Defense industry mergers and monopoly power : analysis of abnormal earnings using the Edwards-Bell-Ohlson model

Abstract

Recent defense industry consolidation has created several large defense firms. As a result of merger activity with their suppliers and competitors, these firms account for an increasing percentage of sales to the Department of Defense. This thesis investigated seven large defense industry mergers, involving 12 defense firms, to assess the effect of the mergers on the firms. Changes in a firms' anticipated abnormal earnings both premerger and post-merger were analyzed to determine whether the defense firms exhibit monopoly power. The merger process was divided into five stages. The Edwards- Bell-Ohlson (EBO) valuation model was used to create measures of firms' expected abnormal earnings at each stage. Each firm's resulting abnormal rates of return on equity were observed and analyzed between stages to track changes in assessments of expected abnormal earnings as the merger process proceeded. Major findings indicate that post-merger abnormal rates of return increased from premerger levels for all firms. These findings are consistent with defense firm earnings power and monopoly position increasing due to merger activity.