The Effect of Inter-Country Integration
on Cross-Border Value Creation
An Empirical Study of European Integration from
the Perspective of Mergers and Acquisitions
Name Thomas Gabriël Baak
Student number 10779132
Programme MSc Finance
Specialization Corporate Finance Supervisor dr. J.E. Ligterink
Date July 2018
ABSTRACT
The effect of inter-country integration of financial markets and national economies on cross-border value creation in mergers and acquisitions is researched through cumulative abnormal return analysis of the announcement returns of completed corporate takeovers of both acquirer and target companies between 1985 and 2018 in the European Union. The effect of inter-country integration on value creation is identified using two approaches: (i) ordinary least squares (OLS) panel regressions using measures of financial (equity and debt market) and economic (business cycle and inflation) segmentation to study intra-European cross-border value creation, and (ii) difference-in-difference methodology based on the staggered acceptance of countries into the European Monetary Union (EMU) to study the effect of increased country integration, and the Brexit referendum to study the effect of increased inter-country segmentation. Results indicate that for acquirer and target firms, takeover value creation decreases when equity markets integrate, and inflation differentials decrease. Acquirer firms have less value creation when inter-country debt markets integrate and business cycles converge, whereas target firms experience more value creation in this situation. Furthermore, takeovers create less value when both acquirer and target firm are incorporated in countries participating in the EMU. The degree of inter-country integration prior to countries joining EMU does not alter the impact of EMU on takeover value creation, instead, for firms incorporated in European Coal and Steel (ECSC) and Periphery countries takeover value creation increases with participation in EMU. Takeovers in which acquirer or target firms are incorporated in the United Kingdom create more value post-Brexit referendum.
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Statement of Originality
This document is written by Student Thomas Baak, who declares to take full responsibility for the contents of this document.
I declare that the text and the work presented in this document is original and that no sources other than those mentioned in the text and its references have been used in creating it. The Faculty of Economics and Business is responsible solely for the supervision of completion of the work, not for the contents.
Table of Contents
1. Introduction 5
2. Literature Review 8 2.1 Determinants of Mergers and Acquisitions 8 a. Single Market Determinants 8 b. Intermarket Determinants 9
2.2 The Segmentation of International Capital Markets 12
2.3 European Integration 13
2.4 Hypotheses 17
3. Methodology 18
3.1 Choice of Sample Group 18
3.2 Measuring Takeover Value Creation 20
3.3 Capturing the Effect of Inter-Country Integration 22
a. Measures of Financial and Economic Integration 22
b. Control Variables 24
3.4 Model of Research 26
3.5 Statistical Hypotheses 27
4. Data 29
4.1 Discussion of Cumulative Abnormal Return Estimates 31
4.2 Descriptive Statistics of Variables 34
5. Results and Analysis 36
5.1 Effect of Financial and Economic Integration 36
a. Acquirer Firms 36
b. Target Firms 37
c. Combined Entity 39
5.2 Integration Effect of the European Monetary Union 42
a. European Union and the European Coal and Steel Community 42
b. Effect Relative to Prior Degree of Inter-country Integration 45
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6. Discussion 51
7. Conclusion 52
8. Bibliography 54
9. Appendix 58
9.1 Development of European Union and European Monetary Union 58
9.2 Statistical Measures and Definitions 60
9.3 Variable Sources 62
9.4 Extended Summary Statistics 64
9.5 Correlation Table 67
9.6 Additional Robustness Tests 68
1. Introduction
Over the last decade, analysis of value creation in cross-border mergers and acquisitions has developed from studying synergies at the firm-level, into research that increasingly takes macroeconomic and socio-political factors at the country-level into consideration (Erel et al., 2012). The segmentation of financial markets as a result of uncoordinated macroeconomic policies and differences in the quality of the prevalent legislative system between countries can unlock opportunities to create additional value in cross-border mergers and acquisitions relative to domestic takeovers. While firm-level synergies such as revenue enhancement, operational cost reductions, and capital structure optimisation (Jensen & Ruback, 1983) are prime sources of value creation in non-cross border takeover single market settings, in recent literature academics indeed find that additional value can be created in international intermarket settings by leveraging on differences in governance standards, access to foreign capital markets and business expansions into foreign markets (Rossi & Volpin, 2004).
These intermarket determinants of value creation in corporate takeovers have been studied extensively by academics in a static market setting: acquiring and target firms are identified according to whether they originate from a “poor” or “wealthy” country, experience “good” or “bad” legislative systems and governance standards (Doukas & Travlos, 1988), and whether there are cultural differences (Erel et al., 2012). However, in the real-world the degree of segmentation between countries is dynamic rather than static in nature (Sapir, 2011). Practical application of current theory on intermarket determinants in cross-border mergers and acquisitions is therefore limited as the dynamic effects of intermarket segmentation have not been clarified in any prior-academic research on corporate takeovers. Furthermore, driven by technological advancements that have led to improved information sharing capabilities over long distances and the diminishing of information asymmetries, the world’s economies are rapidly integrating (Bekaert & Harvey, 1995). Therefore, it is of great importance to understand the effects of financial integration to model future cross-border takeover value creation (Erel et al., 2012). The understanding of financial integration relative to cross-border mergers and acquisitions can guide governments in creating policies and legislation more accurately to ensure overall maximization of economic welfare. Additionally, extending knowledge on cross-border value creation in mergers and acquisitions benefits firms in the financial industry that facilitate corporate takeovers.
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In order to study the dynamic effects of intermarket segmentation and integration in corporate takeovers, this research reviews cross-border mergers and acquisitions within Europe. The economic and political integration of European countries that are part of the European Union, have led to the disappearance of market frictions and creation of a single market (Moschieri & Ragozzino, 2014). Additional financial integration has occurred in countries participating in the European Monetary Union through the adoption of a common currency, the Euro. The gradual financial integration of European markets through the implementation of goods, services, people and capital in 1993, and staggered introduction of a single currency in countries of the European Monetary Union since 1999 can be exploited to study the effects of financial and economic integration (Bekaert et al., 2013).
Due to the intermarket integration of the European Union, there is less opportunity to create value in cross-border mergers and acquisition as differences in terms of quality of legislative systems and access to capital markets are equalized between members of the European Union. To test the hypothesis of decreasing mergers and acquisitions cross-border value creation with the increasing of intermarket integration, the following research question is explored in this master’s thesis:
Has the disappearance of intermarket frictions and consequent integration of financial markets and national economies within the European Union led to a decrease in cross-border value creation in mergers and acquisitions?
In this empirical research, value creation in corporate takeovers is analysed through study of announcement returns of completed cross-border mergers and acquisitions of both acquirer and target firms between 1985 and 2018 in the European Union. Cumulative abnormal return methodology five days prior- and after the announcement date is conducted to identify value creation. To test whether the disappearance of inter-country market frictions in the European Union possibly cause decreasing value creation in intra-European cross-border corporate takeovers, the following two statistical approaches are used in this research: (i) Ordinary Least Squares (OLS) regressions to test the magnitude of changes in value creation relative to the level of inter-country integration of international economies, and European debt and equity markets. This approach does not take an arbitrary point in time to simulate integration (i.e. joining the European Union or the adoption of the Euro), but rather measures the degree of financial and macroeconomic integration
between countries over time. The measures of integration are similar to those in research by Bekaert et al. (2013), Hardouvelis et al. (2006, 2007) and Maltritz (2012) to study European capital markets.
(ii) Difference-in-Difference methodology to exploit the staggered adoption of the Euro across the European Union to test for increases in inter-country integration, and Brexit announcement to study increases in inter-country segmentation. This is similar to the approach used by Gormley and Matsa (2016) to study the staggered adoption of anti-takeover laws in the United States.
Results indicate that for acquirer and target firms, takeover value creation decreases when equity markets integrate, and inflation differentials decrease. Acquirer firms have less value creation when inter-country debt markets integrate and business cycles converge, whereas target firms experience more value creation in this situation. Furthermore, takeovers create less value when both acquirer and target firm are incorporated in countries participating in the EMU. The degree of inter-country integration prior to countries joining EMU does not alter the impact of EMU on takeover value creation, instead, for firms incorporated in European Coal and Steel (ECSC) and Periphery countries takeover value creation increases with participation in EMU. Takeovers in which acquirer or target firms are incorporated in the United Kingdom create more value post-Brexit referendum.
The remainder of this thesis is structured as follows. In paragraph 2 existing literature is reviewed in the sections: 2.1 Determinants of Mergers and Acquisitions, 2.2 Segmentation of International Capital Markets, and 2.3 European Integration. In section 2.4 literature is used to form hypotheses. After that, in paragraph 3, the research methodology is introduced through sections: 3.1 Choice of Sample Group, 3.2 Measuring Takeover Value Creation, 3.3 Capturing the Effect of Inter-Country Integration, 3.4 Model of Research, and 3.5 Statistical Hypotheses. In paragraph 4, the dataset of this research is described in the sections: 4.1 Discussion of Cumulative Abnormal Return Estimates, and 4.2 Descriptive Statistics of Variables. The performed analysis and results are discussed in the sections: 5.1 Effect of Financial and Economic Integration, 5.2 Integration Effect of the European Monetary Union, and 5.3 Robustness Test. In paragraph 6, the limitations of this research are explained. Finally, in paragraph 7, concluding remarks are made, placed into perspective, and suggestions are made for future research.
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2. Literature Review
In this paragraph, existing academic research on the subject of mergers and acquisitions activity, market segmentation and integration, and European integration are discussed. In section 2.1, motives for firms to participate in mergers and acquisitions are explained. Specifically, differences between domestic and cross-border acquisitions are outlined by looking at the sources by which market investors estimate the value gain to acquirer and target firm of the post-takeover combined entity. Considering relative legal standards and financial integration are fundamental in cross-border acquisitions value creation, in section 2.2, segmentation of international capital markets is analysed further. In section 2.3, European market integration and its developments in becoming a single market are explored. Finally, in section 2.4, hypotheses on value creation in mergers and acquisitions within the European Union are formed by relating cross-border mergers and acquisitions theory, and market segmentation theory to European inter-country market integration over time.
2.1) Determinants of Mergers and Acquisitions
In academic literature, many factors have been identified that explain the occurrence of mergers and acquisitions within a ‘single market’ and those that go ‘cross-border’ into markets with different economic, financial, and legislative conditions.
2.1a Single Market Determinants
In a single market, mergers and acquisitions activity is generally explained by a combination of Neoclassical and Behavioural Theory. Neoclassical explanation relies on the rationality of both the acquiring and target managements to maximize shareholder value: Mergers occur only when the combination of two firms increases total value, or utility, relative to when both firms would continue to exist as separate entities (Erel et al., 2012). The increase in value and/or utility are the result of synergies that are not only created through revenue enhancement and cost reductions but can also be a reaction to economic, (de)regulatory, and technological shocks that lead to opportunities for business expansion (Harford, 2005).
Typically, revenue-enhancement is achieved through the branding and cross-selling of goods and services, and/or increased market power. As mentioned by Jensen and Ruback (1983), cost reductions and operational efficiency gains are achieved through
reorganization of the combined entity’s marketing and administrative departments, creating economies of scope. Economies of scale arise from the adoption of more efficient production or organizational technology that one of the firms of the combined entity possessed pre-takeover. Additionally, Hayn (1989) finds that firms also have a financial motivation for acquisitions by creating value post-takeover through optimization of a target firm’s capital structure and underutilized tax shield.
Contrarily, in Behavioural Finance Theory, merger and acquisition activity is explained by agency problems. Agency problems arise from suboptimal contracting, enabling the management of a firm to disregard the principle of shareholder value maximization and maximize individual utility even if at a cost to total firm value (Gormley & Matsa, 2016). Examples of individual value maximization are diversifying acquisitions into businesses that are either: (i) less-risky and ensure the employment of the acquirer’s management in the future, or (ii) increase prestige for the acquirer’s management (i.e. empire building). Additionally, following the logic of Roll’s Hubris Hypothesis, distortions in management ego and consequent hubris induce overbidding in acquisitions due to the management’s biased perception of value that can be created post-takeover (Roll, 1986). From a behavioural point of view, mergers and acquisitions are zero value or even value destroying propositions. 2.1b Intermarket Determinants
Harris and Ravenscraft (1991) argue that if all countries would have perfectly integrated macroeconomic policy and inter-country capital markets, effectively there would be a single market spanning multiple countries. In this situation, only single market determinants of corporate takeovers (as discussed in the previous subsections) would apply, therefore the cross-border takeover market would be driven by identical factors compared to a domestic takeover market.
However, perfect economic and financial integration between different countries is difficult to achieve. In addition to motives for mergers and acquisitions found in domestic (single) markets, acquisitions in the intermarket space are subject to a different set of frictions that can impede or facilitate mergers. The following five frictions at the national level affect volume (Rossi & Volpin, 2004), value creation and the probability of deal completion (Erel et al., 2012) in cross-border takeovers:
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1) Differences in Governance Standards
Rossi and Volpin (2004) argue that firms from countries with low quality regulatory systems are motivated to be acquired by firms from countries with high regulatory systems. When a country possesses a high quality regulatory system, firms within its borders are legally subjected to high levels of shareholder protection and are made to uphold high governance standards. Firms in countries with lower quality regulatory systems can gain value from having to commit to higher legal standards that limit agency problems within firms and thus provides additional certainty for investors into the firm. In other words, by being acquired by an acquiring firm from a country with better legal shareholder protection and governance, additional value can be created for the target firm’s shareholders relative to a domestic takeover (Erel et al., 2012).
2) Differences in Macroeconomic Conditions
Relative inter-country wealth is another potentially important determinant of cross-border mergers: firms in wealthier countries tend to purchase foreign firms residing in poorer countries that are facing adverse macro-economic conditions that affect stock markets (Giovanni, 2005). Indeed, Erel et al. (2012) find that acquiring firms are more likely to be from countries with well-performing stock markets, while target firms are more likely to be from low-performing stock markets.
Similarly, when looking at relative currency movement between countries, acquiring firms are more likely to be from countries of which the ‘home’ currency recently appreciated, while target firms are more likely to have experienced a depreciation of ‘home’ currency value (Giovanni, 2005). At the same time, Danbolt and Maciver (2012) find no evidence to support the hypothesis that exchange rate movement leads to cost of capital (dis)advantages that increase or reduce the amount of takeover activity between countries. However, evidence is found that both acquirer and target firms benefit from business expansions post-takeover by growing market share in, and getting access to, foreign markets (Danbolt & Maciver, 2012).
3) Imperfect Integration of Inter-country Capital Markets
Merger activity is shown to be correlated with capital market liquidity: increases in macro-level liquidity are more important than technological or deregulatory shocks as drivers of merger waves (Harford, 2005). If inter-country markets are imperfectly integrated, liquidity increases in one country may not immediately spill-over to the other country, creating merger
activity from firms within a market with additional liquidity into markets of non-affected countries.
The importance of inter-country market integration is stressed further by Froot and Stein (1991). They note that unless capital markets are highly integrated between countries, domestic and foreign firms are not offered the same loan opportunities. Consequently, acquiring firms in cross-border mergers are often from countries with better integrated financial systems and capital markets because their cost of capital to finance their investments are lower (Erel et al., 2012). For firms in countries with strong capital market integration, cross-border takeovers are relatively cheap as compared to takeovers initiated by firms in countries with weaker capital integration into countries with stronger capital market integration (Francis et al., 2008).
From the perspective of target firms, access to foreign capital markets through means of takeover or cross-listing can be a valuable proposition that reduces the cost of capital associated with financing investments due to obtaining access to foreign investor’s capital (Francis et al., 2008). Additionally, Foerster and Karolyi (1999) find that cross-listed stocks are more liquid, and thus worth more than single-listed stocks due to subsequent liquidity premia. Obtaining additional sources of funding investment is valuable as firm value of financially constrained firms is found to increase post-takeover due to additional sources to fund profitable investments that the firm was barred from investing in earlier (Erel et. al., 2015).
4) Cultural Differences
According to Hofstede (1980), culture at the national level influences firms in terms of organizational values, dynamics and overall structure. Datta (1991) finds that organizational differences between acquiring and target firm have a negative impact on post-acquisition firm performance of the combined entity. Cultural differences thus could have a negative impact on post-acquisition firm performance of the combined entity. Other scholars, such as Erel et al. (2012) also push the idea that cultural differences are potentially value destroying in corporate takeovers because of additional costs associated with combining the two firm’s post-takeover.
5) Geographical Distance
Erel et al. (2012) find that the cost associated with combining a merging firm increases with the amount of geographical distance between the acquiring and target firm.
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2.2) Segmentation of International Capital Markets
Modigliani and Miller (1958) state that under perfect capital market conditions (i.e. in the absence of transaction costs, taxes, financial distress or bankruptcy costs, equivalent borrowing costs for firms and investors, asymmetric information, and agency costs) a firm’s cost of capital is independent of its capital structure. Additionally, if capital market conditions (i.e. liquidity) are similar across national borders and different currencies, and the inter-country capital markets are equally-integrated, the cost of capital should not be different between firms in different countries (Francis, et al., 2008). In a world of perfect capital market conditions, the cost of capital does not offer competitive advantages and consequently does not affect cross-border corporate investment decisions (Modigliani & Miller, 1958).
However, in reality access to capital markets are unlikely to be identical across national borders and different currencies: unless capital markets are highly integrated between countries, domestic and foreign firms are not offered the same loan opportunities (Froot & Stein, 1991). The source of this inequality in available capital to domestic and foreign firms is often a result of macroeconomic policy. Governments and central banks regulate and limit capital inflows and outflows by introducing capital controls and foreign exchange controls (Berk & DeMarzo, 2014). Capital controls can come in the form of taxes, tariffs, and legislation that restrict volume. Foreign exchange controls limit the use of foreign currency within the country, whether to have a fixed exchange rate or a floating exchange rate against other currencies, and the amount of currency that may be imported or exported. Furthermore, in some countries (i.e. China) it is also pre-determined which type of financial securities can be held by foreign investors and which cannot (Chan et al., 2008).
Unless countries coordinate their macroeconomic policies, cross-border investments can be negatively impacted by the resulting segmentation of international capital markets (Froot & Stein, 1991). Due to the unequal accessibility of capital, firms in specific countries, or working with specific currencies, are subjected to higher costs of capital relative to similar firms in other countries (Berk & DeMarzo, 2014). Similarly, growth rates are affected by macroeconomic policies. As firms in the same industry face similar production processes and market conditions, growth opportunities should be industry specific rather than country specific (Bekaert et al., 2013). However, if growth opportunities are not able to be transmitted
rapidly across countries, inequalities arise. As a result of inequalities in growth opportunities, similar industries in different countries will grow at different rates (Bekaert et al., 2005).
Another barrier to foreign investment projects is the volatility of the exchange rate between domestic and foreign currencies. Exchange rate risk can make the pay-off of investment uncertain and firms hesitant of doing business internationally. However, governments and central banks can solve this issue by mandating a fixed exchange rate that induces pay-off to be reliable in non-extreme market events (Obstfeld & Rogoff, 1995).
Thus, uncoordinated macroeconomic policy (i.e. taxes, tariffs and legislation) can result in capital market segmentation that leads to (1) different levels of growth in the same industry due to being located in different countries, and (2) comparative advantages in terms of cost of capital, dependent on the degree to which firms have access to capital to finance themselves across countries. Additionally, firms suffer from exchange rate risk when doing business in foreign non-integrated countries. These frictions disappear when inter-country capital markets are integrated and macroeconomic policy between countries are coordinated. 2.3) European Integration
At the end of World War II, the European economic system has largely collapsed as a result of the war. With European infrastructure in ruins and the loss of the European colonies, rebuilding the European economy was a challenge (Dinan, 2004). In the vacuum of power left by the European nations, two new world superpowers rise with contradictory socio-political ideologies: The United States (i.e. capitalism) and the Soviet Union (i.e. communism/Marxism-Leninism). In order to prevent future war in Europe, sentiment among politicians in European nations is to create an organisation that regulates industrial production under a centralised authority (Rittberger, 2001). The objective of this organisation is to accelerate the rebuilding of the European economy by international cooperation, while de facto eliminating the possibility of war breaking out between countries that are member of this organisation. As the industries necessary for war are integrated between member states and governed by a central authority, a war against one another is made materially impossible (Dinan, 2004). Additionally, a unified Europe offers protection against foreign invasion by the Soviet Union.
In 1952, with the Paris Treaty coming into force, six countries form the European Coal
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authority: Belgium, France, West Germany, Italy, the Netherlands and Luxembourg. In 1957, further efforts to integrate European industries and economic interests are undertaken by members of the ECSC by signing the Treaty of Rome (Rittberger, 2001). This treaty leads to the creation of the European Economic Community (EEC) and European Atomic Energy
Community (Euratom) in 1958. The objective of the EEC is to create a single market in which
there would be free movement of goods, services, people and capital (Sapir, 2011). However, only free movement of goods was achieved through the EEC’s customs union, the other components of a single market proved difficult to enforce due to protectionist attitudes towards national economic welfare from individual EEC members (Dinan, 2004).
In the aftermath of the collapse of the Bretton Woods system that pegged currencies from Canada, Western Europe (among others the EEC members), Australia and Japan to the American Dollar, the EEC initially failed in its plans to create an economic and monetary union in the 1970s due to uncontrollable currency fluctuations between EEC countries (Dinan, 2004). However, the EEC started to expand: In 1973, Denmark, Ireland and the United Kingdom joined. In 1981 Greece joined, while Portugal and Spain followed in 1986. With the prospect of further expansion of the EEC, the Single European Act is signed by which members commit to the creation of a single market by 1993. From 1993 onwards, within the EEC free movement of goods, services, people and capital is indeed achieved (Sapir, 2011).
In the Maastricht Treaty of 1992, the EEC not only renamed itself the European Union (EU) to signify its purposes beyond the economic realm, but also set out to integrate Europe further by proposing the creation of a single European currency: The Euro (Sapir, 2011). This single currency is to be controlled by one centralised authority governing all central banks of countries that participate in the monetary union: The European Central Bank (ECB). To achieve successful implementation of the Euro, four convergence criteria are set for countries to qualify for the newly founded Economic and Monetary Union (EMU):
1) Annual governmental budget deficit is at most 3% of GDP; 2) Countries have public debt of at most 60% of their own GDP;
3) National level of inflation within a range of 1,5% of the three countries in the EU with the lowest inflation rates;
4) National level of interest within a range of 2% of the three countries in the EU with the lowest interest rates.
Additionally, the EMU is implemented in three stages: In the first stage, from 1990 onwards, exchange controls are abolished, and capital movement is completely liberalised within the EU. In the second stage, from 1994 onwards, the ECB is founded, and an agreement (i.e. Stability and Growth Pact) is made between EU members to ensure budget discipline (Lane, 2006). In the final stage, in 1999, the Euro is introduced in EU countries that meet the four convergence criteria.
However, with the collapse of the Soviet Union across central and eastern Europe in the late 1980s and early 1990s, East and West Germany are able to reunite in 1990. To appeal to East Germany, the more expensive West German currency is exchanged on equal terms with the less expensive East German currency leading to inflationary pressures on the West German economy. Since EU members have pegged their currencies to one another, the inflationary pressure resulted in economic difficulty all over the EU (Buiter et al., 1998). Consequently, The United Kingdom and Denmark decide not to join the European Monetary Union over inflationary fears in the future that would be difficult to treat without individual central banks controlling the money supply: If all of Europe is using one single currency, one centralised authority using the money supply to control economic growth and inflation could have ambiguous consequences (i.e. unemployment) for countries with the same currency that are not experiencing similar inflation or economic growth (Meade, 1957). However, both The United Kingdom and Denmark remain part of the European Union and its Single Market.
Even during the economic difficulties of the mid 1990s, the European Union gains three new members: Austria, Finland, and Sweden. The Euro is introduced in 1999 in 11 countries that meet the convergence criteria: Austria, Belgium, Finland, France, Germany, Ireland, Italy, Luxembourg, Netherlands, Portugal, and Spain (Lane, 2006). Physical “Euro” notes and coins make their appearance in 2002. Another 8 countries join the EU and EMU in the years after the introduction of the Euro: Cyprus, Estonia, Greece, Latvia, Lithuania, Malta, Slovakia, and Slovenia. As of 2018, out of the 28 countries that are part of the EU, 9 do not participate in the EMU: Bulgaria, Croatia, Czech Republic, Denmark, Hungary, Poland, Romania, Sweden, and The United Kingdom.
From the perspective of market segmentation theory, European markets progressively have the characteristics of a fully integrated single market: Since 1993 there is free movement of capital, services, goods and people in the EU and macroeconomic policies are coordinated
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(Bekaert et al. 2013). With the abolishment of capital controls and the elimination of exchange rate risk within the EMU from 1999 onwards, inter-country capital markets are highly integrated (Hardouvelis et al., 2007). Research by Gill et al. (2009) confirms that since the introduction of the Euro, correlation between stock markets of EU countries have increased significantly. Similarly, scholars find that the equity cost of capital has decreased since the introduction of the Euro (Bekaert et al., 2013). Campa et al. (2014) find that due to integration in the EU, cultural and political barriers in cross-border takeovers have decreased. Finally, national growth rate differentials between EU countries have declined (Bekaert et al., 2013) and business cycles have shown trends of convergence (Haan et al., 2008).
Although intermarket integration as the result of the creation of a European single market and currency has affected all countries within the EU and EMU, some countries have benefitted more from the unification of Europe than others (Lane, 2003). Countries in the European Periphery (i.e. Portugal, Ireland, Greece, and Spain) have experienced significant economic gains from post-EMU acceptance integration in the form of increased international trade and more investments due to lower costs of capital (Micco et al., 2003). Additionally, lower interest rates on and EMU commitment to government debt have increased financial stability of “periphery” governments (Lane, 2012). Meanwhile, the countries that originally started European integration by establishing the ECSC in 1952 (i.e. Belgium, France, Germany, Italy, Luxembourg and The Netherlands) gained less as there was financial stability, coordination of macroeconomic policy and extensive trade agreements prior to the creation of EMU (Dinan, 2004). Therefore, intermarket integration as a result of EMU have had more impact in the European Periphery than inside the original ECSC countries.
After the results of the 2016 Brexit-referendum, The United Kingdom is planning to leave the European Union by 2021. The Single Market agreements that The United Kingdom has been part of, are in the process of being renegotiated. Depending on the outcome of these negotiations, The United Kingdom might not be as well integrated with EU countries as it is prior to 2021 (Dhingra & Sampson, 2016).
2.4) Hypotheses
In academic research on mergers and acquisitions, the amount of value that can be created in an acquisition is dependent on whether the takeover takes place in a single market or crosses national/inter-market borders: In single markets, value in the post-takeover combined entity is created through operational revenue enhancement, cost reductions and tax savings. Inter-market acquisitions can create additional value through benefitting from obtaining access to foreign capital markets, better governance standards, and using favourable macroeconomic conditions that lead to relatively inexpensive takeovers.
Decades of political and economic integration have led European markets to carry the characteristics of a single market: a common legislation, and free movement of goods, services, people and capital. Additionally, in the European Union macroeconomic policies are coordinated, inter-country capital markets integrated, and exchange rates eliminated between those countries that also participate in the European Monetary Union. With the increase in financial market integration since the adoption of the Euro, there is less opportunity for European firms to create value in cross-border takeovers within Europe. These expectations are reflected in the following four hypotheses that are tested in this research:
1) A decrease in value creation in cross-border mergers and acquisitions between countries after joining the European Monetary Union, relative to value creation in cross-border mergers and acquisitions between the same countries before joining the European Monetary Union.
2) No effect on value creation in cross-border mergers and acquisitions between firms from countries in the European Monetary Union that originally established the European Coal and Steel Community (i.e. Belgium, France, Germany, Italy, Luxembourg and The Netherlands).
3) A greater decrease in value creation in cross-border mergers and acquisitions in countries in the European Monetary Union that are part of the European periphery (i.e. Portugal, Ireland, Greece and Spain).
4) An increase in United Kingdom based cross-border mergers and acquisitions value creation after the announcement that Great Britain will no longer be part of the European Union, as a result of increased market segmentation.
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3. Methodology
In this paragraph, the methodology applied in this research is established. First, in section 3.1, the rationale behind analysis of the European Union, and division of countries into subsample groups are discussed. In section 3.2, value creation in corporate takeovers through study of cumulative abnormal returns is explained. In section 3.3, the measures of financial and economic integration are introduced. In section 3.4, the base regression model to study the relationship between value creation around announcement dates and relative inter-country integration is clarified. Finally, in section 3.5, different specifications of the base regression model are determined to test the four hypotheses of this research.
3.1) Choice of Sample Group
In this empirical research, cross-border mergers and acquisitions are evaluated for possible value creation limiting consequences of economic and financial intermarket integration. To assess intermarket integration, the European Union (EU) is chosen. The EU makes for a well-documented area to study the effects of intermarket integration, as post-World War II political sentiment have led to the gradual establishment of a unified Europe. The progressive implementation of policies to integrate participating European countries create opportunity to study the effect of intermarket integration on value creation.
Research is performed on takeovers from 1985 to 2018 to take into account the most significant advancements in terms of inter-country economic and financial integration respectively: The creation of a single market through the implementation of the Single European Act in 1993 (i.e. the abolishment of capital controls and introduction of free movement of capital, services, goods and people between countries in the EU), and the staggered adoption of a single currency (i.e. the Euro) across participating countries in the European Monetary Union (EMU) since 1999.
To exploit the various degrees of overall inter-country integration and gains from implementation of single market and/or currency, EU countries are divided into three subsample groups: (i) EMU, (ii) ECSC, and (iii) Periphery. EMU countries have a higher degree of inter-country integration than countries that only participate in the EU, due to EMU countries using a common currency and committing to policies surrounding inflation, interest, and government debt and budget deficits. Further distinction can be made between the effect
integration had on ECSC and periphery countries respectively: The countries that founded the ECSC operated trade agreements and had financial stability prior to the introduction of the single market and currency, periphery countries did not. In Table 1 more detail can be found on which countries are assigned to which specific subsample groups.
Table 1
This table reports for each country in the dataset whether the country participates in EMU and can be classified as originally part of the ECSC or European periphery, as well as the first year of EU membership and Euro adoption.
First year of membership/adoption Country EMU ECSC Periphery EU Euro
Austria X 1995 1999 Belgium X X 1957 1999 Bulgaria 2007 - Czech Republic 2004 - Denmark 1973 - Finland X 1995 1999 France X X 1957 1999 Germany X X 1957 1999 Greece X X 1981 2001 Hungary 2004 - Ireland X X 1973 1999 Italy X X 1957 1999 Luxembourg X X 1957 1999 Malta X 2004 2008 Netherlands X X 1957 1999 Poland 2004 - Portugal X X 1986 1999 Spain X X 1986 1999 Sweden 1995 - United Kingdom 19731 - Total Countries 11 6 4 20 11
1After the Brexit-referendum in 2016, the United Kingdom has committed to leaving the European Union
by 2021. The participation of the United Kingdom in the European Union’s single market post-2021, is currently (as of June 2018) in the process of being negotiated.
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3.2) Measuring Takeover Value Creation
In order to measure value creation in mergers and acquisitions, an event study is performed based on the cumulative abnormal stock returns (CAR) of acquiring and target firm around the takeover announcement date. To differentiate between a firm’s stock return that could occur on any trading day (i.e. the “normal return”), and stock returns that are related solely to the takeover announcement (i.e. the “abnormal return”) which capture the value creation or losses of the firms involved in the takeovers as expected by market participants, this research employs two methods: (1) the Market Model, and (2) the Market-Adjusted Return Model.
Using the Market Model approach, a firm’s abnormal stock returns (AR) during a takeover announcement are computed by taking the difference between the stock returns of the firm on the days surrounding the takeover announcement, and the predicted normal stock returns (NR) the firm would experience in the absence of the takeover announcement (MacKinlay, 1997):
!"#$%&,( = "#$%&,(− "#,%&,(-
Predicting a firm’s “normal stock return” is possible through analysis of the firm’s historic stock performance relative to the market index in a time interval prior to the corporate takeover announcement (i.e. “estimation window”), using the following formula:
"#$%&,(./ = 0#$%&,(./+ 2#$%&"34%567,(./+ 8#$%&,(./
By saving the firm’s historic alfa and beta coefficients, the returns of the market index on the days surrounding the takeover announcement can be exploited to predict the firm’s returns if there would not have been a takeover announcement (Brown & Warner, 1985):
"#,%&,(- = 0#$%&,(./+ 2#$%&"34%567,(+ 8#$%&,(
To investigate the robustness of the value creation measured using the Market Model approach, this research also approximates value creation by calculating abnormal returns around the takeover announcement through usage of the Market-Adjusted Return Model. This model is similar to the Market Model but has simplifying assumptions concerning the alfa and beta of a stock (MacKinlay, 1997). Instead of predicting the normal return of a stock by using a firm’s historic alfa and beta coefficients within a certain market, the stock return of a firm is benchmarked against the return of the market index on the same day (i.e. alfa and beta are assumed to be zero and one respectively). In formula form, the Adjusted-Market Return Model looks as follows: !"#$%&,( = "#$%&,(− "34%567,(
Factors of influence on the amount of abnormal returns observed in a specific article can not only be related to the model used to identify normal returns, but also to the number of trading days taken to approximate normal return (i.e. the “estimation window”), and sum abnormal returns (i.e. the “event window”). In this research, the “estimation window” used to calculate historic alfa and beta coefficients in the Market Model are a year and a month, or -273 to -21 trading days, prior to the takeover announcement. The “estimation window” equals an entire year in order to control for any bias caused due to the effect of seasonality (Keim, 1983), and ends a month prior to the announcement to control for insider-trading that may cause biased stock returns (Keown & Pinkerton, 1981). As the estimation window in the Market-Adjusted Return Model eclipses the event window, in this model only data on the target and acquirer firm’s stock return and returns of the market index during the event window are used.
Finally, to analyse the overall takeover announcement effect for each individual target and acquirer firm in the dataset, the abnormal returns are summed for a specific number of days around the announcement date (i.e. the “event window”) to form cumulative abnormal returns (CARfirm):
9!"#$%& = : !"#$%&,(
(;<
(;.<
For the combined the combined announcement effect, the market value-weighted average of acquirer and target firm cumulative abnormal returns is used (Berkovitch & Narayanan, 1993). In this research, the core “event window” is five days prior- and after the announcement date of a corporate takeover in order to limit the amount of noise in the data and ensure stock returns only reflect the expected value creation (or destruction) related to the takeover announcement (Brown & Warner, 1985). However, stock returns of acquirer and target firms are downloaded in excess of 20 trading days around the takeover announcement date for purposes of robustness.
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3.3) Capturing the Effect of Inter-Country Integration
Apart from classifying firms in takeovers according to their respective country of incorporation’s participation in the EMU, this research also uses specific inter-country financial and macroeconomic data to statistically measure varying levels of integration over time. These measures of integration are employed in the analysis to specify integration effects on value creation that can be related to integration in financial markets (i.e. equity and debt markets) or originate from inter-country economic convergence (i.e. inflation and business cycle convergence). Additionally, in this section control variables are introduced.
3.3a Measures of Financial and Economic Integration
To study the effect of integration of inter-country financial markets, measures for both equity and debt markets are developed.
Similar to the approach used by Bekaert et al. (2013) to measure equity market integration, the absolute difference in the year of the takeover is taken between earnings yield (EYseg) present in the market indices of the stock exchange in the country the acquirer and target firm are from respectively: |EY Country Acquirer Firm – EY Country Target Firm|. Annual earnings yields are computed manually by taking the inverse of an annual market value weighted-average of Price/Earnings (PE) ratios of firms in the market index of a country’s stock exchange. Studying the earnings yield spread between countries to gauge equity market integration exploits the idea that as countries integrate, industries across countries will increasingly face similar market conditions, growth opportunities and production processes which lead to inter-country decreases in valuation and growth differentials (Bekaert et al., 2013). Therefore, as inter-country integration increases, earnings yield spreads should decrease. Additionally, as equity market integration increases, cross-listing premiums decrease and overall value creation in cross-border takeovers are expected to decline.
To measure the degree of debt market integration in the year of the takeover, the absolute difference between yield on sovereign debt (YSDseg) in the country the acquirer firm is incorporated in and the yield on sovereign debt in the country that the target firm is incorporated in, is computed (Maltritz, 2012): |YSD Country Acquirer Firm – YSD Country Target Firm|. Yield on sovereign bonds are the dominant metric to gauge the default and liquidity risk of a country as perceived by investors (Lane, 2012). By studying the inter-country spread of
sovereign debt yield, the integration of debt markets can be derived as capital market integration should increasingly lead to equal costs of capital and a similar degree of financial stability between countries (Lane, 2006). As integration between the country of the acquiring and target firm increase, the benefit in terms of attaining a better cost of capital decreases and overall value creation in the takeover is expected to decline.
To research how the convergence of inter-country economic conditions are affecting cross-border corporate takeover value creation, the annual inter-country growth differential between the Gross Domestic Product (DGDPseg) of the countries the acquirer and target firm are incorporated in are studied (Hardouvelis et al., 2006): |DGDP Country Acquirer Firm – DGDP Country Target Firm|. As firms face the difficulty of maintaining high organic growth, a solution can be found in expanding into foreign territory with higher economic growth rates to sustain firm growth figures (Becketti, 1986). However, the convergence of business cycles eliminates this opportunity as the difference between inter-country growth rates declines. Therefore, as business cycle converge, value creation in cross-border acquisitions decrease.
Another measure of economic integration is the relative level of inflation between countries. Inflation causes the devaluation of capital, as a result interest rates (i.e. cost of debt) rise in order to offset the value decrease providers of debt will suffer over time. As the relative level of inflation between countries increases, prospects of value creation decrease as any growth potential in foreign territory is limited by inflation induced devaluations and higher costs of capital (Fischer & Modigliani, 1978). Additionally, takeover value increases due to increased inter-country inflation differentials might be explained by market expectations that factor in inflation risk reductions by international diversification of the business (Levy & Sarnat, 1970). In this research, the inflation differential is measured by comparing the annual change in Consumer Price Index (CPI) between countries (Hardouvelis et al., 2006): |CPI Country Acquirer Firm – CPI Country Target Firm|.
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3.3b Control Variables
To ensure that the measured effect of varying levels of integration between countries on announcement returns in cross-border takeovers is unbiased by correlation with deal characteristics of the takeover, the following seven control measures are introduced: Industry Relatedness, Wealth of Country of Incorporation Acquirer, Deal Attitude, Deal Value, Method of Payment, Firm Size, and Relative Size:
(1) Industry Relatedness is a dummy variable that equals 1 if takeover is between firms within the same industry, and 0 if otherwise. This variable is taken into account to control for influences on the announcement stock return that originate from whether a firm expands its business into a new industry or the takeover takes place between firms that operate in the same industry (Doukas & Travlos, 1988). Expectations of additional growth potential in terms of both market share and revenue streams when expanding into a new industry, biases announcement returns upwards compared to non-industry diversifying takeovers.
(2) Wealth of Country of Incorporation Acquirer, based on the absolute value of GDP per Capita, is taken into account to control for the possibility that acquirer firms from wealthy countries have the ability to pay more in a takeover, thereby creating an upwards bias in announcement returns of the target firm that is not based on differing levels of inter-country market segmentation (Rossi & Volpin, 2004).
(3) Deal Attitude is a dummy variable that equals 1 if the takeover is perceived as friendly, and 0 if otherwise. This variableis taken into account to control for influences on the announcement stock return that are based on the target firm management’s attitude towards the acquiring firm’s initiative to pursue takeover of the target firm. A hostile attitude towards a takeover by the target firm’s management leads to marginally higher abnormal returns (Huang & Walkling, 1987).
(4) Deal Value, based on the absolute deal transaction value, is taken into account to control for influences on the announcement stock return that are based on the size of the transaction, rather than the future prospect of the combined entity after the takeover (Fuller et al., 2002).
(5) Method of Payment is a dummy variable that equals 1 if the takeover is completed in a cash only transaction, and 0 if otherwise. This variableis taken into account to control
for influences on the takeover announcement return that are based on the signalling properties of the method of payment (stock, cash or mixed offers) with which the transition of ownership is completed (Martin, 1996). When the acquisition offer is all cash, abnormal returns are higher in both the short (Huang & Walkling, 1987) and long run (Loughran & Vijh, 1997). Additionally, abnormal returns in all cash offers are not only higher for the acquirer firm, but also for the target firm (Malmendier et al., 2016). (6) Firm Size, based on the absolute value of a firm’s market capitalization, is taken into account to control for influences on the announcement return that are based on the size of the firm itself. Moeller et al. (2004) report that announcement returns for small acquirer firms are higher than for big acquirer firms.
(7) Relative Size is taken into account to control for the upward bias of increasing target firm size relative to acquirer firm that influences the announcement stock return of the acquirer (Fuller et al., 2002). The following formula is used to calculate Relative Size: (Market Value Target Firm / (Market Value Acquirer Firm + Market Value Target Firm)).
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3.4) Model of Research
In order to research whether inter-country integration leads to decreasing value creation in cross-border corporate takeovers, a panel data-based event study is performed to analyse the effect of inter-country financial and economic integration on the announcement returns of cross-border mergers and acquisitions. In this research, the following base regression model is employed:
Base Model
(1) =>?@A 9BA>CDEF = 0G+ 2/HI@DCJK>BLACMFCANB>CDEF + 2OPAQCK>BLACMFCANB>CDEF +
2RS@TDFATT9JU?A9EFVABNAFUA + 2WMFX?>CDEFPDXXABAFCD>? +
2<MFY@TCBJ"A?>CAYFATTP@ZZJ + 2[!UI@DBAB\P]U>^DC> +
2_!CCDC@YAP@ZZJ + 2`PA>?=>?@A + 2a9>TℎP@ZZJ +
2/GKBLC9>^cDBZ + 2//"A?>CDVAdDeA + fC + g$ + 8$7
Value creation is measured through analysis of the Cumulative Abnormal Returns (CARs) five trading days prior and after the takeover announcement date using Market Model methodology. While for individual acquirer and target firms observed cumulative abnormal returns remain unaltered, to study the overall announcement return of the post-takeover combined entity, the market value-weighted average of acquirer and target firm cumulative abnormal returns is used.
The measures of financial, {b1, b2}, and economic integration {b3, b4} are measured by taking the absolute inter-country difference between target and acquirer country of incorporation’s annual earnings yield, sovereign debt yield, GDP growth rate, and inflation. Control variables are represented by {b5, … b11}. Furthermore, this regression contains time (lt) and industry (gi) fixed effects, whenever possible, to control for systematic differences in announcement returns of specific industries or years by clustering the standard errors.
In case inter-country integration of financial markets and economies lead to less value creation in cross-border mergers and acquisitions, statistical inference is expected to be found corresponding to widening (narrowing) international segmentation leading to increasing (decreasing) value creation in the form of higher (lower) cumulative abnormal returns. This is reflected in the following pattern of coefficients in which H0 corresponds to the hypothesis that inter-country segmentation has no effect, while H1 describes the alternative hypothesis that increasing segmentation induces higher cumulative abnormal returns and thus indicates increased value creation in takeovers: H0: {b1, b2, b3,b4} = 0 H1: {b1, b2, b3} > 0 & {b4} < 0
3.5) Statistical Hypotheses
Having established an empirical approach to measure the effect of inter-country integration of financial markets and economies, in this section three different specification of the base regression model are introduced that are employed to test the four hypotheses of this research as mentioned in paragraph 2.4.
Regression Model Specifications
(1) =>?@A 9BA>CDEF = 0G+ 2/HI@DCJK>BLACdANZAFC>CDEF + 2OPAQCK>BLAC dANZAFC>CDEF +
2RS@TDFATT9JU?AdANZAFC>CDEF + 2WMFX?>CDEFdANZAFC>CDEF +
2<HKhP@ZZJ + 9EFCBE? =>BD>Q?AT + fC + 87
(2) =>?@A 9BA>CDEF = 0G+ 2/HI@DCJK>BLACdANZAFC>CDEF + 2OPAQCK>BLAC dANZAFC>CDEF +
2RS@TDFATT9JU?AdANZAFC>CDEF + 2WMFX?>CDEFdANZAFC>CDEF +
2<HKhP@ZZJ + 2[]ABD^ℎABJP@ZZJ + 2_H9d9P@ZZJ +
2`HKhP@ZZJ ∗ ]ABD^ℎABJP@ZZJ + 2aHKhP@ZZJ ∗ H9d9P@ZZJ +
9EFCBE? =>BD>Q?AT + fC + 87
(3) =>?@A 9BA>CDEF = 0G+ 2/HI@DCJK>BLACdANZAFC>CDEF + 2OPAQCK>BLAC dANZAFC>CDEF +
2RS@TDFATT9JU?AdANZAFC>CDEF + 2WMFX?>CDEFdANZAFC>CDEF +
2<SBAjDCP@ZZJ + 9EFCBE? =>BD>Q?AT + f7 + 87
In order to study the effect of increased inter-country integration on value creation in cross-border takeover announcements, the staggered acceptance of European Union (EU) countries into the European Monetary Union (EMU) is first exploited in regression model 1, using Difference-in-Difference methodology. First, to reflect hypothesis 1, the regression is performed on acquirer and target firms from all EU countries to find the overall integration effect of EMU. Countries accepted into the EMU are in the treatment group, while those countries that are not join the control group. As all countries of the European Union appear to integrate over time, even without joining EMU, this research assumes a common trend of integration. Furthermore, the staggered acceptance of countries into the EMU makes for repeated shocks to inter-country segmentation over time. For decreasing value creation due to inter-country integration caused by participation in EMU, in regression 1, the coefficient on EMU Dummy {b5} must be negative.
Next, as reflected in hypothesis 2, the effect of EMU on cross-border acquisition announcement value creation is specified according to the degree of integration prior to acceptance into EMU. As countries that originally formed the European Coal and Steel Community (ECSC) had inter-country agreements on capital controls and trade long before
28
the instalment of the EMU, the shock on inter-country integration of adopting a single currency is expected to be lower or even leave ECSC countries unaffected. Again, regression model 1 is used, yet this time restricted to only acquisitions with acquirer and target firms that are incorporated in ECSC countries. To reflect the limited effect of participation in EMU due to prior-inter-country integration, the coefficient on EMU Dummy {b5} must be equal to zero. Contrarily, due to EMU’s low cost of debt and advanced legislative institutions, Periphery countries are expected to benefit more from acceptance into EMU than countries that had those economic conditions prior to participation in EMU (i.e. ECSC countries). Therefore, Periphery countries experience a greater shock to inter-country integration with acceptance into EMU by reaching similar economic conditions to other countries in EMU. Due to the increased integration effect of EMU, as reflected in hypothesis 3, takeover announcement returns for firms incorporated in Periphery countries are expected to decrease more. This is tested first through regression model 1, restricting the sample to takeovers in which either the acquirer or target firm is incorporated in a Periphery country. To reflect the effect of increased inter-country integration due to participation in EMU, the coefficient on EMU Dummy {b5} must be negative. Next, using regression model 2, a comparison is made between takeover announcement returns of acquirer and target firms in Periphery countries and ECSC countries post-acceptance into EMU. The coefficient on the interaction term between Periphery Dummy and EMU Dummy {b8} are expected to be more negative than the coefficient on the interaction term between ECSC Dummy and EMU Dummy {b9}.
In order to check the robustness of the researched relationship between inter-country integration of financial markets and national economies, as reflected in hypothesis 4, the Brexit-event (referendum in which citizens of the United Kingdom voted to leave the EU) is exploited and used as an exogenous shock that leads to increased segmentation between the United Kingdom and other countries in the EU. As segmentation leads to additional value creation, the overall trend of decreasing value creation among cross-border takeovers within the European Union is expected to reverse when the takeover involves an acquirer or target firm from the United Kingdom. This is tested through regression model 3, restricting the sample to takeovers in which either the acquirer or target firm is incorporated in the United Kingdom. To reflect the effect of increased inter-country segmentation after the Brexit, the coefficient on Brexit Dummy {b5} must be positive.
4. Data
From the Thomson ONE Securities Data Corporation’s (SDC) Mergers and Acquisitions (M&A) Database a list of completed acquisitions is collected in which both acquirer and target firm are incorporated in European countries that participate in the European Union as of December 2017, with takeover bids announced between January 1, 1985 and December 31, 2017. Next, Datastream is used to retrieve firm stock data, and relevant macroeconomic measures. To be included in the sample, the following conditions must be satisfied:
1. Both acquirer and target firm are public, and have stock trading in a stock exchange at the time of the takeover announcement.
2. Takeovers take place between firms incorporated in different countries.
3. The prime industry acquirer and target firm are active in can be identified by Standard Industrial Classification (SIC) code.
4. Market capitalization of both acquirer and target firm are available one month prior to the takeover.
5. Deal value of one hundred million euros or more, and the method of payment in the transaction in terms of percentage paid in cash is known.
6. Macroeconomic measures of financial and economic integration (i.e. Price/Earnings (PE) ratios, Yield on Sovereign Debt with a maturity of 10 years, Gross Domestic Product, and Inflation as measured through the Consumer Price Index (CPI)) at a national level are available annually.
Aforementioned conditions have the following effect on the number of acquisitions in the dataset: Of the 310.000 observed takeovers in Europe between 1985 and 2017, 100.000 takeovers involved a public acquirer firm. After taking out acquisitions in which the target is a private firm, 12.844 takeovers remain. When dropping observations detailing domestic takeovers, 1.628 cross-border mergers and acquisitions between firms in European countries are left. After deletion of observations with missing Datastream codes, deal values, SIC codes, and market capitalization, the dataset consists of 905 takeovers. When correcting for takeover deal values below one hundred million, 534 takeovers remain in the dataset. At this point, the dataset consists of acquirer and target firms from 26 out of the 28 countries in the European
30
However, due to unavailable PE ratios for the market indices of the stock exchanges situated in Cyprus, Estonia, Latvia, Lithuania, Slovakia, and Slovenia, the sample is reduced to 436 observed takeovers in 20 of the 28 countries in the European Union. The total number of target and acquirer firms in this research therefore accumulates to 862. In Table 2 more detail can be found on the number of observations per country and subsample group (i.e. the European Coal and Steel Community (ECSC), Periphery countries, and European Monetary Union (EMU)).
First Year of Data Country Acquirer Target Total Acquirer Target Austria 4 11 15 1991 1997 Belgium 20 21 41 1990 1989 Bulgaria - 1 2 - 2003 Czech Republic 1 5 6 2005 1997 Denmark 5 8 13 1992 1998 Finland 13 8 21 1989 1996 France 105 63 168 1987 1988 Germany 72 52 124 1989 1989 Greece 1 14 15 1999 1999 Hungary - 3 4 - 2002 Ireland 7 3 10 1989 1988 Italy 45 22 67 1985 1987 Luxembourg 3 9 12 2000 1998 Malta - 1 2 - 2011 Netherlands 39 41 80 1988 1988 Poland 1 12 13 2004 1994 Portugal 6 16 22 1997 1994 Spain 43 45 88 1989 1988 Sweden 20 25 45 1989 1987 United Kingdom 51 66 117 1987 1985 Total 436 426 862 ECSC 284 208 492 Periphery 57 78 135 EMU 358 305 663 Table 2
This table reports for each country the number of cross-border takeovers, whether the takeover involves an acquirer or target firm incorporated in a certain country, and the first year a country appears in the form of an acquirer or target firm in the dataset.
4.1) Discussion of Cumulative Abnormal Return Estimates
In this research, the Cumulative Abnormal Returns (CAR), calculated through Market Model methodology, are used to measure value creation in European Cross-border takeovers five days around the announcement date. To compare the CAR estimation results of the Market Model, in this section CAR estimation results of the Market-Adjusted Return Model are evaluated. In Table 3, CAR estimates using the Market Model and Market-Adjusted Return Model are reported in Panel A and Panel B, respectively. Further comparison is made by contrasting Market Model CAR estimates of this research with CAR estimates found in research on cross-border mergers and acquisitions by other scholars.
Overall results in Panel A show that CAR estimates for acquirer and target firms are on average positive over the entire sample. Acquirer firms experience 0.008% abnormal increase in value, while target firms generate 5.412% abnormal value increase due to the takeover announcement. Interestingly, target firms CAR over the full sample show an increasing trend over time: from 3.457% CAR in a time interval ranging from 1985 to 1995, to 5.564% CAR from 1996 to 2005, to 5.777% CAR from 2006 to 2017. Overall acquirer firm CAR does show a similar increase in value creation between the time interval ranging from 1985 to 1995 (0.341%) and 2006 to 2017 (0.878%), however observed CAR turn negative (-0.679%) between 1996 and 2005. The market value-weighted combined effect of acquirer and target firm CARs increases over time, after a dip between 1996 and 2005, from 0.391% between 1985 and 1995 to 0.981% between 2006 and 2017.
Furthermore, distinct differences are visible between CARs of acquirer and target firms in ECSC and Periphery countries: CARs of acquirer firms in Periphery countries are higher in time intervals 1985 to 1995 and 2006 to 2017 (2.855% and 1.919%) than for acquirer firms in ECSC countries (0.182% and 0.474%). Yet, CARs of acquirer firms incorporated in Periphery countries are lower compared to acquirer firms in ECSC countries for the time interval 1996 to 2005 (-2.128% versus -0.077%). The exact opposite is true of CARs of target firms in ECSC and Periphery countries: Over the full sample CARs of target firms in ECSC countries are systematically higher (5.699%) than those of target firms in Periphery countries (3.608%). Only in the time interval 1985 to 1995, CARs of target firms in periphery countries are higher (4.679% versus 1.935%). The market value-weighted combined effect that is observed in ECSC and Periphery countries seems to converge to the same level over time. Where between 1985
32
and 1995 the combined effect of acquirer and target firm CARs in Periphery countries equalled 3.325% and in ECSC countries -0.204%, between 2006 and 2017 CARs for both subsamples equalled 0.915% and 0.658% respectively.
Analysis of CAR of firms that are incorporated in countries that participate in the EMU, reveals that for acquirer firms CARs have increased from being negative on average in the early years of EMU, -0.511% from 1996 to 2005, to positive, 0.888% from 2006 to 2017. Contrarily, target firms show the opposite trend in the same time interval, moving from an average 6.608% CAR to 5.352%. The market value-weighted combined effect of acquirer and target firms increases from 0.275% to 0.788% CAR over both time intervals. The trend in CAR for the EMU subsample group, increasing for acquirer firms and decreasing for target firms, seems to be similar to the one visible in CAR from firms in the ECSC subsample group.
Because the CAR estimates following Market Model methodology in this research do not appear to differ systematically from zero (in fact only on four occasions is the CAR estimate for a certain sample group and time interval proven to statistically differ from zero at some level of significance) the Market-Adjusted Return Model (Panel B) is employed to provide a benchmark. Comparison of Panel A and Panel B shows coefficient patterns to be exactly the same between both methodologies of calculating CAR. However, Market-Adjusted Return Model estimates do appear to be 0.5% to 1% greater than CAR estimates calculated through the Market Model. The greater CAR estimates reflect that announcement returns are adjusted less by market index returns than if predicted normal returns would be employed to determine the abnormality in firm stock returns. Even with higher observed CARs, estimates reported in Panel B do not solve the issue of insignificant coefficient values.
To put the CAR estimates of this research into perspective, research on cross-border value creation by other scholars is considered. Most comparable to this research, Goergen and Renneboog (2004) study intra-European cross-border acquisitions of public acquirer and target firms between 1993 and 2000. In the article, announcement returns are reported of 12.96% for target firms and 1.18% for acquirer firms in an event window of [+2,-2] days. Danbolt (2004) finds cross-border target firms in the United Kingdom in a similar time interval to be associated with CARs above 20%. However, this research only finds 5.564% CARs for target firms and -0.679% CARs for acquirer firms, between 1996 and 2005 in an event window of [-5,+5] days. The validity of this research therefore seems compromised by significantly
