As BHP’s mega hostile takeover of Canada’s Potash Corp continues, investors continue to question the value of takeovers. Empirical studies have long shown that the vast majority of value created (if any) by corporate activity accrues to target companies rather than acquirers.

Such a view was repeated by Melbourne Business School’s Paul Kerin to the Australian Financial Review today, with Kerin noting “acquisitions do create value on average, but all of that value created goes to the target’s shareholders”.  The AFR stated that a large number of international studies tend to indicate that over a five years, the value of the acquirer’s shares tends to fall by about 6.5%.

If takeovers lose money for the acquirer, and CEOs and their boards are supposed to be expert at allocating capital, why does so much takeover activity still occur? There are two main reasons. The first, is largely hubris — that is, the belief that the management of an acquirer is more skilled at gaining a higher return on investment than the management of the target. The second is that managers have an incentive to control a larger company, that is because executive pay is largely correlated to company size. The larger the company, the more the executives are paid.

Some mergers create “value” (or synergies), that is largely achieved through either gaining a monopoly or strengthening market power (if allowed by regulatory bodies) or more commonly, by firing employees. Some of these expense side synergies make sense — for example, being able to remove senior management of the target will usually increase earnings. However, as studies have shown, virtually all of those benefits (and then some) get paid to shareholders in the target company to satisfy the aforementioned hubris.

The lack of value created by takeovers is now well entrenched in the minds of investors, Earlier this year, when the ACCC blocked NAB’s bid for AXA Asia Pacific, NAB’s share price rose by around 3%. NAB continues to persist with the acquisition and has been trying to overcome regulatory concerns.

The market also appears to be unhappy with BHP’s moves to acquire Potash Corporation. While most are cognisant of the importance of potash as a key ingredient in fertilizer, the cost of the acquisition and the diversion from BHP’s current operations into what is a “soft” commodity has scared investors. BHP, by contrast, most likely on the advice on its fleet of investment bankers is seeking to utilise its massive balance sheet. With the prices and demand for its commodities such as iron ore and copper still high, BHP is generating so much cash that it has virtually wiped out its debt load. In short, BHP has more money than it knows what to do with.

The other option for BHP, of course, is to return some of that cash to shareholders by way of a buy-back or special dividend (shareholders, if they wanted, could use the cash to buy shares in Potash Corp themselves). While it has been calculated that returning money to shareholders may lead to an increase in BHP’s earnings-per-share by upwards of 16% that would, of course, be far less fun than a big takeover.

Shareholders’ distaste for corporate activity was also proved in recent times by the poor performance of media and tractor company, Seven Holdings. Earlier this year, Seven shareholders ignored advice from proxy adviser RiskMetrics and approved the merger with Kerry Stokes’ privately owned Caterpillar equipment company, WesTrac. At the time of the deal, when Seven shares were trading at about $7.30, Seven’s claimed that “the independent directors believe that the merger will alleviate market concerns relating to re-investment risks, and will reduce or eliminate the value discount currently applied to Seven’s share price.”  Thus far, it appears this has not been the case — last week, Seven closed at $6.10.

BHP cost its shareholders tens of billions of dollars in its takeover of Biliton, and almost lost billions in its takeover of Rio Tinto. The problem was while the companies BHP was buying owned high quality assets, it was paying too much for those assets. BHIP shareholders will be hoping that its purchase of Potash does not end the same way.