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UNIVERSITY OF AMSTERDAM

Amsterdam Business School

BSc Economics and Business, Finance and Organization Track

Corporate Governance and Mergers and Acquisitions:

An Empirical Study on the Relationship Between Corporate

Governance and M&A Performance

Abstract

This study delves into the issue that shareholders of acquiring firms experience normal returns or even have significant losses in times of acquisitions. To investigate the effect of corporate governance on the acquirers’ mergers and acquisitions (M&A) performance, samples of acquiring firms are retrieved from the completed M&A announcements made in the U.S. during 2006 — 2016, and event study and regression analysis are carried out. The empirical results confirm that corporate governance can mitigate the negative effect on M&A performance and secure acquirers’ shareholder value. Moreover, strengthening corporate governance is found to improve acquirers’ M&A performance especially on the announcement day. This study contributes to deepening the understanding of the relationship between corporate governance and M&A.

Student: Yujie Zhu

Student Number: 10894330

Supervisor: Dr. S.R. (Stefan) Arping Date: January 2018

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Statement of Originality

This document is written by Yujie Zhu, who declares to take full responsibility for the contents of this document.

I declare that the text and the work presented in this document are 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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Contents

1. INTRODUCTION ... 4

2. LITERATURE REVIEW ... 7

2.1. Theoretical Definitions of Research Variables ... 7

2.1.1. Corporate Governance ... 7

2.1.2. Mergers and Acquisitions ... 8

2.1.3. Performance of Mergers and Acquisitions ... 8

2.1.4. Causes of Value-destroying M&A: Agency Conflicts and Managerial Hubris ... 9

2.2. Empirical Measurements of Variables ... 10

2.2.1. Measurement of M&A Performance ... 10

2.2.2. Measurement of Corporate Governance ... 11

3. METHODOLOGY AND DATA ... 12

3.1. Overall Methodology ... 12

3.2. Methodology of Event Study ... 12

3.3. Hypotheses, Tests and Models ... 13

3.4. Control Variables ... 15

3.5. Data Source and Process ... 17

3.6. Descriptive Statistics ... 18

4. EMPIRICAL RESULTS ... 20

4.1. Market Reactions of M&A Announcements ... 20

4.2. Effect of Corporate Governance on the Day of M&A Announcement ... 21

4.3. Effect of Corporate Governance in Different Event Windows ... 22

4.3.1. Five-day and Eleven-day Event Window ... 22

4.3.2. Pre-announcement and Post-announcement Period ... 23

5. CONCLUSION ... 24

5.1 Conclusion ... 24

5.2 Limitation and Further Research ... 26

APPENDIX REFERENCES

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1. Introduction

Mergers and acquisitions (M&A) are considered as an essential driver of corporate performance (Bruner, 2004). As the fundamental goal of M&A is to create synergies so that the acquirer can generate corporate growth, boost profitability, enhance market power and increase shareholder value (Alexandridis, Petmezas, & Travlos, 2010). Corporate takeovers over the last decades are characterized into six “Mergers and Acquisitions Waves” (insert Table 1), and both transaction amount and their aggregate dollar value of M&A have dramatically increased. A common explanation for these is that acquirers treat M&A as a bundle of positive net present value projects to realize value-maximization. Barkema and Schijven (2008) give further interpretations — firms need to grow and survive in current dynamic business world; besides growing organically, undertaking acquisitions can be defined as an optimal growth strategy. To understand the root causes and to justify corresponding growth strategies, plenty of researches have been conducted to study the M&A performance.

In these researches, shareholder value of target firms has generally been regarded as a positive reaction to M&A announcements. However, divergent results are found with respect to the impacts on the M&A performance of acquiring firms (Asquith, Bruner & Mullins, 1983; Jensen & Ruback, 1983; Roll, 1986; Andrade Mitchell & Stafford, 2001; Moeller, Schlingemann & Stulz, 2004). Although a few studies show a slight positive value effect, most empirical studies reveal a neutral or even negative effect on the shareholder value of acquirers (e.g. Andrade et al., 2001; Moeller et al., 2004). In these studies, shareholders either experience normal returns, or even have significant loss in times of acquisitions (Weidenbaum & Vogt, 1987; Bruner, 2004).

According to existing literature (Jensen & Meckling, 1976; Roll, 1986; Jensen, 1986; Morck, Shleifer &Vishny, 1990; Hayward & Hambrick, 1997; De Jong, Van der Poel & Wolfswinkel, 2007), the observed negative shareholder returns can be explained by the so called “agency problem” (e.g. separation of ownership and control) as well as managerial hubris (e.g. CEO overconfidence), which will be

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discussed in detail in Section 2.1.4.

Corporate governance is the system of controls, regulations, and incentives designed to prevent or minimize agency problems, and to ensure that managers act in the interest of the firm. For example, the corporate governance codes designed and assessed by governments since 1980s have been regarded as the obstruction of agency problems, as they remind shareholders of reliable information on firms’ performance to limit asymmetric information effect (Bushman & Smith, 2001). Particularly, the concept of corporate governance exists several mechanisms, in which governance procedures are implemented in both internal and external ways to help mitigate the conflict of interest between manager and shareholder (Shleifer & Vishny, 1997). Since corporate governance is the system that directs and controls firms, having a high corporate governance standards may ideally solve the issue regarding the negative effect of M&A on financial performance.

This study attempts to investigate the corporate governance and M&A performance and expects to find a significant relation between them. It will use the abnormal returns (AR) and cumulative abnormal returns (CAR) based on stock prices of acquiring firms surrounding the day of M&A announcement as an indicator of the M&A performance. In order to find evidence for this expectation, the following research question is proposed:

Does corporate governance influence acquirers’ performance of mergers and acquisitions?

To answer the research question, this study investigates M&A involving publicly traded U.S. firms (excluding utility firms, financial firms and government-related firms) in the period between January 1st, 2006 and December 31st,

2016 with an event study of five different time windows. This research adds value to existing academic literature on the fields of corporate governance and M&A by means of obtaining the insight: (1) whether corporate governance affects acquirers’ M&A performance and (2) how corporate governance affects their M&A

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performance.

The remainder of this empirical research is organized as follows. In Section 2, literature relevant to corporate governance and M&A performance is reviewed. Thereafter, research methodology and sample data in this study are addressed in details in Section 3. Section 4 entails empirical results and further analysis and discussion based on the research findings. Finally, Section 5 concludes research findings and presents the limitations of this study and potential directions for the future research.

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2. Literature Review

This section provides a theoretical basis for this study regarding the influence of corporate governance on M&A performance in times of acquisitions. It begins with a theoretical definition of research variables, namely corporate governance and M&A performance. Then, it continues with an illustration of agency problem and managerial hubris that affect M&A performance. Finally, empirical measurements of research variables are addressed.

2.1. Theoretical Definitions of Research Variables 2.1.1. Corporate Governance

According to Shleifer and Vishny (1997), corporate governance “deals with the ways in which suppliers of finance to corporations assure themselves of getting a return on their investment”. It aims at resolving conflicts of interest between managers and shareholders so that agency costs can be mitigated (Rani, Yadav & Jain, 2014). Indeed, in large firms that are characterized by the separation of ownership and control, managers may attempt to transfer corporate resources from shareholders to pursue their own objectives if there lacks appropriate incentives and monitoring mechanisms (Shleifer & Vishny, 1997).

In order to control and motivate managers, firms carry out internal corporate governance procedures, such as monitoring, supervision and performance-based remuneration schemes. In addition to these internal mechanisms, external environment that firms operates in (e.g. market for corporate control) allocates control over managers, and it has impacts on firm-level outcomes. Especially when internal control mechanisms fail in their tasks, external governance control may promote that the interest of shareholders and directors are more in line.

Agency theories suggest that firms with high corporate governance standards perform better due to lower agency costs and more effective monitoring mechanisms. It is pointed out that an improvement in corporate governance practices reduces asymmetry information between managers and shareholders and leads to higher abnormal announcement returns (Yermack, 1996; Botosan, 1997; Core, Guay &

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Rusticus, 2006; Brown & Caylor, 2006; Bebchuk, Cohen & Ferrell, 2009). Furthermore, Masuilis, Wang and Xie (2007) suggest that managers from acquiring firms with more corporate governance face more pressure from the market for corporate control and thus they are less likely to indulge in empire-building acquisitions that may potentially destroy shareholder value.

2.1.2. Mergers and Acquisitions

Mergers and acquisitions refer to the consolidation and integration of corporations. A merger is two or more corporations combining their resources so that they form a new entity. Whereas an acquisition is a corporation purchasing another by offering cash or stock, causing that no entity is created and the target corporation ends to exist (Seth, 1990). Since firms need to maximize their value (Jensen, 1986), the basic idea of M&A conducted extensively is that the purchasing firm regards the M&A as a profitable investment.

Over last couple of decades, the total dollar volumes of M&A transactions have almost doubled (World Bank statistics, 2014) and the amount of acquisition deals has greatly increased (Barkema & Schijven, 2008). Although firms undertake M&A for different purposes, the most common one is subject to growth strategies. More precisely, when a firm is undergoing a slow internal expansion, it will often conduct expansion strategy by external means, which involves acquiring another firm within the operating industry or taking advantages of diversification outside the firm’s industry. In this case, Grinblatt and Titman (1998) identifies six potential sources of gains from M&A as motives: operating synergies, tax motivations, mispricing motivations, market power, disciplinary takeovers and earnings diversification motivations.

2.1.3. Performance of Mergers and Acquisitions

Performance of M&A can be measured from different aspects. One of the measurements is focusing on the shareholder value generated or destructed in times of the acquisition as a proxy for the performance of M&A. Roll (1986) states that M&A can be simply considered as a redistribution of acquirer’s wealth to the shareholders

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in the target firm. On one hand, Andrade, Mitchell and Stafford (2001) support Roll’s statement, as they analyze the market reaction of M&A announcements and find that the shareholder value for the target firm is enhanced while this particular value for the acquirer turn out to be negative. Besides, in the study of the merger wave in the late 1990s, Moeller et al. (2005) find that M&A deals have a value-destroying effect for shareholders of acquiring firms in an average sense.

Despite the negative effect of M&A on shareholder value of acquirers, other researches, on the other hand, have suggested in a different way. Jensen and Ruback (1993) make an overview of event studies and point out that corporate takeovers generate positive gains in which target firm shareholders benefit and acquiring firm shareholders do not lose. Bruner (2002) also presents a similar result in terms of an M&A transaction: on average it creates value for shareholders of the target firm, but there is no clear gain or loss for shareholders of the bidding firm.

2.1.4. Causes of Value-destroying M&A: Agency Conflicts and Managerial Hubris Apart from the previous literature in M&A, Moeller et al. (2005) report an aggregate loss of $216 billion for shareholders in acquiring firms from the 1990s to the early 2000s. Moreover, they claim that shareholders of acquiring firms tend to at least break even. Why is this the case? Brown and Sarma (2007) give a plausible explanation for the puzzling phenomenon that the driving motives for managers to take M&A are not only creation of synergy, but also agency conflicts and managerial hubris.

Agency conflicts between managers and shareholders arise due to a separation of ownership and control (Berle & Means, 1932). In fact, shareholders do need to assign rights to managers on their behalf. Within this separation of ownership, managers are regarded as the “agent”, while shareholders act as the “principals”. Although managers are supposed to give first place to maximize firm value, they may not always make value-creation acquisitions and sometimes they pursue their own interests at shareholders’ cost (Jensen & Meckling, 1976). These can lead to the misalignments of interests. A good illustration is the Jensen’s (1986) free cash flow

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hypothesis, which indicates that managers realize large personal gains from empire building. Those firms, with abundant cash flows but few profitable investments opportunities, are more likely to undertake value-hurting acquisitions rather than returning the excess cash flows to shareholders. Furthermore, Morck, Shleifer and Vishny (1990) not only support this hypothesis but also identify several types of acquisitions (e.g. diversifying acquisitions as well as high growth targets acquisitions), resulting in substantial gains to managers but do harm to shareholders at the same time. On the other hand, Gorton, Kahl and Rosen (2005) reports that managers conduct M&A to increase their firm size and to reduce the potential risk of being taken over. This action allows them to secure their own positions and preserve their private benefits of control even at the expense of shareholders.

In Roll’s (1986) hubris hypothesis, it is suggested that managers from acquiring firms are so optimistic about the potential synergies and their own capabilities that their overconfidence leads to valuation errors. Consequently, they bid too much for target firms at the expense of shareholders. Besides, the data from the U.S. evince that overconfident managers are more likely to undertake acquisitions that are finally proved to be value-destroying due to the existed conflicts (Brown & Sarma, 2007).

2.2. Empirical Measurements of Variables 2.2.1. Measurement of M&A Performance

An event study will be performed in which the abnormal stock market reaction, namely the stock return, surrounding the M&A announcement is being measured. Abnormal returns provide information on whether the market sees the M&A as either value creating or destructing, which determines the return for shareholders. Hayward and Hambrick (1997) state “a positive abnormal return, indicating that the security market has revised upward its expectations of future returns from the firm”, whereas a negative return is the other way around. Therefore, the sign of abnormal returns from the stock market therefore can be used as an indicator of M&A financial performance. And having positive abnormal returns implies profitable M&A deals (Brunner, 2002).

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Instead of just looking at the performance on the M&A announcement day, cumulative abnormal stock returns which are the summation of abnormal returns, are also used to examine the M&A performance in different event windows.

2.2.2. Measurement of Corporate Governance

The corporate governance score by ASSET4 ESG database offers environmental, social and governance (ESG) information. It is based on key performance indicators (KPIs) including a normalized score and individual data points covering every aspect of governance reporting along with their original data sources. In particular, the score takes several corporate governance factors into account, such as board structure, compensation policy, shareholders rights, board diversity, anti-takeover devices and so on. The comprehensive database makes the score reliable for investigating governance on a company level from both internal and external aspects.

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3. Methodology and Data

In this section, the overall research methodology and event study methodology are addressed at first. Thereafter, the hypotheses and models used in this study are described. Data sample and variables tested are illustrated and provided with descriptive statistics in the end.

3.1. Overall Methodology

This study entails two steps in exploring the relationship between corporate governance and M&A performance of acquiring firms. The first step involves an event study on acquisition announcements after the sample selection of M&A deals, which is aimed to determine the abnormal returns (AR) on the announcement day and cumulative abnormal returns (CAR) surrounding the announcement day. The second step includes proposing hypotheses and building linear regression models between (1) AR and corporate governance score of acquiring firms; (2) CAR and corporate governance score of acquiring firms. The variables used to control regressions are given in Section 3.4.3.

3.2. Methodology of Event Study

To investigate the effect of corporate governance on stock return of acquiring firms, an event study will be performed to see the abnormal stock market reaction in terms of M&A announcements. First, the market return and acquirer return are primarily used in estimation windows to derive expected returns of event windows. Afterwards, the (cumulative) abnormal returns for acquiring firms in the research sample are generated. This event study methodology follows the guidance “Event Studies in Economics and Finance” (Machinaly, 1997) and “Event Study Methodology” (De Jong, 2007).

The market return model is showed as follows:

𝑅!,! = 𝛼! + 𝛽!𝑟!"#,!+ 𝜀!,! (1)

𝑅!,!= Return of security I for time 𝜏

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𝛽!=Slope coefficient

𝑟!"#,!=Return of the S&P 500 Index market portfolio for time 𝜏 𝜀!,!=Error term of security i for time 𝜏

Abnormal Returns (AR) are defined as the Return (R) minus a benchmark or normal return:

𝐴𝑅!,! = 𝑅!,!− 𝛼! − 𝛽!𝑟!"#,! (2) t= Event window (t=0 as the event date)

𝐴𝑅!,!=Abnormal return of security i for event window t

Figure 1 gives a visual overview of the event period. In this study, four event windows are chosen, namely [-2,2], [-5,5], [-1,10] and [-10,1], in order to prevent the negative effects of data mining techniques. For example, by applying [-5,5] besides [-2,2] the overall M&A performance in an extended period can be revealed. M&A information leakage as well as M&A information delay are checked in the event windows of [-1,10] and [-10,1].

This study focuses on not only the M&A performance at the event date, but also the performance over longer periods surrounding the event. Hence, the abnormal returns are aggregated from the start of the event period 𝑡! to time 𝑡! to generate Cumulative Abnormal Returns (CAR), as follows:

𝐶𝐴𝑅! = 𝐴𝑅!,!! + ⋯ + 𝐴𝑅!,!! = 𝐴𝑅!,!

!!

!!!! (3)

In event studies the CARs are aggregated over the cross-section of events to generate Cumulative Average Abnormal Returns (CAAR):

𝐶𝐴𝐴𝑅 =!! !!!!𝐶𝐴𝑅! (4)

Therefore, the significance of the abnormal returns surrounding the M&A announcement day can be tested by using t-test, which is discussed in Section 3.3.

3.3. Hypotheses, Tests and Models

According to the literature mentioned in the previous section, shareholders of acquiring firms are at best break-even but usually make a loss during the acquisitions.

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This suggests that a relationship exists between M&A and abnormal returns. On the basis of this idea, Hypothesis 1 and Hypothesis 2 are proposed to test whether M&A have a significant effect on abnormal returns on the day of acquisition announcement:

Hypothesis 1 𝐻!: 𝐸 𝐴𝑅 = 0 𝑣𝑠 𝐻!: 𝐸 𝐴𝑅 ≠ 0 Test: 𝐴𝐴𝑅!!!= !! ! 𝐴𝑅! !!! (5) 𝑆!!!= !!!! !!!!(𝐴𝑅! − 𝐴𝐴𝑅!!!)! (6) 𝑡 = 𝐴𝐴𝑅𝑆 !!! !!! 𝑁 ~𝑡!!! (7)

and to test whether M&A have a significant effect on cumulative abnormal returns around the day of acquisition announcement:

Hypothesis 2

𝐻!: 𝐸 𝐶𝐴𝑅! = 0 𝑣𝑠 𝐻!: 𝐸 𝐶𝐴𝑅! ≠ 0 where t indicates different time windows

Test: 𝐶𝐴𝐴𝑅 =!! ! 𝐶𝐴𝑅! !!! (8) 𝑆 = 1 𝑁 − 1 (𝐶𝐴𝑅! ! !!! − 𝐶𝐴𝐴𝑅)! (9) 𝑡 = 𝐶𝐴𝐴𝑅𝑆 𝑁 ~𝑁 0,1 (10)

The literature shows a close relation between corporate governance and M&A performance. By controlling several variables in Section 3.4, acquirers with high corporate governance scores are expected to obtain higher abnormal returns in times

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of acquisitions. For this consideration, two regressions based on different time windows are proposed:

𝐴𝑅 = 𝛼 + 𝛽!" ∗ 𝐺𝑜𝑣𝑆𝑐𝑜𝑟𝑒! + 𝛽!"∗ 𝑇𝑜𝑏𝑖𝑛𝑠𝑄!+𝛽!∗ 𝐿𝑒𝑣𝑒𝑟𝑎𝑔𝑒! + 𝛽!"∗ 𝑆𝑖𝑧𝑒! + 𝛽!"!∗ 𝐹𝐶𝐹!+ 𝛽!"#∗ 𝑅𝑂𝐴!+ 𝜀!

(regression 1)

𝐶𝐴𝑅! = 𝛼 + 𝛽!"∗ 𝐺𝑜𝑣𝑆𝑐𝑜𝑟𝑒! + 𝛽!"∗ 𝑇𝑜𝑏𝑖𝑛𝑠𝑄!+𝛽!∗ 𝐿𝑒𝑣𝑒𝑟𝑎𝑔𝑒! + 𝛽!"∗ 𝑆𝑖𝑧𝑒! + 𝛽!"!∗ 𝐹𝐶𝐹!+ 𝛽!"#∗ 𝑅𝑂𝐴!+ 𝜀!

where t indicates different time windows: [-2,2],[-5,5],[-10,1] and [-1,10]

(regression 2)

Based on the regressions, Hypothesis 3 and Hypothesis 4 are used to test whether corporate governance has a significant effect on abnormal returns on the day of acquisition announcement.

Hypothesis 3

𝐻!: 𝛽!" = 0 𝑣𝑠 𝐻!: 𝛽!" ≠ 0

and to test whether corporate governance has a significant effect on abnormal returns in times of acquisitions.

Hypothesis 4

𝐻!: 𝛽!" = 0 𝑣𝑠 𝐻!: 𝛽!" ≠ 0

3.4. Control Variables

Figure 2 provides the control variables used for studying the relationship between corporate governance and M&A performance, referring to De Jong, Van der Poel and Wolfswinkel (2007) and Masulis, Wang and Xie (2007). The formulas for calculating these control variables are given in Appendix I. The meanings and functions of these variables are introduced as follows.

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Tobin’s Q

Tobin’s Q is a measure of economic efficiency. Lang, Stulz and Walkling (1989) find that acquirers with high Q ratios generate significantly more abnormal returns than acquirers with low Q ratios, because high-Q-ratio companies tend to invest in positive net present value projects (e.g. M&A). Additionally, after studying on the relationship between takeover gains and the Tobin’s Q of acquirers and targets, Servaes (1991) also comes out with the same findings. Hence, acquisitions undertaken by high-Q-ratio companies are expectedly considered as positive investment opportunities so that shareholder value is less likely to be destroyed.

Firm size

There is a strong evidence of the existence of the so-called “size effect” in acquisitions (Moeller, Schlingemann & Stulz, 2004). Moeller et al. (2004) argued that small public firms usually gain from their small acquisitions, whereas large public firms usually undertake large acquisitions yielding large dollar losses. In addition, they interpret this size effect as evidence that supports the Roll’s managerial hubris hypothesis (1986). Therefore, it is expected that managers in larger entities are more likely to be entrenched and to undertake value-destroying M&A.

Free Cash Flow and Leverage

Jensen (1986) posits that managers who have large free cash flows in control are more likely to undertake low-benefit or even value-destroying M&A. However, debt could potentially reduce the agency costs caused by free cash flows (Jensen, 1986). This is because debt could lower the amount of discretion cash flow for managers. Moreover, managers may be afraid of failing to pay back obligatory debt, indicating that debt can also be an effective motivating force for managers. Thus, leverage is assumed to have a positive effect on the abnormal returns while the effect of free cash flow stays to be either positive or negative.

Return on Asset

Firms with high ROA are often characterized by efficient management (Yermack, 1996) and efficiently-managed firms tend to undertake value-increasing acquisitions (Eisenberg, Sundgren & Wells, 1998). In this case, companies with high

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ROA are expected to result in high abnormal returns in times of the acquisition.

3.5. Data Source and Process

From 1980s to 2000s, there were seventy thousand completed M&A transactions worldwide for a total deal value of nine trillion in US dollar (Tabachnick & Fidell, 2005). Transactions during this period involve a U.S. firm as either an acquirer or a target accounted for half of the number and 70% in total deal value. These evidences confirm that the U.S. market for corporate assets is the most mature so far (Sundaram, 2004). For this reason, acquirers for this study are selected from the completed M&A transactions in the U.S.. The dataset has been retrieved from “Thomson One” database with following selection criteria:

• The announcement date of the M&A transactions should lie between January 1st 2006 and December 31st 2016.

• Both the acquirer and the target firm must be publicly listed. • Both the acquirer and the target firm’ nation code are U.S. • Only completed deals are included.

• The percentage of shares owned by the acquiring firm after the transaction should be larger than 50%.

• Firms in utility industry (SIC 4000-4949), firms in financial industry (SIC 6000-6999) and firms related to government (SIC 9111-9999) are excluded.

The last criterion is quite important because these firms usually operate in special regulatory environments, which potentially makes governance mechanisms less important (Vafeas & Theodorou, 1998). These firms should not be taken into account, because they have different corporate governance mechanisms and firm characteristics in comparison with the firms in other industries (Berger, Ofek & Yermack, 1997).

Starting with 478,388 M&A announcements, 306 transactions are retained after being filtered by the criteria.

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is measured by the AR and CAR on the shares of the acquiring firms surrounding the M&A announcements. Eventus database of Wharton Research Data Service (WDRS) has been used to calculate both returns. By merging CUSIP of acquirers and announcement dates of M&A from Thomson one, returns of specific event windows [-2,2], [-5,5], [-1,10] and [-10,1] are collected.

The other key dataset for analysis is corporate governance of the acquiring firm. It is simply measured by corporate governance score in ESG database. Combing the two datasets, acquirers with no corporate governance score available on the specific year are dropped, yielding a reduction of the data sample to 126 M&A transitions. All the control variable data are generated by DataStream. The variable normality is tested and variable with outliers is winsorized at 2% level.

Finally, a complete data sample of acquirers and target firms generated from 126 M&A transactions is left. The observations with missing data or outliers are excluded. Therefore, the analysis of this study has been performed in STATA with a clean dataset.

3.6. Descriptive Statistics

Before making regression analysis is conducted, descriptive statistics of the research sample are presented at first. This section gives an overview of the data and addresses some initial insights for the research.

Figure 3 shows the deal amount of M&A announcements made by the initial 307 sample firms in the period 2006 to 2016. The M&A deal number grew in 2006 and peaked in 2007, which is in congruence with the sixth M&A wave studied by Alexandridis, Mavrovitis, and Travlos (2012). During the sample time span 2006-2016, the highest amount of M&A announcements is also found in the first 2 years. However, the deal number dropped in the year of 2008 and 2009 due to the financial crisis. Later on, M&A surged again in 2014, appearing as the seventh wave (The Institute for Mergers, Acquisitions & Alliance, 2017).

Figure 4 indicates the total value of the deals over years. In Figure 4, the highest annual transactions occurred in the year of 2015 with a total deal value of

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69.474 billion dollars. The Institute for Mergers, Acquisitions & Alliance (2015) reports a total transaction value of twenty-four thousand billion dollars in the United States in 2015, which broke a new record in M&A history and was defined as the biggest M&A year ever by Wall Street Journal report (2015).

Table 2-4 presents the descriptive statistics of the final selected acquiring firms. Data of acquiring firms are first analyzed in three ways: total samples (126 firms), samples with corporate governance score smaller than the median score (63 firms) and samples with corporate governance score equal or larger than the median score (63 firms). In concordance with most studies, Table 2 shows that acquiring firms on average experience negative abnormal return in times of acquisitions. In the research period, the average abnormal returns is -0.831%; the average cumulative returns for four event windows are -1.599%, 0.552%, -1.053% and -1.292% respectively.

For all the samples and the samples with relatively low corporate governance score, the closer to the announcement day, the lower their average CAR are. This may indicate that M&A announcements yield negative abnormal returns. However, this is not the case for samples with relative high corporate governance score, since their average CAR tends to act in the other way around when getting closer to the M&A announcements, which follows the intuition behind the Hypothesis 3 and Hypothesis 4. Firms with relative high corporate governance score experience higher CAR in almost entire time windows relative to firms with low scores. Besides, these firms achieve better CAR performance on the announcement day and in the period of 10 days post-announcement than all samples means.

When looking at the control variables, firms with high governance score also have slightly larger firm size, more leverage and free cash flow, and higher Tobin’s Q and ROA. Further analysis will be given after the regressions are performed.

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4. Empirical Results

This section presents the results of regressions and the discussion on the proposed hypotheses. Both statistical and econometric significance will be specified for the results, and the economic meanings and implications will be discussed.

4.1. Market Reactions of M&A Announcements

Table 5 presents the t-test results for AAR and CAAR in times of acquisitions in this study. The critical value of the two-tailed t-statistic is calculated as 𝒕!!!.!";!"!!"#= 1.98, Hypothesis 1 and Hypothesis 2 can then be determined.

Both the AAR on the event day and the CAAR during the eleven-day [-5,5] period are significant at 1% level, indicating the significant market reaction on stock prices of acquiring firms to M&A announcements. The CAAR of the five-day [-2,2] period is significant at 5% level, while the M&A announcements effect on cumulative abnormal return for ten-day pre-announcement period and ten-day post-announcement period are relatively weak.

Although the cumulative abnormal returns in the pre-announcement [-10,1] window is significant at 10% level, significant returns before the event day could imply that insiders may reap benefits via information leakage (Ma, Pagan & Chu, 2009). Besides, the abnormal volume is widely used as an indication of information leakage in Meulbroek’s (1992) research. Ma et al. (2009) also report that valuation effects of M&A information leakage are found to be positively and statistically significant, which implies managers can earn the financial gains associated with M&A.

The test statistics of post-announcement is not significant at all, but this period has a negative mean of returns. This might be explained by the verified overvaluation hypothesis of Shleifer and Vishny (2003): shareholders of acquiring firms experience negative abnormal returns over long windows after M&A but not on the event day (Mueller & Yurtoglu, 2007).

On average, acquirers obtain a positive stock returns on the announcement day. However, in most cases, the returns are relatively low and the cumulative abnormal

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returns around the event day are negative. Owing to this finding, acquiring firms tend to not receive a large increase and even have a loss in shareholder value in times of mergers and acquisitions, which is in consonance with the research results by Jensen and Ruback (1993) and Moeller et al. (2005).

Hypothesis 1 is rejected, as M&A do have a significant effect on abnormal returns on the event day. Since M&A are only found to have a significant effect on cumulative abnormal returns around the event day, Hypothesis 2 is also rejected except for the cases of ten-day pre-announcement and ten-day post-announcement.

4.2. Effect of Corporate Governance on the Day of M&A Announcement In order to investigate the relationship between the corporate governance and M&A performance in the U.S. from 2006 to 2016, regression (1) aims at testing the effect of corporate governance on abnormal returns of acquiring firms exactly on the announcement day. Before analyzing the results, the variance inflation factor (VIF) is tested to check any possible multicollinearity. A rule of thumb is that if VIF is larger than 10, then multicollinearity is high (Myers, 1990). The VIF for the explanatory variable is computed as a value of 1.036 and is less than 10, which obviates the issue of multicollinearity. Thereafter, the white test is performed to test the heteroskedasticity. The null hypothesis of homoscedasticity is rejected, which means that the variance is not variance. Therefore, the standard errors are robust to heteroskedasticity in the models (Stock & Watson, 2015).

Table 6 shows the results of regression (1). Generally, the model explains 26.5% variation in the dependent variable. In this regression, the corporate governance score is significantly correlated to the abnormal returns at 1% level. Therefore, the corporate governance standards do affect the performance for acquirers on the day of M&A announcement. Since the dependent variable has a positive coefficient, an increase in the corporate governance score yields an increase in the stock gains of acquirers on the announcement day. Hypothesis 3 is therefore rejected. The only control variables revealing significant effects on the abnormal returns are Firm Size and Tobin’s Q. According to the sign of their coefficients, both

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variables have an expected relationship with abnormal returns, which is in good agreement with the previous studies. More precisely, Moeller et al. (2004) support the Roll’s managerial hubris hypothesis with so called “size effect” evidence, as they find larger firms tend to pay higher premiums to undertake acquisitions and thus generate negative synergies. On the other hand, the study of Lang et al. (1989) as well as Servaes (1991) show that acquiring firms with high Tobin’s Q obtain significantly positive abnormal returns, which are valid not only for tender offers, but also for mergers. However, in this regression, other control variables do not have significant effects, and the interpretations of their coefficients does not show consistency with previous findings.

4.3. Effect of Corporate Governance in Different Event Windows

Four regressions with dependent variable of different time windows derived from Regression (2) are performed to investigate the relationship between corporate governance and M&A performance in the U.S. from 2006 to 2016. Regression (2) is to test how corporate governance affect cumulative abnormal returns of acquiring firms surrounding the announcement day. Likewise, multicollinearity and heteroskedasticity are checked before conducting the analysis. The regression results of CAR in four different event periods are presented in Table 6.

4.3.1. Five-day and Eleven-day Event Window

Regression (a) and (b) in Table 6 are used to test the corporate governance effect on [-2,2] and [-5,5] event windows. The 𝑅! for these two models are found to

be 23.2% and 17.9% respectively. The evidence suggests that there exists a relatively small significant governance effect on the five-day [-2,2] event period but has no effect on eleven-day [-5,5] event period. Therefore, Hypothesis 4 is rejected under the condition of these two event periods at 5% significance level.

However, it is interested to see a higher corporate governance score will increase the CAR in both cases, controlling for other variables. Especially for the CAR of the extended event window [-5,5], same volume increase in corporate

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governance practice leads to more enhancement in the returns acquirers gained during this period when compared to the [-2,2] event period. Although Masulis et al. (2006) find a significantly positive relationship between corporate governance and M&A performance, no conclusion can be drawn from these two models since the statistics of corporate governance score are not significant enough.

For most control variables, there is no clear impact during both event windows. Two exceptions are Tobin’s Q and Firm Size. In both cases, they have an expected sign of coefficient. However, they have little contribution to the explanation of CAR, as they only significant at 10% level.

4.3.2. Pre-announcement and Post-announcement Period

Regression (c) and regression (d) in Table 6 are used to test the corporate governance effect on pre-announcement [-10,1] and post-announcement [-1,10] event windows. The 𝑅! for these two event windows are found to be 21.6% and 18.1%

respectively. Corporate governance is only found to have a weak effect on the cumulative abnormal returns of pre-event period. Accordingly, the Hypothesis 4 is rejected at 5% significance level.

Although there have been very few studies directly explaining this less significant result of pre-announcement period, information leakage might be interpreted as a cause. It is possibly the case that high corporate governance standards somehow obstruct the benefits reaping by managers from information leakage of M&A deals. Therefore, the corporate governance does have an indirect effect on cumulative abnormal returns during the pre-event period.

Not surprisingly, Tobin’s Q and Firm Size are both statistically significant in the pre-announcement event window, same as the findings in Lang et al. (1989), Servaes (1991) and Moeller et al. (2004). Although GovScore is not significant in the post-announcement window, or say it has no influence on M&A performance, Firm Size does have an expected relation to the cumulative abnormal returns during this period. Besides, ROA is only significant in a relative low confidential level and it has an opposite predicted effect on the returns.

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5. Conclusion

This section makes a general conclusion of this study, points out the limitations and proposes topics for further research.

5.1 Conclusion

This study begins with literature review on the issue of M&A performance over the past decades. In previous research, undertaking M&A do not increase or even destruct shareholder value of acquiring firms (Roll, 1986; Jensen et al., 1993; Andrade et al., 2001; Bruner, 2002; Moeller et al., 2005). Two causes of value-destroying M&A claimed in this study are agency problem and managerial hubris. In order to explain and solve this issue, corporate governance, the system that directs and controls firms, is suggested and discussed by many researchers. Given the background and problem statement, the research question “Does corporate governance influence acquirers’ performance of mergers and acquisitions?” is proposed. In order to answer the question, event study and regression model are performed to investigate the effect of corporate governance on M&A performance of acquirers.

In the initial stage, t-test is performed to check the M&A performance. As a result, M&A is found to have a significant effect on abnormal returns not only on the announcement day of the acquisition, but also over longer periods (e.g. event windows [-2,2] and [-5,5]). These findings are in line with the previous study results (Asquith et al., 1983; Andrade et al., 2001; Moeller et al., 2004). Although the effect on pre-announcement event [-10,1] period is relatively insignificant, a suspicion of, for example, information leakage is determined. On the other hand, M&A turn out to have no influence on post-announcement event period [-1,10] at all, which indicates no information delay (as opposed to information leakage) in this study.

In order to investigate the effect of acquirers’ corporate governance on their M&A performance, five regression models with different event windows are analyzed. From the positive coefficients of the key explanatory variable GovScore, it can be interpreted that shareholders of acquiring firms with high corporate governance score

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obtain higher returns in times of acquisitions. And corporate governance is especially found to have a significant positive effect on the abnormal returns on the announcement day. This is in accordance with the study results generated by Masulis et al. (2006) and Brown and Caylor (2006), in which they find a positive relationship between corporate governance and M&A performance. A reasonable interpretation of this relationship is that managers of firms with more corporate governance are better controlled and monitored so that they are less likely to take irrational behaviors (e.g. undertaking value-destroying M&A to pursue own interest). Therefore, shareholders and investors may have positive attitudes towards M&A. As a result, stock prices as well as abnormal returns will increase due to the high demand and high expectation of the firms’ stock. However, corporate governance has relatively less effect on pre-announcement event period and [-2,2] event window. And no significant relations are found during post-announcement event period and when event window is expanded to [-5,5].

In all models, Tobin’s Q has a positive relation to M&A performance, and it poses a significant effect except in the post-announcement event window, which demonstrates that acquiring firms with high Q ratios generate significantly more abnormal returns than those who with low Q ratios (Lang et al., 1989). Besides, firm size turns out to be negatively related to the abnormal returns, which meets the expectation of “size effect” in Section 3.4 that small acquiring firms generate significantly more value from acquisitions than large firms (Moeller et al., 2004). Although abnormal returns seems to decrease when firms’ ROA goes up in all models, the identity of the significance for ROA is rather unclear at 5% significance level. Therefore, no conclusion can be drawn from this finding. Unexpectedly, there are no observed impact of Free Cash Flow and Leverage in all regressions. However, the implication of positive coefficients of Leverage is in line with Jensen’s free cash flow hypothesis (1986), as the increase in leverage ratio leads to the increase of abnormal returns in this study. Jensen (1986) also posits that managers with large free cash flows in control are more likely to carry on irrational events that do harm to M&A performance, whereas Free Cash Flow in all models affect the abnormal returns in a

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positive way.

5.2 Limitation and Further Research

One limitation of this study is the relatively small sample size. Data are collected from different databases and then are merged in order to generate the final dataset. Due to the selecting criteria, a large number of the collected M&A transactions are dropped from 478,388 to 306. Besides, the limited availability of data on corporate governance score by ASSET4 ESG finally narrows down the dataset from 306 observations to 126 observations. Therefore, this relatively small sample size may inevitably affect the accuracy of the analyzed results.

Another limitation is subject to the issue of endogeneity. This study implicitly assumes causality from corporate governance to M&A performance. On the other hand, there might be in the same time that M&A performance do have effect on the corporate governance. For example, successful or failed acquisitions may increase or reduce the number of directors and executives, which affects corporate governance scores of firms. And firms with high corporate governance standards (e.g. efficient and independent board) tend to choose overconfidence CEOs in risky industries who potentially have motivation to indulge in empire-building acquisitions that may affect shareholder value (Hirshleifer, Low & Teoh, 2012).

Since the scope of this study is limited, future research can adopt different measuring factors of corporate governance instead of simply using the overall score. And the investigation on the relationship between corporate governance and M&A performance can extend to different regions rather than the U.S., such as Europe and Asia. In addition, both the financial crisis and non-crisis research periods can be performed separately and then comparing the results to see whether the financial crisis matters. In this case, more comprehensive conclusion will be drawn on the relationship between corporate governance and M&A performance in different industries, different regions and under certain crises.

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APPENDIX Appendix I

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Appendix II Figures and tables

Figure 1: Event period

T1 T2 t1 Event t=0 t2

Estimation Window Event Window

Figure 2: Control Variables

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Figure 3: Deal amount

Figure 4: Deal value

0 5 10 15 20 25 30 35 40 45

50 Number of M&A transations in the U.S.

0 10 20 30 40 50 60 70 80 T ra n sa ct io n V al u e (i n b ln $)

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Table 1

Table 2: Descriptive statistics Sample: all samples

(1) (2) (3) (4) (5)

N mean sd min max

AR 126 -0.00831 0.0350 -0.133 0.121 CAR1 [-5,5] 126 -0.01599 0.0609 -0.203 0.193 CAR2 [-10,1] 126 0.00552 0.0319 -0.199 0.160 CAR3 [-1,10] 126 -0.01053 0.0597 -0.238 0.212 CAR4 [-2,2] 126 -0.01292 0.0654 -0.120 0.122 FIRMSIZE 126 16.300 1.5560 12.00 19.080 ROA 126 0.0701 0.0874 -0.460 0.329 TOBINSQ 126 2.4230 1.2890 0.841 7.555 FCF 126 0.0935 0.0685 -0.113 0.399 GOVSCORE 126 77.800 13.740 31.420 96.460 LEVERAGE 126 20.650 13.330 0 59.700

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Table 3: Descriptive statistics Sample: GOVSCORE LOW (< 𝑚𝑒𝑑𝑖𝑎𝑛)

(1) (2) (3) (4)

VARIABLES N mean min max

AR 63 -0.0411 -0.0795 0.121 CAR1 [-5,5] 63 0.00197 -0.203 0.193 CAR2 [-10,1] 63 0.00275 -0.199 0.152 CAR3 [-1,10] 63 -0.0455 -0.238 0.212 CAR4 [-2,2] 63 -0.00803 -0.120 0.122 GOVSCORE 63 67.59 31.42 79.19 FIRMSIZE 63 15.95 12.00 18.62 LEVERAGE 63 19.68 0 43.74 ROA 63 0.0607 -0.460 0.329 TOBINSQ 63 2.333 0.841 7.555 FCF 63 0.0914 -0.0938 0.399

Table 4: Descriptive statistics Sample: GOVSCORE HIGH (≥ 𝑚𝑒𝑑𝑖𝑎𝑛)

(1) (2) (3) (4)

VARIABLES N mean min max

AR 63 0.0244 -0.133 0.0732 CAR1 [-5,5] 63 -0.0340 -0.138 0.116 CAR2 [-10,1] 63 0.00829 -0.119 0.160 CAR3 [-1,10] 63 0.0245 -0.103 0.132 CAR4 [-2,2] 63 -0.0178 -0.0900 0.110 GOVSCORE 63 88.02 79.29 96.46 FIRMSIZE 63 16.65 13.49 19.08 LEVERAGE 63 21.62 0 59.70 ROA 63 0.0795 -0.0842 0.299 TOBINSQ 63 2.514 0.963 6.999 FCF 63 0.0956 -0.113 0.334

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Table 5 Time window observa

tions AAR CAAR | t | 0 126 0.00831 2.6651*** [-5,5] 126 -0.0160 2.94*** [-10,1] 126 0.00552 1.9424* [-1,10] 126 -0.01053 0.8878 [-2,2] 126 -0.01292 2.2175**

The symbols *, **, and *** denote statistical significance at the 0.10, 0.05 and 0.01 levels respectively, using a two-tailed t-test.

Table 6

Regression(1) Regression(a) Regression(b) Regression(c) Regression(d) VARIABLES AR CAR1 [-5,5] CAR2 [-10,1] CAR3 [-1,10] CAR4 [-2,2]

GOVSCORE 0.0860*** 0.0588 0.0472* 0.0529 0.0530* (0.0263) (0.0374) (0.0271) (0.0322) (0.0312) TOBINSQ 0.0415*** 0.0491* 0.0363*** 0.0457 0.0273* (0.0153) (0.0291) (0.0135) (0.0534) (0.0161) FIRMSIZE -0.0613*** -0.0831* -0.0830** -0.0753** -0.0567* (0.0233) (0.0486) (0.0419) (0.0380) (0.0310) LEVERAGE 0.0368 0.0498 0.0512 0.0606 0.0192 (0.0344) (0.0493) (0.0326) (0.0532) (0.0418) ROA -0.0800 -0.1411* 0.1363 -0.1560* -0.1352 (0.0614) (0.0795) (0.0870) (0.0917) (0.1020) FCF 0.0782 0.132 0.147 0.145 0.116 (0.0548) (0.130) (0.126) (0.155) (0.102) Constant -0.0250 0.1093 -0.0301 0.0756 -0.0296 (0.0561) (0.1632) (0.0875) (0.1320) (0.0909) Observations 126 126 126 126 126 R-squared 0.265 0.179 0.216 0.181 0.232

Robust standard errors in parentheses *** p<0.01, ** p<0.05, * p<0.1

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