Part: B
Effect of the news on stock price
The chart below represents the movement of the share price of CK Assets before and after the announcement of the planned purchase of Greene King.
Source: Li Ka-shing’s CK Asset 2020
From the above graphical representation, there was a decline in the stock price as from August 2019 onwards. The purchase of Greene King led to a decline in CK Asset’s share price instead of a raise, which resulted in the decrease in the company’s value. The purchase of Greene King by CK Asset resulted in the alteration of the latter’s financial status. Spending US$ 3.27 on the acquisition negatively affected the organization’s capability to service its debt and run its functions. Through acquisitions, companies expect to increase their sales hence more revenue, which results in profitability. According to Campbell, Sirmon and Schijven (2016), the reduction in the stock price is an indication of low investor confidence on the acquisition. The reduction in the stock price shows that the process of company valuation was poorly done. In its projections, CK Asset did not assign the correct value to Greene King.
Carrying out a valuation for an acquisition is complicated because it is determined by the collaboration that is to be obtained from the union of the two firms and the expanded demands of management on the bigger organization unlike the smaller company ahead of the purchase (Ben-David, Drake & Roulstone 2015). Additionally, the reasons for the acquisition may also affect the results of the purchase. For example, some managers may be motivated by the desire to manage larger companies as opposed to the financial effects of such acquisitions. Lack of a monetary motive from the onset may result in a decline in the stock price. The decline in share price may be attributed to the signaling theory (Bergh et al. 2014). According to this theory, shareholders may be in the know about the dismal performance of the acquired company and or the likelihood that its performance will decline in the future. Shareholders’ may have lost trust and confidence in the company’s potential to register improved performance in the future due to such negative perceptions, which resulted in more shares being offered for sale. An increase in the number of shares of a firm offered for sale in the market results in a decline in the share price. Similarly, when there is a decline in the demand for shares of a particular company in the market, the stock price also declines. It is therefore prudent to consider these scenarios to effectively manage stock prices.
When a firm purchases a company whose value is low but at an overvalued price, its share price is likely to decrease. The decision by CK Asset to purchase Greene King at an overvalued price of US$ 3.27 billion led to a reduction in its stock prices. Firms purchase either undervalued or overvalued companies due to poor acquisition valuations (Ben-David, Drake & Roulstone 2015). In this case, Greene King was overvalued, which resulted in the reduction of CK Asset share prices. A reduction in the company’s value may lead to a drop in the stock prices when information about such a reduction in the value reaches the investors.
Efficient market hypothesis
According to the efficient market hypothesis, the stock prices of a market mirror all the information regarding the company and shares are traded at their fair value on the markets, which makes it impossible for an investor to buy undervalued shares or sell shares at an overstated price (Gabriela 2015). Based on CK Asset’s stock price movement, this perception is not applicable. As noted earlier on, CK Asset’s stocks rapidly declined after the acquisition of Green King. This decline in share price implies that CK Asset did not purchase the company at the correct price. The supposition here is that, the information on the acquisition of a firm with several branches and with the capacity to generate profits mirrored the stock prices. Instead, investors lost interest in the firm’s stocks. A decline in the demand of a share in the market results in a decrease in its price. In this case, the efficient market hypothesis cannot offer an explanation as to why the purchase of Greene King that was expected to increase revenues and profits resulted in a decrease in the stock prices of CK Asset. Purchasing underpriced stocks is usually profitable to investors. Nevertheless, the existence of underpriced shares is ruled out by the efficient market hypothesis which advocates the notion that stocks are usually purchased at the fair prices in the market.
The connection that exists between the current market information and the stock prices is a critical factor used to measure the market efficiency. The efficient market hypothesis is founded on the supposition that share prices are hinged on all the relevant information regarding that share, which in turn results in the share prices being always being fair (Gabriela 2015). This assumption therefore refutes the rationale that stocks in the market may be either very low or very high. However, this is not applicable to CK Asset’s case where the acquisition of Greene King was expected to improve its performance. Instead, it resulted in a decline in the demand for its shares, which caused a reduction in the stock prices in the exchange. According to the efficient market theory, investors pay the right price when purchasing stocks in the market. However, this is contentious as observed in CK Asset’s case where the purchase of another company resulted in a decrease in its stock price instead of having a raise in the share prices.
In a study by (Gabriela 2015) noted that the efficient market hypothesis (EMH) has some shortcomings. For example, it is now evident that stock prices vary based on the day of the week. The presupposition is based on the notion that share prices in the market are never fixed but they keep on oscillating during the week even when there is no new information available in the market about the shares. The massive oscillation of the share prices contradicts the efficient market theory. Similarly, the stock market faces the risk of being unresponsive to new market information and data. The effective market hypothesis is not in agreement with the momentum effect, which is founded on the supposition that the decision to purchase shares is anchored on reasonable perceptions. However, the demand for a specific stock may be as a result of the emotional connection with the share, which may increase the share prices even in the absence of information on the noticeable changes in the value of the stock. A decline in the response to fresh information results in the reduction in the capability to identify the right stock prices.
The decision by CK Asset to acquire Greene King was wrong. The firm might have purchased the other company at an overvalued price more than its projection, which shows another weakness of the EMH. Occasionally, markets experience mispricing of shares, which misleads investors who end up buying overpriced or underpriced shares. The supposition as provided by the EMH that the right level of price is exhibited in the market is hence not correct. Firms and individual investors intending to purchase shares in the market always look for the undervalued shares (Gabriela 2015). Purchasing undervalued shares give higher returns if the price of such shares raises, a phenomenon that is not supported by the efficient market theory. Therefore, there is a need to reassess the correctness of the EMH and its applicability in firms. This theory is vital in the identification of the changes in the share prices but does not always provide an explanation to those changes.
Financial managers’ decisions
Specific decisions pertaining to stock prices and acquisitions are sometimes made by financial managers. For example, the above analyses demonstrate that the entire information of a company may not always be reflected by the stock prices. Therefore, there is a need to have a detailed assessment of all the data and information regarding the company because the stock prices do not mirror all the information as per the supposition of the market hypothesis. The results of the above analyses may also influence the financial managers’ decisions. Before execution of the acquisitions, financial managers must analyze a company’s value to ensure that they only pay for the right level of company value (Lebedev et al. 2015). In this case, financial managers at CK Asset may have failed to evaluate and determine the right value of Greene King and ended up purchasing an overvalued company.
Conclusion
Firms with surplus cash invest this money in securities such as stocks with the aim of enhancing the value of the company by selling the acquired shares at a higher price. However, firms record losses when the share price declines. Overpricing of shares occasionally happens in the market contrary to the efficient market hypothesis. When making decisions regarding acquisitions, financial managers should not presuppose that the market is efficient. The acquisition of Greene King by AK Asset was undertaken without adequate information about the firm which resulted in the decline in the share price of AK Asset. Therefore, financial managers must obtain all the relevant data about a firm, which enables them to determine the correct stock prices.
Reference List
Ben-David, I., Drake, M.S. and Roulstone, D.T., 2015. Acquirer valuation and acquisition decisions: identifying mispricing using short interest. Journal of Financial and Quantitative Analysis, 50(1-2), pp.1-32.
Bergh, D.D., Connelly, B.L., Ketchen Jr, D.J. and Shannon, L.M., 2014. Signalling theory and equilibrium in strategic management research: An assessment and a research agenda. Journal of Management Studies, 51(8), pp.1334-1360.
Campbell, J.T., Sirmon, D.G. and Schijven, M., 2016. Fuzzy logic and the market: A configurational approach to investor perceptions of acquisition announcements. Academy of Management Journal, 59(1), pp.163-187.
Gabriela ğiĠan, A., 2015. The efficient market hypothesis: Review of specialized literature and empirical research. Procedia Economics and Finance, 32, pp.442-449.
https://www.ckah.com/eng/about_ckah.html
Lebedev, S., Peng, M.W., Xie, E. and Stevens, C.E., 2015. Mergers and acquisitions in and out of emerging economies. Journal of World Business, 50(4), pp.651-662