A relaxation of financing constraints in corporate takeovers : effect on method of payment and acquisition premium

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University of Amsterdam

Faculty of Economics and Business

A Relaxation of Financing Constraints in

Corporate Takeovers;

Effect on Method of Payment and Acquisition Premium

Master Thesis

Student Name: Tanguy Wagenaar

Student Number: 10243690

Supervisor: Dr. Vladimir Vladimirov

Program: Msc Business Economics – Finance track

2016

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Statement of Originality

This document is written by Student Tanguy Wagenaar, 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.

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Abstract

This dissertation focuses on the method of payment and takeover premiums in Mergers and Acquisitions. This thesis particularly looks at the effect of a relaxation of financing constraints on the method of payment and takeover premiums in M&A. The HP index is used as a measurement for financial constraints. The effect of a relaxation of financing constraints is tested with the use of difference in difference regressions, with

quantitative easing as the treatment effect and comparing financially more constraint companies to financially less constraint companies. The results of the regression that looks at the effect of a relaxation of financing constraints on the payment method were not in line with previous research and what was expected. After a relaxation of the financing constraints, financially less constrained companies used more cash in takeovers compared to financially more constraint companies. The results of the

regressions with the takeover premium as dependent variable confirmed the hypothesis that after a relaxation of financing constraints, the takeover premiums for financially more constrained companies increased more compared to the takeover premiums paid by financially less constrained companies. The results of the difference in difference regressions of this thesis have to be carefully interpreted, as the sample size was small, and the robustness checks could not confirm the main regressions. This thesis also tested if financial constraints, measured with the HP index, influenced the percentage paid in cash in corporate takeovers and the acquisition premiums paid. The results showed that less financially constrained companies used a higher percentage of cash in takeovers and that less financially constrained companies paid higher takeover

premiums compared to more financially constrained companies.

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Acknowledgments

First, I want to thank my supervisor Dr. Vladimir Vladimirov for his expertise and help. He brought this dissertation to a higher academic level and he also helped me with producing the right regressions. I also want to thank my parents and my brother for their support. Last but not least, I thank my friends, for being there for me and making my period as a student at the University of Amsterdam unforgettable.

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1. Introduction

Theory about mergers and acquisitions is a topic with continued interest. Corporate takeovers are among the largest investments that a company ever will undertake (Betton et al., 2008). Important rationale used to clarify M&A is that bidding companies want to enhance financial performance or reduce the company’s risk

exposure. Betton et al. (2008) found that the average, value weighted combined

cumulative abnormal returns for acquirers and targets is significant and positive for the run-‐up and announcement period. However, the long-‐run abnormal stock returns were found to be either negative and significant or insignificantly different from zero (Betton et al., 2008). As mentioned before, corporate takeovers are one of the largest

investments a company can make, therefore cash balances are often insufficient to pay for these investments and companies rely on external sources of financing (Martynova & Renneboog, 2009). Also, companies do not have the same access to external sources of finance because of market imperfections. It has been stated that investment decisions are affected by the accessibility of a company to external capital markets (Keynes, 1936).

It can therefore be argued that due to financial constraints (the inability to issue debt or

equity is referred to as financing constraints) companies might not be able to do

investments with positive net present values, and that financial constraints could have an effect on M&A deal considerations. The relationship between financial constraints and

corporate takeovers received more academic interest in recent years due to the increased macroeconomic uncertainty since the financial crisis that started in in late 2007. During and since the financial crisis, banks were and are more reluctant on giving credit to companies. There were more requirements companies had to meet in order to receive credit form banks. Firms were facing more financing constraints. More

financially constrained companies would have more difficulty to finance M&A

transactions and this could lead to underinvestment, which than could lead to less future growth. Maksimovic & Phillips (2001) argued like Keynes (1936) that the likelihood of an acquisition also depends on a company’s access to external finance. Due to the financial constraints companies were facing, companies might have had to use more internal funds then was preferred to finance an acquisition.

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monetary policy has become ineffective. A central bank implements QE by buying

financial assets from financial institutions and thus raising the prices of those assets and lowering their yield. QE was implemented to increase investments. The empirical evidence is still ambiguous and does not support strong stimulating effects (Gern, Janssen, Kooth & Wolters). However, it is argued that QE led to a relaxation of financial constraints (Joyce, Lasaosa, Stevens & Tong, 2011). Therefore I will use a sample period of before and after QE.

There are several important M&A strategy decisions that are important for a successful takeover. Two of these M&A strategy decisions are the method of payment and the takeover premiums paid by the acquirer. These deal characteristics have an impact on the post-‐merger capital structure. Most of the research on the topic of the method of payment investigated the determinants of the method of payment in corporate acquisitions. These papers try to determine what the reasons are an

acquisition is paid with equity, cash or a combination of equity and cash. The acquisition premium is the difference between the estimated value of a target company and the price paid to obtain the target company. There are studies that argued that a high acquisition premium destroys value for shareholders. There are also papers that used high acquisition premiums as low-‐quality decision making (Laamanen, 2007).

For the method of payment, it is argued that financially constrained acquirers more often use stock as their method of payment than are financially less constrained acquirers (Alshwer & Sibilkov, 2010). Furthermore, Eckbo et al. (2008) argued that higher-‐valued bidders are more likely to use more cash to finance the acquisition. Crawford (1987) concluded that acquirers with higher cash balances tend to prefer cash-‐financed acquisitions. Finally, Choe et al. (1993) implied that business cycle factors such as pre-‐acquisition changes in the overall stock market, interest rates and industrial production are likely to influence the method of payment. Based on these findings I will look at how and if the method of payments is expected to change after a relaxation of financial constraints.

Officer (2007), found that acquisition discounts are significantly greater when debt capital is relatively more expensive to obtain, and when the parent company has below market stock returns in the 12 months prior to the acquisition. Therefore, the relaxation of financial constraints as an effect of QE could have a positive impact on the acquisition premium. In this research I will test whether there was a change in

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acquisition premiums and if a relaxation of financing constraints has more effect on the acquisition premium of financially constrained acquirers compared to financially less constrained acquirers.

More specifically, with this dissertation I will try to find an answer to the main research question;

What is the effect of a relaxation of financial constraints on the method of payment

and the acquisition premiums for US public financially constrained acquiring companies compared to US public financially less constrained acquiring companies.

With this research I will try to fill the gap that there is with regard to the link between financial constraints and corporate takeover deal characteristics.

In order to answer the research question, I will use a difference in difference regression. The sample will consist of completed takeover and not mergers, done by US public companies. I chose the US, because the Federal Bank implemented QE 1, and the US financial market is characterized as a system with a deep financial market, which results in a lot of publicly available data about the financing structure of firms, which is required for the empirical analysis of this dissertation. The first round of QE, which started in late 2008, will be used as the treatment. Furthermore, the data will only consist of completed takeovers with a known takeover premium in the Thompson One database. The level of financial constraints will be calculated with the use of the HP index, which was constructed by Hadlock and Pierce (2010). Later in this research it will be argued why the HP index is used. In the regression, financially constrained companies will be the treatments group and the less financially constrained companies will be the control group.

The remainder of this dissertation will have the following look. The second paragraph will discuss existing literature on financial constraints, method of payment and the takeover premium. In the third paragraph the hypothesis will be given and explained. The third paragraph will discuss the methodology used to test the hypothesis. The fourth paragraph will describe the sample data that is used and will discuss the summary statistics. The fifth paragraph will show and discuss the results obtained from the regressions. Paragraph six will present robustness checks and additional results. The last paragraph will contain the conclusion.

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2. Literature review

The literature review will present the most significant papers in relation to financial constraints, the payment method and the acquisition premium. The first part will give some clear definitions of financial constraints, the second part will compare internal versus external financing, the third part will discuss the different types of measurements for financial constraints, the fourth part will focus on the effect of financial constraints on M&A activity, the fifth and sixth part will focus on the most significant papers for the method of payment and the takeover premium respectively.

2.1 Defining Financial Constraints

Financing constraints can be explained in different ways. One clear explanation is that Financing constraints are frictions that prevent a company from funding desired investments (Lamont et al., 2001). The limitations to finance investments might be caused by credit constraints, an inability to issue debt or equity or an illiquidity of assets. Kaplan and Zingales (1997) explained that more financial constraint companies face a larger wedge between the internal and external cost of financing. Companies that are looking for M&A transactions often need access to external capital markets, but due to the company’s financing constraints, they might not be able to have access to external funding. As in the paper of Lamont et al. (2001), this research will not use financing constraints as a meaning of financial or economic distress, or bankruptcy risk. Even though they are correlated with financing constraints. This research will focus on the effect of a relaxation of financing constraints and comparing financially constraint companies to less financially constraint companies.

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2.2 Internal Vs. External financing

In a world with perfect capital markets, all companies have equal access to capital markets. A company’s financial structure does not matter for investments, as external financing is a perfect substitute for internal financing. Therefore, according to Modigliani and Miller (1958) with perfect capital markets a company’s M&A investment decisions are independent of the company’s financial condition (Fazzari et al., 1988).

However, with market imperfections or frictions such as transaction costs, tax regulations, financial distress costs, asymmetric information and agency problems, a company’s investment decision is not independent of their financial condition anymore. The external financing costs will not be equal to the internal financing costs. A

company’s investment decision now depends on their financial constraints. If a company does not have enough internal funds, it will have to try and issue equity or debt.

The costs for issuing debt and equity are different. Companies that issue equity will suffer from adverse selection, transaction costs and tax costs (Myers & Majluf, 1984). When firms use debt financing, there will be, just as with issuing equity,

asymmetric information. Company managers have more information than the creditors have. It can be hard for creditors to estimate the value and quality of the borrower and its investments. The creditors have an information disadvantage and they therefore often increase the interest rates and decrease the size of the loan they want to issue. Fazzari et al. (1988) stated that “asymmetric information makes it very costly for debt providers to evaluate the quality of company’s investment opportunities, and as a result the cost of new debt and equity can differ substantially from the opportunity cost of internal finance generated through cash flow and retained earnings”. The asymmetric problem could lead to companies not being able to finance investments with a positive net present value. The asymmetric information and agency problems often decrease however, when companies are larger and older, as more information will be available. More mature public companies will therefore have an advantage over smaller and younger companies with regard to the costs of external financing.

The purpose of this section was to explain and give an overview of the problems, mainly asymmetric information problems, which arise when using internal or external funds. It

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can be concluded that financially less constrained companies have an advantage in attracting external funds.

2.3 Different types of measures for financing constraints

There is not a universally used method to measure the severity of financing constraints. Fazzari, Hubbard and Petersen (1988) examined what happened to a company’s

dependency on cash flows for investments when a cost disadvantage of external funds is significant. They argued that when a company has a small cost disadvantage of external funding, retention practices will not reveal a lot on investment decisions, as they will use external funding anyway. Fazzari et al. (1988) used observed a priori retention practices as their measurement of financing constraints. They created three groups where class 1 had the lowest ratio of dividend to income and class 3 had the highest. Their research showed that when companies are more financially constrained, the company’s

investment to cash flow ratio increases. Which implies that companies that are more financially constraint depend more on their cash flow as a financing method for investments than financially less constrained companies.

However, research is hesitant on the methodology that was used in the research. Kaplan and Zingales (1997) concluded in their paper that investment-‐cash flow

sensitivities do not provide a useful measurement of financial constraints. Kaplan and Zingales investigated the relation by doing an in-‐depth analysis of a sample of

companies that had an unusually high sensitivity to cash flow. Kaplan and Zingales used previously unexplored data sources such as a company’s annual report, quantitative data and public news about the companies. They also investigated each company’s future needs for financing and the sort of financing it planned to use in order to be able to finance these needs. Based on this information they ranked how financially constraint each company was. Kaplan and Zingales found that less financially constrained

companies had significantly greater investment-‐cash flow sensitivity than companies that were classified as more financially constrained.

Based on the Kaplan and Zingales (1997) paper, Lamont et al. (2001) constructed an index (the KZ index) that is based on the regression coefficients of the Kaplan and Zingales model. The KZ index has the likelihood that a firm will face financing

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constraints as the dependent variable. The dependent variable is than calculated by the following regression (Lamont et al., 2001):

KZ index = −1.002 * (cash flow/lagged net capital) + 0.283 * (market-‐to-‐book) + 3.139 * (long-‐term and short-‐term debt/total assets) − 39.368 * (dividends/lagged net capital) − 1.315 * (slack/lagged net capital).

The higher the KZ index the more financially constraint a company is. However, the KZ index is only examined for manufacturing companies that had positive sales growths. Hadlock and Pierce (2010) raised questions about the validity of the KZ index as a measurement of financing constraints. Hadlock and Pierce also gathered detailed

qualitative information regarding financing constraints from statements that managers in financial statements. They then approximated an ordered logit function that predicted a company’s level of financial constraints as a function of a couple of different

quantitative factors. HP found that only two of the five variables in their sample were reliable related to financing constraints that are were also consistent with the KZ index. Hadlock and Pierce furthermore examined in their research what were appropriate indicators of financing constraints in their sample. They found that company size and age were particularly efficient predictors of financing constraints. Furthermore, in their research there were two more variables that seemed to offer extra explanatory ability for predicting financing constraints. These variables were the cash flow and leverage of a company. Hadlock and Pierce however than argued that a firms cash flow and leverage could imply endogeneity problems. Farrel and Yu (2014) also concluded that there were endogeneity problems for cash flow and leverage, as a measure of financing constraint. HP continued further with only firm size and age in predicting a measurement of financing constraints. The model that Hadlock and Pierce used to predict a firm’s financing constraints is as follow:

HP= -‐0.737*size + 0.043*size^2 -‐0.04*age

They concluded in their research that age and firm size as estimates for financing constraints were appealing measures and had a long tradition in corporate finance research. Based on the research of Hadlock and Pierce, I will use their index as a measurement for the financing constraints a company faces.

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The purpose of this part was to give a rationale on why the HP index will be used as a measurement of financial constraints.

2.4 Financing constraints and M&A activity

In this part of my thesis I will discuss papers that examined the determinants of M&A activity, and what papers found on the relationship between financing constraints and M&A activity. This is interesting because it gives insight on how financing constraints have an influence on investment decisions.

In the corporate finance world it is seen as a fact that corporate takeovers come in waves. Martinova and Renneboog (2008) concluded first of all that M&A waves occur in periods of economic recovery. They found that takeover activity usually is disrupted by a steep decline in the stock markets and the economic recession that than could follow, and that the waves coincide with rapid credit expansion, which than again could result into burgeoning external capital markets.

Maksimovic and Phillips (2001) showed that the probability of a corporate takeover also depends on a firm’s access to external funds. They argued that financially constraint firms have a lower probability of participating and completing corporate takeovers.

Harford (2005) found empirically that the increase in corporate takeovers in the United States from the second part of the 1990s was also explained by the increase in liquidity, which was a result of the decline in the interest rates. Harford (2005) also argued that an increase in liquidity at a macroeconomic level, will decrease the financing constraints and that would lead to an increase in corporate takeover activity. It is argued that higher market valuations will relax company’s financing constraints and that

market valuations are an important element of capital liquidity (Harford, 2005). In another paper, empirical evidence was found which showed that companies that have higher cash balances are more active in the corporate takeover market (Harford, 1999).

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2.5.1 Method of Payment

The method of payment choice in corporate takeovers includes payment in all-‐stock, several debt securities, a combination of securities and cash, and finally payment in all-‐ cash.

Previous studies have examined the role of asymmetric information on the method of payment choice. It is argued that when a company chooses stock as the payment method, it forces the target to share the risk that the buyer may have overpaid (Hansen, 1987). It is also said that when a company chooses stock as the payment method, the company is overvalued, and when it chooses cash the company is

undervalued. The method of payment gives a message about the value of the acquirer’s shares because it is argued that the management of a company has more knowledge about the value of assets and the growth opportunities of the company than the market has. Myers and Majluf (1984) formulated the asymmetric information hypothesis, which stated that a takeover paid with stock is regarded as a negative signal of the quality of the biddings firm’s stock.

Another important determinant for the method of payment is the management’s desire to maintain control over the company and keep personal benefits (Faccio & Masulis, 2005). Managers have incentives to keep or even increase their voting rights and power. When the takeover is financed with stock, their stake in the company will diminish. Their percentage of ownership in the company will decrease because there will be more stocks outstanding while their proportion will remain the same. Stulz (1988) also noted that although shareholders will try to maintain their shareholdings, growing companies can rely on debt financing and so maintain their ownership

percentage and voting power.

A third determinant for the method of payment is the different tax treatments each payment method has. When a takeover is financed with cash, target shareholders will immediately have to pay taxes over their capital gains (Betton et al., 2008). This is different when the payment method is with stock. When paying with al stock, the target shareholders capital gains taxes will be deferred until the shares that the target

shareholders received for the takeover are sold (Betton et al., 2008). Because of the negative tax effect that cash payments have, it is argued that target shareholders will

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desire to receive a higher takeover premium, to offset the negative tax effect that a cash offer has on the target’s shareholder profits (Betton et al., 2008).

2.5.2 Financing constraints and the Method of Payment

In this part I will look at papers that linked financing constraints to the method of payment in corporate takeovers.

Faccio and Masulis (2005) argued that financing constraints and bankruptcy risk can make acquirers/lenders more reluctant to finance a corporate takeover with cash as the payment method. This would be in particular true for relatively bigger deals. Faccio and Masulis (2005) also found that the larger the size of the bidder compared to the target, the higher the probability that the takeover is funded with stock than with cash. When the acquiring company has a lots of growth opportunities, it also more often tries to fund the takeover with shares instead of with cash. This is explained with the fact that companies with a lot of growth opportunities will prefer to keep their cash balance in order to be able to fund future investments. In their results, Faccio and Masulis found that cash reserves are negatively correlated with the ratio of cash used as a method of payment. Finally it was concluded that acquirers are more likely to use stock as the method of payment when their financial conditions worsened.

Alshwer et all. (2010) wrote another paper that discussed the relationship between financing constraints and the method of payment in corporate takeovers. They found that “financially constrained acquirers have a higher probability of using stock as payment in takeovers and are more sensitive to the valuations of stock and future growth opportunities than financially less constrained acquirers in their method of payment decision”. Financially more constrained bidders with inflated stock valuations also often offer higher takeover premiums than less financially constrained bidders. Finally it is concluded that financially more constrained companies will try to maintain their cash balances and internal resources in order to diminish future financing

uncertainty and keep their funding flexibility (Alshwer et all., 2010).

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2.6.1 Acquisition Premium

The acquisition premium that a company pays, is the difference between the estimated value of a company and the actual price paid for the acquisition. There doesn’t need to be a premium, as it depends on the situation. However, on average companies pay substantial premiums. Bradley and Korn (1979) found that acquisition premiums were on average 53%, with a range between 23% and 115%. In the United States, the average premium paid ranged between 30 and 50 percent (Hayward & Hambrick, 1997; Varaiya and Ferris, 1987). Kohers and Kohers (2001) found that the highest premia are being paid for companies in technology-‐intensive industries (Laamanen, 2007).

The determinants of the takeover premium have been a topic for finance research for a long time. Takeover premiums are expected to be positively linked with the seller’s bargaining strength and the acquirer’s expected gains from the takeover (Varaiya & Ferris, 1987). The level of competition in the takeover market and the incorporation of anti-‐takeover amendments will increase the target’s bargaining power versus the acquirer. Varaiya and Ferris (1987) confirmed this in their research and found that the acquirer paid significantly higher premiums when there were multiple bidders and when the target had anti-‐takeover amendments.

As mentioned before takeover premiums are greater in all-‐cash offers compared to all-‐stock offers (Betton et al., 2008). In this paper it was also concluded that takeover premiums are lower for toehold bidders. A toehold bidder is an acquiring company that already holds just under five percent of the target when the takeover bid is announced. Betton et all. (2008), also found that takeover premiums are higher for public

companies.

The variables that I discussed, as determinants for takeover premiums (payment method, toehold, hostility and public bidder) could themselves be endogenous variables. The effects of these variables however, appeared robust to corrections for endogeneity (Betton et al., 2008).

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2.6.2 Acquisition Premium and Financing Constraints

There has been a lot of literature on corporate takeovers, takeover premium and

financing constraints separately, however there is little of research done on the effect of financing constraints and the takeover premium.

One important finding from a relevant paper was that takeover discounts are significantly bigger when external capital is relatively more expensive to obtain (Officer, 2007). This implies that lower borrowing rates would lead to an increase in acquisition premiums. Quantitative easing was implemented to relax financing constraints and increase credit supply. The lower borrowing rates that followed from the QE policy could thus have led to an increase in takeover premiums.

Moeller et al. (2004) found evidence that the acquisition premium increases with the size of a company after controlling for company and deal characteristics. As in the HP index, size is an important measurement of the financing constraints a company faces, this is an important finding. During the period 1980-‐2001, they calculated that shareholders from small companies earned 9 $ billion from the takeovers and that shareholders from large companies lose 312 $ billion. More specifically, large companies have significant shareholder losses when they announce a takeover of a public company irrespective of the form of funding. It was also concluded that the announcement return for acquiring company shareholders is approximately two percent lower for large acquirers irrespective of the form of funding and whether the target is a public or private company. Based on the findings of Moeller et al. (2004) the fact that papers use high premiums as low quality decision can be validated.

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3. Hypotheses and Methodology

This part of the paper will introduce the hypotheses and the methodology that will be used in order to test the hypotheses. A brief explanation will be given on the literature from which I derived my hypotheses and expectations of the empirical models.

Hereafter it will show the methodology that will be used for the event-‐study and how the significance tests will be designed.

3.1. Hypotheses

First, this thesis will investigate what happens to the method of payment when there is a relaxation of financing constraints, comparing financially constrained companies to financially less constrained companies. Faccio and Masulis (2005) concluded that acquirers more often use stock as a method of payment when their financial condition worsens. A relaxation of financing constraints could lead to an improvement of the financial condition of companies, as it will become easier to attract money and therefore companies will have underinvestment. Alshwer and Sibilkov (2010) found that

financially more constrained acquirers are more likely to use stock financing compared to financially less constrained acquirers. Alshwer and Sibilkov (2010) also concluded that financially more constrained companies will try to maintain their cash level in order to diminish future financing uncertainty. As a relaxation of financing constraints can make it easier for companies to attract external funds, the future financing uncertainty decreases.

Based on these findings the first and second hypothesis will be as follows:

H1: The more financially constrained a company is, the more stock it will use to finance

a corporate takeover.

H2: A relaxation of financing constraints will have more impact on the likelihood that

financially more constrained companies will choose cash as a method of payment compared to financially less constrained companies.

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Second, this thesis will investigate what the effect of a relaxation of financing constraints is on the acquisition premium for financially constrained acquirers compared to

financially less constrained acquirers. Moeller et al. (2004) concluded that the

acquisition premium increases with the size of a company. The HP index formula heavily depends on the size of a company. The larger the size of a company, the less financing constraints it has. Therefore I expect that financially less constrained companies will pay higher premiums than financially more constrained companies. An explanation for this could be that hubris is a bigger problem for larger companies.

As discussed by Officer (2007), when debt capital is more expensive to obtain, acquisition premiums are significantly lower. One reasoning for this finding could be that when debt capital is less expensive, target companies are facing less financing constraints, and therefore it reduces their nececity to accept lower takeover premiums in return for a liquidity provision (Officer, 2007).

QE1 led to cheaper debt capital markets and a relaxation of financing constraints. As a relaxation of financing constraints will have less impact on financially

unconstrained companies, this thesis argues that a relaxation of financing constraints should have a bigger impact on financially constrained companies. Based on the arguments stated above, the hyothesis will be as follow:

H3: Financially less constrained companies pay higher acquisition premiums than

financially more constrained companies.

H4: A relaxation of financing constraints will have a bigger positive effect on the

acquisition premium for financially constrained companies compared to financially less constrained companies.

3.2 Methodology

3.2.1 HP index Regressions

The first and third regressions will test the effect of financial constraints on the method of payment and the takeover premium respectively. This will be tested with an ordinary least squares regression. The coefficient of interest will be the HP index, which measures

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the level of financial constraints a company faces. The control variables will be given in part 3.2.4 of this thesis. The dependent variables will be the proportion that is paid in cash and the acquisition premium, respectively. The “X” variable in the regression is the vector of control variables. The regressions to test the first and third hypothesis will look as follows:

ε β χ β + + + = B HP Cash " " * % 2 1 0 ε β χ β + + + = B HP emium " " * Pr 2 1 0

3.2.2 Tobit Regression

The second hypothesis will test the effect of a relaxation of financing constraints on the method of payment. This will be tested with the use of a difference in difference

regression. The regression model will be similar to the one of Faccio and Massulis (2005). In the difference in difference regression, QE1 will be the treatment. Using a difference in difference regression decreases endogeneity. A difference in difference regression is used to mitigate extraneous factors and differences between the control group and the treatment group. The difference in difference method helps constructing a more unbiased treatment effect. The treatment effect will be a dummy variable, which is 0 for an acquisition that is done in the year before QE1 (November 2008) and 1 if an acquisition is done in the year after QE1. QE1 as a treatment effect is however, probably a weak instrument. QE1 could be a weak instrument because it was implemented during a financial crisis and it is not possible to see which company exactly benefited from QE1. The dependent variable will be the proportion that is paid in cash in the transaction. The proportion is a value between 0 and 1, therefore a two-‐boundary Tobit estimator will be used. The dependent variable has both left and right censoring so that:

𝑌 = 0 𝑖𝑓 𝑦 < 0 𝑦 𝑖𝑓 < 𝑦 < 1 1 𝑖𝑓 𝑦 > 1

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The HP index will measure the level of financing constraints of the acquirer. The coefficient of interest will be the interaction term of the HP index and the QE dummy. The third hypothesis will be accepted when the interaction term is positive and

significant. The “X” variable in the equation is the vector of control variables. The list of control variables will be introduced and explained below. The regression equation to test the first and second hypothesis will be as follows:

%cash = β

0+ B1" χ "+ β2*QE + β3* HP + β4*QE * HP +ε

3.2.2 Ordered Probit regression

Like Faccio and Masulis (2005), next to the Tobit regression, an Ordered Probit regression is used to add a robustness check. In the Ordered Probit regression, the dependent variable is 0 for an all-‐stock deal, 1 for a combination of cash and stock, and 2 for all cash deals. The control variables will remain the same as in the Tobit regression.

3.2.3 Takeover premium

This dissertation will also test the effect of a relaxation of financing constraints on the acquisition premium. In order to test this, just like the second regression, a difference in difference regression will be used. In the difference in difference regression, QE1 will again be the treatment. There will be a dummy variable, which is 0 for an acquisition that is done in the year before QE1 (November 2008) and 1 if an acquisition is done in the year after QE1. The dependent variable will be the acquisition premium, which is measured by the offer price minus the price 30 days before the offer divided by the price 30 days before the offer.

𝑃𝑟𝑒𝑚𝑖𝑢𝑚 =(𝑂𝑓𝑓𝑒𝑟 𝑃𝑟𝑖𝑐𝑒 − 𝑅𝑒𝑓𝑒𝑟𝑒𝑛𝑐𝑒)

𝑅𝑒𝑓𝑒𝑟𝑒𝑛𝑐𝑒

The level of financial constraints will again be measured by the HP index. The coefficient of interest will be the interaction term between the HP index and the QE dummy. When this coefficient is positive and significant, it would imply that the fourth hypothesis could

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be accepted. The “X” variable in the regression is the vector of control variables. The control variables will be explained below. The regression equation to test the third and fourth hypotheses will look like this:

Pr emium = β

0+ B1" χ "+ β2*QE + β3* HP + β4*QE * HP +ε

3.2.4 Control Variables

There are several control variables added in the regression equations in order to

produce unbiased results. I will include the following control variables: positive toehold, all share deal (only in the regression with the method of payment as dependent

variable), horizontal acquisition, cross border acquisition, cash ratio acquirer, leverage acquirer, the size of the target, contested bid and if the target is a subsidiary. The regressions will also include industry fixed effects. I included a dummy variable for all stock offers because Betton et al. (2008) argued that offer premiums are higher in all cash offers than in all stock offers. Betton et al, (2008) also concluded that premiums are lower for acquirers that hold a percentage of stock (toehold) in the target prior to the acquisition. Varaiya and Ferris (1987) concluded that premiums were higher for

contested bids, therefore a dummy is included that is one if there were multiple bidders and 0 if not. The dummy variable for a horizontal takeover is 1 when the SIC code of the target is the same as the acquirer. The dummy for a cross-‐border acquisition is 1 when the target is not a US based company. The variable subsidiary is included because it can be argued that corporations that are selling a subsidiary are often motivated by financial distress (Faccio & Masulis, 2005), and this could have an impact on the acquisition premium.

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4. Data collection, Samples and Characteristics

4.1 Data description

For the difference in difference regressions (tables 5,6 and 8), the sample consists of US public companies that completed a takeover during the period from 25-‐11-‐2007 until 25-‐11-‐2009. For the regressions with the HP index as variable of interest (tables 4 and 7), the sample period from 1-‐1-‐2000 until 31-‐12-‐2015 is chosen. The takeovers were selected from the M&A Thompson One database. Takeovers were selected on the following requirements: (1) The acquirer is listed on the New York Stock Exchange; (2) The buyer has financial and accounting data available; (3) Deal value is at least 1 million dollar; (4) No financial (SIC codes 6000 to 6999) or regulated (SIC codes 4900 to 4999) companies ;(5) The target is a listed company with known stock prices; (6) The deal type has to be a disclosed value. After all the requirements were met, there were 169 transactions left for the regressions.

Furthermore, most of the data for the different variables is extracted from the M&A Thompson One database. For example, the Thompson One database provides the percentage of stock and cash as the payment method of the takeover. The database also provides the acquisition premium that was paid in the takeover. The only variable that was not extracted from the M&A Thompson One database was the IPO date of every company. The IPO dates of the companies were found in the Compustat database. The IPO dates were found by looking at the first date that a company got a known stockprice.

4.2 Summary statistics

This part of the thesis discusses the summary statistics for the difference in difference regressions. The first parts of the summary statistics are stated in table 1. More

extensive summary statistics are shown in table two and three. Table one presents the summary statistics of the two dependent variables. In table one it can be seen that there were 110 transactions in the year before QE and 59 transactions in the year after QE.

A relaxation of financing constraints in corporate takeovers : effect on method of payment and acquisition premium

University of Amsterdam

Faculty of Economics and Business