These trends started around 20 days before the
announcement of the deal compatible with Dodd’s and
Asquith’s findings that identify the possibility of leakage of
merger information during 20 days prior to the
announcement of offer33.
However, an opposite trend is observed immediately after
such returns. In case of RIL, after the trend of negative returns
for 30 days it experienced positive returns for the next ten
days. On the other hand, in case of RPL, after the trend of
positive returns it experienced negative returns for the next
11 days. The subsequent opposite trend can be due to
‘overshooting’ of market expectations 34. The leaked
information about the proposed merger deal was taken as
negative information for the shareholders of RIL and positive
information for the shareholders of RPL. Hence, the market
responded to the information likewise. However, in the

Exhibit 6 Announcement Effect: Comparing RIL and RPL

8
6
4
2
CEE

0
-20 to -11 -10 to -1 0 -1 to -10 -11 to -20
-2
-4
-6
Sub-period
RIL RPL

76 Returns to Shareholders from Mergers: The Case of RIL and RPL Merger
 Exhibit 7 Excess Returns for RIL- RPL Combined (t =0 to +20)
Daily Excess
Returns (%) Combined Wealth Gain or loss (Rs in cr.) XR bt

1
Day (t) Based on Market Value Based on Book Value2
RIL RPL as on cumulative as on cumulative
day (t) gain/loss day (t) gain/loss

0 0.81% -4.98% -0.010 -0.010 -0.017 -0.017

1 -1.64% 2.82% -0.002 -0.013 0.003 -0.014

2 0.29% -2.13% -0.005 -0.017 -0.007 -0.021

3 -1.07% -0.70% -0.010 -0.027 -0.009 -0.031

4 -0.93% -1.13% -0.010 -0.037 -0.010 -0.041

5 -0.53% -0.66% -0.006 -0.042 -0.006 -0.047

6 -1.04% 0.22% -0.006 -0.049 -0.005 -0.052

7 0.28% 0.80% 0.004 -0.044 0.005 -0.047

8 -0.61% -0.09% -0.004 -0.049 -0.004 -0.050

9 1.06% 0.21% 0.008 -0.041 0.007 -0.043

10 2.34% 1.82% 0.022 -0.019 0.021 -0.022

11 -0.35% -0.48% -0.004 -0.023 -0.004 -0.026

12 -0.43% 0.42% -0.002 -0.025 -0.001 -0.027

13 0.73% 0.21% 0.006 -0.019 0.005 -0.022

14 1.50% 1.05% 0.014 -0.006 0.013 -0.009

15 0.91% -0.09% 0.006 0.000 0.005 -0.004

16 0.52% 1.44% 0.008 0.008 0.009 0.005

17 0.36% -0.03% 0.002 0.011 0.002 0.007

18 -0.19% -1.10% -0.005 0.006 -0.006 0.001

19 -0.94% 1.35% -0.002 0.004 0.000 0.002

20 0.70% 0.42% 0.006 0.010 0.006 0.007

Mean -0.018174 -0.021476

1 Market Value of Equity as on the previous day of the announcement of merger (t = -I) i.e. as on
28/02/2002 was Rs. 32397.76 cr for RIL and Rs. 15006.81cr for RPL.
2 Book Value of assets as on the previous day of the announcement of merger (t = -I) i.e. as on 28/
02/2002 was Rs. 13314.86 cr for RIL and Rs. 9957.10 cr for RPL.

process they ‘overshot’ their expectations and the prices
followed the opposite trend for the next 10 to 11 days and the
market revised their expectations for both the firms.
Excess Returns to RIL-RPL Combined
Excess returns to the RIL-RPL combined have been found to
be negative (Exhibit 7). There is average cumulative loss to
the combined firm in terms of market capitalisation as well
as book value. The means of both the indicators have been
found to be negative. Thus, negative returns have not arisen
because of the overvaluation of the firms.
RIL-RPL merger deal, apparently, was not driven by any
synergy gains35. The merger is in keeping with the Free cash
flow hypothesis or the Managerialism hypothesis or both.
Since the study concentrates on stock price performance
rather than free cash flow, the evidence provided by the study
is inadequate to either accept or reject the free cash flow
hypothesis.

IIMB Management Review, September 2005 77

Effectively, the RIL-RPL merger deal generated negative
excess returns for the combined firm. The results are
consistent with the Managerialism hypothesis that postulates
negative excess returns for the combined firm due to empire
building strategy or risk reduction. This is evident from several
facts. RPL shareholders were able to obtain most of the gains
even when there was no competition for the acquisition of
RPL (Exhibit 2). RPL was a group company and it was almost
impossible for an outsider to acquire it — a clear case of
empire building. RIL’s ambitious plans for diversification were
dependent in large measure on RPL’s strong cash flows and it
also needed to increase the size of its balance. The merger
effected both. Despite RIL’s professed objective of ‘attaining
leadership in the industry peer group, not only in terms of
assets base, revenues, production volumes and market share,
but also in terms of maximisation of total shareholder returns’,
the negative combined returns clearly indicate that the deal
was undertaken by RIL managers to maximise the utility of
RPL business at the expense of RIL shareholders.
Conclusions
The purpose of this study was to examine the financial
implications of RIL- RPL merger on the shareholder’s wealth.
The profitability for shareholders was investigated by
examining the daily excess returns that accrue to the
shareholders around the date of announcement of the merger
deal. The study shows that positive excess return occurred to
the shareholders of the target company RPL and negative
excess returns to the shareholders of the acquiring company,
RIL.
It was found that in this process of merger, despite the deal
appearing to be favourable to the shareholders of RIL they
lost and RPL shareholders gained from the deal. This deal
was led with the ‘empire building’ motive along with spreading
the risk and return more equally among the shareholders of
the two companies.
Suggestions for Further Research
Similar studies can be carried out on the larger set of merger
deals. The general motives behind the merger and acquisition
process among Indian companies may be explored.
Future research might investigate whether the shareholders'
returns vary with the nature of mode of payment. The
profitability of the bidder firms and target firms can be
investigated for different kinds of strategies like tender offers,
related mergers, unrelated mergers or conglomerates. These
78 Returns to Shareholders from Mergers: The Case of RIL and RPL Merger
returns can be studied both for the short term as well as the
long term and the performances compared.
Stock price movements are one of the tools to study the
performance of mergers. Other tools also can be used to
calculate the synergy generated by such deals. The strategy
area is significantly affected by the laws and regulations
governing M&A. A study may be conducted to examine the
performance of the companies before and after the
introduction of the takeover code.
References and Notes
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Scherer, 1987, Mergers, Sell-offs and Economic Efficiency ,
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3 Campbell, J Y, A W Lo, and A C MacKinlay, 1997, The
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Princeton.
4 Mandelker, G, 1974, ‘Risk and Return: The Case of Merging Firms’,
Journal of Financial Economics, Vol. 1, pp. 303-335; Langetieg, T
C, 1978, ‘An Application of a Three-Factor Performance Index to
Measure Stockholder Gains from Merger’, Journal of Financial
Economics, Vol. 6, pp. 365–384; Dodd, P, 1980, ‘Merger Proposals,
Management Discretion and Shareholder Wealth’, Journal of
Financial Economics, Vol. 8, pp. 105–138; Malatesta, P H, 1983,
‘The Wealth Effect of Merger Activity and the Objective Functions
of Merging Firms’, Journal of Financial Economics, Vol.11, pp.
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Wealth’, Financial Management, Vol. 15, No. 4, pp. 43–52; Bradley,
M, A Desai and E H Kim, 1988, ‘Synergistic Gains from Corporate
Acquisitions and their Division between the Stockholders of Target
and Acquiring Firms’, Journal of Financial Economics, Vol. 21,
pp. 3-40.
5 Jensen, M C, and R S Ruback, 1983, ‘The Market for Corporate
Control: The Scientific Evidence’, Journal of Financial Economics,
Vol. 11, pp. 5-50; Merger Policy (Her Majesty’s Stationery Office),
1988, Department of Trade and Industry; Malatesta, P H, ‘The
Wealth Effect of Merger Activity and the Objective Functions of
Merging Firms’; Mathur, I, 1989, ‘A Review of the Theories of and
Evidence on Returns Related to Mergers and Takeovers’, Managerial
Finance, Vol.15.
6 Mandelker, G, ‘Risk and Return: The Case of Merging Firms’.
7 Kaur, S, 2002, ‘A Study of Corporate Takeovers in India’, thesis
submitted to Delhi University, India.
8 Jensen, M C, and R S Ruback, ‘The Market for Corporate Control:
The Scientific Evidence’; Jarrell, G, J Brickley, and J Netter, 1988,
‘The Market for Corporate Control: The Empirical Evidence Since
1980’, Journal of Economic Perspectives , Winter, pp. 49-68;
Andrade, G, M Mitchell, and E Stafford, 2001, ‘New Evidence and
Perspectives on Mergers’, Journal of Economic Perspectives, Vol.15,
pp.103-120.
9 Mueller, D C, 1969, ‘A Theory of Conglomerate Mergers’, Quarterly
Journal of Economics, Vol. 83, pp. 643-59; Malatesta, P H, 1983,
‘The Wealth Effect of Merger Activity and the Objective Functions
of Merging Firms’, Journal of Financial Economics, Vol.11, pp.
155–182.
10 Firth, M, 1980, ‘Takeovers, Shareholder Returns, and the Theory
of the Firm’, Quarterly Journal of Economics, Vol. 94, pp. 235-60.
11 Dodd, P, ‘Merger Proposals, Management Discretion and
Shareholder Wealth’; Asquith, P, 1983, ‘Merger Bids, Uncertainty,
and Stockholder Returns’, Journal of Financial Economics, Vol.
11, pp. 51-83.
1 2 Mandelker, G, ‘Risk and Return: The Case of Merging Firms’.
1 3 Roll, R, 1986, ‘The Hubris Hypothesis of Corporate Takeovers’,
Journal of Business, Vol. 59, pp. 97-216.
14 Jensen, M C, 1986, ‘Agency Costs of Free Cash Flow, Corporate
Finance and Takeovers’, American Economic Review, Vol. 76, pp.
323-329.
1 5 Mitchell, M L, and K Lehn, 1990, ‘Do Bad Bidders Become Good
Targets?’, Journal of Political Economy, Vol. 98, No. 2, pp. 372-
98.
16 Bradley, M, et al, ‘Synergistic Gains from Corporate Acquisitions
and their Division between the Stockholders of Target and
Acquiring Firms’; Seth, A, 1990, ‘Value Creation in Acquisitions:
A Re-Examination of Performance Issues’, Strategic Management
Journal, Vol. 11, No. 2, pp. 99-115.
1 7 Asquith, P, 1983, ‘Merger Bids, Uncertainty, and Stockholder
Returns’, Journal of Financial Economics, Vol. 11, pp. 51-83.
18 The exchange ratio was determined on the basis of a valuation
report by valuation advisors Price Waterhouse and S B Billimoria
& Co (member of Deloitte Touche Tohmatsu International), jointly.
1 9 J M Morgan Stanley acted as the financial advisor to the entire
transaction and Amarchand & Mangaldas & Suresh A.Shroff & Co
as legal advisors. Arun Gandhi of N M Raiji & Co, Bansi Mehta of
Bansi Mehta & Co and N V Iyer of CC Chokshi & Co acted as tax
advisors for the proposed merger.
2 0 As per the Companies Act, it was estimated to be in excess of Rs
800 crore (for the year 2002) and when the depreciation rates
under the income tax are higher then obviously the merger would
lead to saving in payment of current taxes.
2 1 The target firm (RPL) although smaller in size as compared to RIL
was still as large as 52% of the size of the bidding firm (RIL).
2 2 A similar model is used by Asquith. Asquith, P, 'Merger Bids,
Uncertainty and Stock-holder Returns'.
2 3 Fama, Eugene F, 1976, Foundations of Finance, New York: Basic
Books.
2 4 N Strong emphasises that ‘For estimation of the parameters of the
market model, the number of observations used in practice has
varied widely. For example, on daily data Lambert and Larcker
used 60 observations, while Dodd et al. used 600 observations. In
practice there is a trade off between including more observations
to increase statistical accuracy and not going too far forward or
back from the test period in case the parameters of the return
generating mechanism have shifted’. Strong, N, 1992, ‘Modelling
IIMB Management Review, September 2005
Abnormal Returns: A Review Article’, Journal of Business Finance
and Accounting, Vol. 19, No. 4, pp. 533-553.
2 5 This is with the assumption that the major movements of share
prices can be tracked within forty days (from 20 days before the
merger to 20 days after the merger, 0 day being the date of event).
2 6 Dong, M, D A Hirshleifer, S A Richardson, and S H Teoh, Sept 28,
2003, ‘Does Investor Misvaluation Drive the Takeover Market?’,
EFA 2003 Annual Conference Paper No. 652, Dice Center Working
Paper No. 2003-7.
2 7 This is with the assumption that the major movements of share
prices can be tracked within forty days (from 20 days before the
merger to 20 days after the merger, 0 day being the date of event).
2 8 The company said that the ratio was arrived at by swap ratio
specialists from a global accounting firm and there would be no
reason to doubt their methodology. Critics, however, said that the
ratio does not reflect the true worth of RPL. UTI and other
institutions were also not too happy with the merger. The UTI
official said that no other institution had got in touch with it on
the issue of merger or the swap ratio, but the Trust was undertaking
the exercise of going into the valuation and the ratio on its own to
be totally sure about the rationale.
2 9 If RIL and RPL merged, it was to attain size and scale because the
corporation knew that HPCL and BPCL were to be disinvested.
The corporation knew that it would have to battle the oil biggies
like Shell, Aramco, Chevron, BP and regional players like Petronas
and Kuwait Petroleum.
3 0 Unique resources include (a) saving of sales tax paid by RIL on the
output purchased from RPL. (b) tax cover provided by the
depreciation of the Rs.14404 crore refinery at Jamnagar of RPL.
Before the merger, RPL was not availing of this depreciation cover
since profits from the refinery of the company do not attract any
tax due to the tax holiday.
3 1 Source: Prowess based on 2000-01 figures.
3 2 The markets did not greet the RIL-RPL merger with much
enthusiasm. The merger was anticipated to lead to an increase in
business risks for RIL, given the intrinsic low margin nature of oil
refining, and the merged entity’s higher taxes, interest costs and
depreciation provisions were perceived to have a dampening effect
on the company’s profitability. These were arguably the most
worrying factors for the RIL shareholders.
3 3 At the time of the announcement, the news of the merger had
already been discounted by the market, as shareholders had a
premonition from reports in the media and their experience with
the group’s previous two mergers. The RIL stock lost about 20%
since the formal announcement of the merger.
3 4 Mandelker, G, ‘Risk and Return: The Case of Merging Firms’.
3 5 Since the merger represents the folding of subsidiary (RPL) into
the parent company, all the benefits of integration in the refining/
chemicals chain were captured by the earlier parent-subsidiary
structure. To quote a DSP Merrill Lynch report: ‘’We do not see
any visible near term synergies from the merger and would be
cautious of any sharp price rally on this news”.
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79