The effect of uncertainty on the method of payment in M&A with a special focus on the source of funding in cash offers : an analysis based on the Brexit referendum

(1)

Master Thesis

The effect of uncertainty on the method of payment in M&A with a

special focus on the source of funding in cash offers.

An analysis based on the Brexit referendum

Abstract

This study investigates whether the uncertainty, that has arisen about the future relation of the UK with the EU after the outcome of the Brexit referendum, has had an impact on the payment method in M&A transactions with any UK involvement. The announcement that the majority of UK citizens voted in favor to leave the EU is used as exogenous event. Both repeated cross-sectional- and difference-in-difference models (non-UK

acquirers as control group) for the period January 2012 – May 2018 could not find evidence in favor of UK acquirers to be more inclined using stock as payment method after the referendum. On the other hand, globally diversified UK acquirers (less exposed to the Brexit) are less inclined using stock after the referendum than UK acquirers relying more on the UK economy (5% significance). So, ambiguous evidence is found regarding the explanatory power of greater uncertainty about the fundamentals of the acquirers on the payment method. Accordingly, opportunities for acquirers to exploit short-term relative overvaluation when they are exposed to greater uncertainty about their fundamentals do not consistently explain a greater likelihood of stock payments. Furthermore, Insignificant evidence is found in cross-border deals only where acquirers of UK targets are more inclined to use stock as payment method after the referendum, which gives strength to the hypothesis that acquirers prefer to share post-acquisition risk when the fundamentals of targets become more uncertain. Lastly, this study examines whether non-debt funding sources in cash offers are less likely to be used by UK acquirers due to the deteriorated investors sentiment after the Brexit referendum. A linear probability model finds insignificant evidence in favor of this, while a difference-in-difference model with the same (non-UK countries) control group and sample period as for the payment method finds significant evidence in favor of this hypothesis, implying that underbidding is less likely for cash offers amid periods of greater uncertainty.

Keywords: Brexit, Uncertainty, Mergers and Acquisitions, Payment Methods, Funding Sources, United

Kingdom, European Union

Date: 1st_{of July 2018}

Name (student number): Molenaar, Martijn (10323143) Supervisor: Professor Vladimirov, Vladimir

Study program: MSc Finance, Duisenberg Honours programme in Corporate Finance and Banking Number of credits thesis: 15

(2)

Statement of Originality

This document is written by Student Martijn Molenaar 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.

Acknowledgment

I would like to take this opportunity to thank all the professors involved in the MSc Finance program for making this year extremely instructive and challenging. It has been a year full of hard work and a steep learning curve. I have created a broader and better knowledge base across the broadest areas of Finance this year, which will benefit me for the rest of my career.

In particular, I would like to thank my supervisor, Professor Vladimirov, for providing me with helpful suggestions regarding this thesis and at the same time encouraging me to work independent.

(3)

1 Introduction

The global Mergers and Acquisitions (M&A) activity has exceeded an amount of $3 trillion for the fourth consecutive year and this activity is expected to keep growing (Massoudi et al., 2017), which explains the continuously growing awareness of M&A in academic research. Despite the fact that M&A has become part of the business strategies for a growing number of organizations the last few decades, there are still implications in M&A which are not fully understood. An important implication which is not fully understood is the choice whether to pay for an M&A transaction with cash, stock or a combination of these. It is important to understand the determinants of this payment method because it affects the wealth of shareholders (both target and acquirer). Furthermore, the payment method has a significant impact on financial-, corporate control-, and operational implications for the shareholders of the involved companies (Faccio and Masulis, 2005). Two factors determining whether to pay for an acquisition with cash, stock or a mix of these are relative overvaluation (Rhodes-Kropf et al., 2005; Dong et al., 2006) and sharing the risk of post-acquisition performance (Rappaport and Sirower, 1999). Besides the payment method, the way companies fund their cash offers also impacts the wealth of shareholders and implications regarding financials, corporate control and operational activities. The funding sources in this thesis are roughly divided into debt-, non-debt- and internal corporate funds. Compared to research on pricing and market reactions in M&A, the M&A payment decision has received relatively little attention. Research on the funding sources in cash offers is even more scarce. Nevertheless, several studies did research on determinants regarding the method of payment1_{in M&A}

and funding sources2_{for cash offers in M&A already.}

Oftentimes M&A transactions within the same industry, country and in more or less the same time period use a different payment method. Two recent M&A transactions with the same acquirer (John Wood Group), which is incorporated in the UK, are the acquisition of Amec Foster Wheeler and the acquisition of BETA Machinery Analysis (both in the engineering services industry). Yet, the payment method for the first mentioned acquisition was all-stock and the latter was all-cash,

indicating the difficulty to understand the payment method choice and raises the question why this company uses different payment methods. The first mentioned acquisition was done prior to the Brexit referendum and the latter came about after this referendum, which subsequently raises the question whether this was a factor in the payment decision. The announcement of the UK leaving the EU on the 24th_{of June, which is generally acknowledged as the “Brexit”, has brought a considerably}

amount of uncertainty about the future relation of the UK with the EU. Market participants did not predict the majority of UK citizens vote to leave the EU, which can be derived from the fierce market reactions: A strong depreciation of the pound sterling, a strong short-term fall of the stock market, the

1_{Among others: Amihud et al. (1990), Martin (1996), Faccio and Masulis (2005), and Swieringa and Schauten}

(2008)

(5)

Bank of England (BOE) reducing the interest rate and a downgrade of the UK’s triple-A credit rating by big rating agencies. These reactions indicate exogenous features regarding this event. Hitherto, it is obscure how several agreements3_{between the UK and the EU will change after the Brexit, which}

generates uncertainty regarding the impact on the UK economy for almost 2 years now. Accordingly, due to its exogenous features, the Brexit referendum is an appropriate event to use in order to test the effect of this uncertainty on the method of payment in M&A and funding sources in cash offers. The question this thesis examines is whether uncertainty, as a consequence of this Brexit referendum, affects the method of payment in M&A transactions. Additionally, the effect of this uncertainty on the use of non-debt funding sources in (partial) cash offers for UK acquiring companies is examined. This study tries to fill the void in literature to address the effect of uncertainty on the fundamentals of both acquirers and targets with regard to the payment method and funding sources (for cash offers) in M&A, by using the Brexit referendum as a source of this uncertainty.

Accordingly, a contribution is made to the broader area regarding the determinants in the method of payment and funding sources (for cash offers) in M&A, which will be useful for stakeholders4

participating in M&A. Altogether, this study contributes in multiple ways. First of all, the exogenous feature of the Brexit referendum is used to alleviate endogeneity problems regarding the effect of uncertainty on the payment method in M&A transactions encountered by previous literature. Secondly, certain theories regarding the method of payment are tested because of this event, namely the behavioral theory which claims that short-term relative overvaluation is a factor in determining the payment method in M&A and the theory that acquirers prefer to share the risk of post-acquisition performance when the value of the target becomes more uncertain (risk-sharing motive). Thirdly, the source of funding in (partial) cash offers is a relatively new topic in literature, in which this thesis contributes by looking at the effect of increased uncertainty that deteriorated the investors sentiment after the referendum on non-debt sources.

The uncertainty after the Brexit referendum affects both acquirers and targets incorporated in the UK such that an accurate value assessment has become more difficult for all market participants. Luypaert and Van Caneghem (2017) argue that acquirers are more inclined to use stock as payment method when both the fundamentals of the acquirer and / or the target become more uncertain, where the first can be argued by opportunities to exploit short-term relative overvaluation and the latter by shifting part of the increased risk regarding the post-acquisition performance. Moreover, the first depends on whether targets are willing to accept relatively overvalued stock (behavioral motives5_),

which prior literature empirically demonstrated to be a valid statement (Rhodes-Kropf et al., 2005;

3_{Among others the international trading agreements and free movement of people.} 4_{In particular shareholders of the acquiring- and target companies.}

5_{Behavioral motives comprise of: top management of targets have either a relatively short-time horizon, get}

paid individually for deal agreement, are offered an attractive position in the newly combined company (Hartzell et al., 2004; Shleifer and Vishny, 2003), or overestimate synergies amid periods of high market valuations (Rhodes-Kropf and Viswanathan, 2004).

(6)

Dong et al., 2006). Accordingly, both UK acquirers and acquirers of UK targets are expected to be more inclined using stock as payment method after the Brexit referendum due to the greater

uncertainty. Cross-border deals with UK involvement are used to isolate the effect whether a potential greater incline to use stock as payment method after the referendum is due to the sharing the increased risk of post-acquisition performance (fundamentals UK targets harder to assess) or opportunities to exploit short-term relative overvaluation (fundamentals UK acquirers harder to assess). Additionally, the effect of the referendum on the method of payment by the degree global diversification of the UK acquirer is examined, because Hill et al. (2017) provided evidence that UK companies with larger international exposure are less exposed to the uncertainties with regard to the Brexit. So, following the findings and conjectures of Hill et al. (2017) and Luypaert and Van Caneghem (2017) it is expected that the more globally diversified a UK company is, the less it is affected to be more inclined using stock as payment method after the referendum. The conjectures about the effect of the Brexit referendum on the method of payment are tested by conducting repeated cross-sectional models complemented with difference-in-difference (DiD) models over the period January 2012 through May 2018.

Weak (insignificant) evidence is found in favor of acquirers being more inclined to share post-acquisition performance risk when the target is exposed to more uncertainty about their fundamentals, because non-UK acquirers are more inclined (insignificant) to use stock as payment method for UK targets after the Brexit referendum. Furthermore, Ambiguous evidence is found with regard to the explanatory power of greater uncertainty about the fundamentals of UK acquirers on the method of payment, because DiD models where Brexit exposure is separated by country of

incorporation (UK vs non-UK) and by global diversification (fraction of international revenue to total revenue) provide different results. The model where Brexit exposure is separated by the acquiring company’s country of incorporation demonstrates mostly insignificant results of UK acquirers (more exposed to Brexit) being less inclined to use stock after the Brexit referendum. On the other hand, the model where the extent to which the UK acquiring company is globally diversified (more globally diversified means less exposed to Brexit) is used to distinguish Brexit exposure, shows significant results that less globally diversified UK acquirers are more inclined to use stock as payment method. As a result, the evidence with regard to the explanatory power of uncertainty about the fundamentals of the acquirers is ambiguous. Accordingly, opportunities that acquirers exploit short-term relative overvaluation (as a result of greater uncertainty about their fundamentals) do not consistently explain a greater likelihood of stock payments.

Furthermore, the greater uncertainty about the fundamentals of UK acquirers after the Brexit referendum is expected to reduce the likelihood to use non-debt funding sources in (partial) cash offers for these companies. Vladimirov (2015) argues that endogenizing the way cash bids are funded is just as important as the choice whether to pay with cash, stock or a mix of these (method of

(7)

with non-debt funding sources are lower compared to internally financed and debt financed cash offers, which indicates underbidding. An important note here is that he endogenizes the financing decision. So, when cash offers are less likely to be funded by non-debt sources, it implies that underbidding is less likely. According to Martynova and Renneboog (2009), the investors sentiment (stock price run-up) determines whether non-debt funding sources are used in cash offers if there are not sufficient internal corporate funds to finance the cash offer. The uncertainty after the Brexit referendum has deteriorated the investors sentiment and, accordingly, expected to have reduced the use of this non-debt funding source in cash offers for UK acquirers. In order to test the effect of uncertainty after the Brexit referendum on the non-debt funding sources in (partial) cash offers, a linear probability model is conducted and complemented with a DiD model over the same time span and with the same control group (non-UK acquiring companies) as for the method of payment. When looking at UK acquirers, the linear probability model found insignificant results in favor of a lower probability for the use of non-debt funding sources in (partial) cash offers after the Brexit referendum. The DiD model provided significant evidence in line with the linear probability model, which is mainly because of the increased use of non-debt funding sources in the control group. This gives strength to the hypothesis that greater uncertainty indeed lowers the likelihood of using non-debt funding sources in cash offers, which implies that underbidding is less likely for cash offers in periods of greater uncertainty.

This thesis proceeds in section 2 with a theoretical framework that focusses on the method of payment in M&A, funding sources in (partial) cash offers, and elaborates on the Brexit (referendum). Hereafter, the Hypotheses, Methodology, Data and Descriptive Statistics, Results, and Discussion are set out in sections 3, 4, 5, 6 and 7 respectively. Lastly, a conclusion finalizes this thesis in section 8.

2 Theoretical Framework

The theoretical framework starts with discussing what effect uncertainty is expected to have on the payment method according to prior literature, followed by a discussion on the behavioral theory with regard to the method of payment. Hereafter, other theories and variables controlling for these theories concerning the payment method are set out. Subsequently, the main literature regarding the source of funding is discussed, followed by an analysis on what variables determine the use of non-debt funding sources according to existing literature. Lastly, the event that is used to test the effect of uncertainty on the method of payment and funding sources is elaborated on, namely the Brexit referendum.

2.1 Uncertainty and the Method of Payment

Luypaert and Van Caneghem (2017) distinguish the effect on the method of payment in M&A by uncertainty and information asymmetry separately because they demonstrate that the impact on the

(8)

payment method in M&A transactions is different. Uncertainty is defined in a way that it is more difficult to assess the underlying fundamentals of a company in a symmetric way by all market participants (both insiders of the company and outside investors). Information asymmetry can be seen as one party (either insiders of the target or the acquirer) gain superior information about the

underlying fundamentals of the company. So, asymmetric information creates a competitive

advantage for the party that gain superior information. Luypaert and Van Caneghem (2017) use both implied volatility and idiosyncratic volatility as proxies for uncertainty in their study.

They argue that an increase in uncertainty about the underlying fundamentals of the target company affects acquiring companies in a way that they are more inclined to use stock as payment method in M&A transactions, in order to shift part of the risk for not realizing the on beforehand expected post-acquisition performance. When looking at uncertainty regarding the underlying fundamentals of the acquirer, they hypothesize that stock payments are more likely if this uncertainty is greater. They argue that uncertainty about the fundamentals of the acquiring company offers opportunities to exploit short-term relative overvaluation. Furthermore, they demonstrate that the fraction of cash offers is lowest when the uncertainty of both acquirers and targets is highest. This indicates that acquirers prefer shifting part of the risk when the uncertainty with regard to the fundamentals of the target is high and they exploit opportunities of short-term relative overvaluation when the uncertainty with regard to the fundamentals of the acquirer itself are high. Although, targets would be more reluctant accepting stock from acquirers of which the fundamentals have become more uncertain, Rhodes-Kropf et al. (2005) and Dong et al. (2006) empirically demonstrated targets to accept relative overvalued stock. The underlying theory behind targets accepting relative overvalued stock from an acquirer lies in behavioral motives and is explained in the next section, followed by other theories regarding the drivers of the payment method.

2.2 Behavioral Theory

The hypothesis that acquirers are able to use relative overpriced stock in M&A transactions, is regarded as the behavioral theory. The evidence in favor of relative overvaluation as determinant in the payment method is not unambiguous whatsoever. Prior literature already elaborated on behavioral motives (the willingness) to accept relatively overvalued stock from the point of view of the target, which is explained in this section.

The theoretical model of Shleifer and Vishny (2003) assumes inefficient financial markets and rational managers, where rational managers of the acquiring companies are able to use relative overvalued stock in a merger as payment method because top management of targets tend to have a short-time horizon or get paid individually for deal agreement. In other words, they assume top managers of target companies to be self-interested. Hartzell et al. (2004) complements on Shleifer and Vishny (2003), by arguing that target’s top management is explicitly paid for their permission to agree

(9)

on the deal in the form of an attractive position in the newly combined company or valuable resources (money). Rhodes-Kropf and Viswanathan (2004) provide a theoretical model where the activity of stock payments in M&A transactions is positively related with high market valuations, because they assume that top management of the targets do not take into account the error component of the market. This subsequently leads to a better perception of bids in high market valuation from the standpoint of the target, indicating that the top management of targets accept relative overvalued stock more often in periods of high market valuation and thus are inclined to overestimate synergies amid these periods. Both these models imply that relative overvaluation leads to more stock payments. Rhodes-Kropf et al. (2005) empirically test the theoretical predictions of Shleifer and Vishny (2003) and Rhodes-Kropf and Viswanathan (2004) by using the market-to-book ratio to explore relative overvaluations and they provide evidence in favor of both theoretical predictions. Moreover, Dong et al. (2006) use different ratios (price-to-book value of equity and price to residual income value) to detect relative overvaluation and found similar results in the sense that the likelihood of a stock payment increases in the opportunity to take advantage of relative overvaluations. The evidence in favor of these behavioral motives depend on market timing, meaning that managers of acquiring companies are able to detect a relative overvaluation and rationally anticipate.

Evidence that is contradictory to the explanatory power of relative overvaluation on the payment method is provided by Harford (2005). They find evidence in the form of an economic model that includes capital liquidity to be a better predictor of merger waves (high frequency of stock payments in M&A) than the market-to-book ratio (proxy for market overvaluation). This finding does not support the prior evidence in favor of relative overvaluation to be the driver of stock as payment method. Moreover, Betton et al. (2008) highlight that the high market valuation before the dot.com crash (prior to 2000) did not demonstrate an increase in stock payments relative to mixed and cash payments. So, accordingly it can be concluded that there is ambiguity in existing literature about the explanatory power of opportunities to exploit short-term relative overvaluation.

2.2.1 Other Theories regarding the Method of Payment

According to Betton et al. (2008), the empirical evidence on the payment method choice can be divided roughly into 5 theories: capital structure-, asymmetric information-, managerial control-, tax- and the behavioral theory, which was elaborated on in previous section. It is necessary to identify what determines the payment method in M&A and control for this in order to mitigate endogeneity in the form of omitted variables when testing for the effect of uncertainty. Accordingly, these theories plus two macro-economic (country-specific) determinants in the method of payment are elaborated on. Variables (determinants) that control for these theories, supported by existing literature and empirical findings, are discussed and set out subsequently.

(10)

2.2.1.1 Capital Structure Theory

Modigliani and Miller (1958) suggest in their proposition 1 that companies have no preferences on how to finance investment projects (including M&A) whatsoever, since this would not affect the total value of the company. In proposition 2, Modigliani and Miller (1958) propose that the Weighted Average Cost of Capital (WACC) is not affected by the amount of debt a company holds. This means that in proposition 2 the capital structure has no effect on the value of the company, just as in

proposition 1. However, for these propositions the assumption has been made that perfect markets exist, which is an unrealistic assumption to make. Perfect markets imply perfect competition, equal accessibility to relevant information for everybody, equal lending and borrowing rates and it lacks taxes and transaction costs to name a few. So, arbitrage opportunities do not exist and the capital structure has no effect on the value of the company.

However, in their modified proposition 2, Modigliani and Miller (1963) imply that the capital structure has an effect on the value of the company by including the concept of the interest tax shield. In this modified proposition, they show that the higher the leverage of a company, the higher the value of the company because the interest they pay on their debt is tax deductible. This modified proposition, however, does not take into account the higher probability of bankruptcy with a higher levered company and the costs that come with this risk. Prior literature6_{evince that the direct costs of}

distress range from 1.4% to 7.5% of a company its assets in bankruptcy. Moreover, besides these direct costs, distressed companies also suffer from indirect costs of distress. Andrade and Kaplan (1998) demonstrated indirect costs of 10% to 20% for a sample of 31 leveraged transactions. The trade-off between the advantage of the interest-tax shield with high leverage on the one hand and the disadvantage of distress costs with high leverage on the other hand, is known as the static trade-off theory (Myers and Majluf, 1984). M&A transactions result in significant deviations from the optimal capital structures, with all its consequences for shareholder wealth. The pecking order theory, which elaborates on the static trade-off theory, states that companies have a preference to finance an investment with internally raised cash, then debt and lastly with the issuance of equity (Myers and Majluf, 1984). Hence, if a company does not have sufficient internally raised cash in hand to fully finance the M&A transaction, it relies on debt financing, which explains the importance of the capacity to borrow cash for a company when deciding the payment method in an M&A transaction. Therefore, the cash availability and borrowing capacity of the acquiring company are of paramount importance when the payment method is determined.

2.2.1.1.1 Variables controlling for the Capital Structure

The free-cash flow theory, which is developed by Jensen (1986), argues that less cash available for management reduces agency costs and thus increases shareholder value. So, from a free-cash flow

(11)

theory point of view (preventing inefficient CEO’s to use free cash flows for their own interest), cash offers would be the preferred method of payment. Zhang (2003) provided evidence that the dividend

pay-out ratio and the probability of a cash payment are positively related. Following the method of

Zhang (2003), the dividend pay-out ratio will be used as a proxy for the free-cash flow of the acquiring company.

Complementing on the direct and indirect costs of bankruptcy by taking high levels of leverage from the previous section, Rose (1977) argues that increased financial leverage makes the event of default more likely and thus increases indirect costs of distress. This implies stock payments to be positively related with the leverage of the acquiring company. Moreover, it can be induced that a company’s ability to obtain debt financing decreases in the degree financial leverage and thus stock payments become more likely when financial leverage increases. Significant evidence in favor of this argument is provided by Faccio and Masulis (2005).

In case the available internal cash is not enough to pay for the M&A transaction, debt has to be borrowed. It is cheaper and easier (and thus more attractive) to borrow debt when there is

collateral against which this debt can be borrowed. According to this argument, a positive relation to

cash payments is expected for the amount of collateral an acquiring company has.

On average larger companies have a more diversified portfolio and thus a lower probability of default. This consequently affects the accessibility to debt markets in a positive way. Accordingly, larger companies are expected to have easier access to debt markets and thus are more likely to finance an M&A transaction with cash. Faccio and Masulis (2005) provided significant evidence in favor of a positive relationship between the size of the acquiring company with cash payment, while Swieringa and Schauten (2008) had a p-value of 11% on the relation between size and a cash payment.

Karampatsas et al. (2014) imply that higher capability to access public debt markets affects the choice of payment method in M&A transactions. In particular high credit quality, which is associated with lower financial constraints and easier accessibility to public debt markets, allows highly rated (credit ratings received from rating agencies like Moody’s and S&P) acquiring

companies to be less reluctant using cash in an M&A transaction, as it is less painful for them to find cash for new investments in the future.

2.2.1.2 Asymmetric Information Theory

An important, yet realistic, assumption in the pecking order theory is that managers know more than the market about the value of their company, so a certain amount of asymmetric information is present. Subsequently, managers who perceive their company’s equity to be undervalued will prefer to fund investments using internal funds or debt, rather than equity and the converse is also true. Therefore, using retained earnings or issuing debt or equity to finance investments gives a signal to

(12)

the market that affects the stock price. Several studies (e.g., Travlos, 1987; Martin, 1996) provided evidence that bidder announcements induced abnormal stock returns which are negative on average in all-stock offers for public targets. While other studies (e.g., Chang, 1998; Fuller et al., 2002)

conducted research on the bidder announcement returns in all-stock offers for private targets, which are non-negative. So, from these results an inference can be made that the investors’ concern of asymmetric information is something to take into account when deciding how to finance for the transaction. This is known as the one-sided information asymmetry theory, which only looks at information asymmetry from the acquirer’s point of view.

Hansen (1987) constructed a theoretical model that also includes the target’s point of view, which is known as two-sided information asymmetry. According to this model, the payment method choice depends on the probability of valuating the target (and synergies) right. So, when the

information asymmetry on the value of the target increases, the likelihood to pay with stock from the acquirer’s point of view will also increase in order to hedge the increased risk exposure of valuating the target too high. In his model, he does not take into account that acquirers have incentives to signal to other (potential) acquirers.

Fishman (1989) also provided a theoretical model based on two-sided information

asymmetry, which differs from the model of Hansen (1987) in a way that it does take into account the incentives of acquirers to signal to other (potential) acquirers. A cash offer will give a signal to other (potential) acquirers that the initial private valuation of the target is high, which is a discouraging signal to other acquirers who are then more reluctant to incur costs preparing an offer. So, when acquirers attach more value to signal their high valuation to other (potential) acquirers in order to deter competing offers than to hedge the increased risk exposure of valuating the target too high in case of increased information asymmetry, a cash offer will be more likely. Both Chemmanur et al. (2009) and Luypaert and Van Caneghem (2017) found evidence that is consistent with the theory that acquirers attach more value to signal a high value of the target than to hedge increased risk exposure when the information asymmetry increases.

2.2.1.2.1 Variables controlling for Asymmetric Information

According to the theoretical model in the research of Hansen (1987), stock offers tend to be less likely when the acquirer has a relatively high equity value compared to the value of the deal. Both Faccio and Masulis (2005) and Swieringa and Schauten (2008) provide empirical evidence on a significant negative relationship between this relative size (market capitalization compared to deal size) and cash payments. On the other hand, Martin (1996) does not find a positive significant relationship between relative size and a cash payment.

According to the theories provided by Myers and Majluf (1984) and Hansen (1987), acquiring companies prefer to use stock as a payment method when their stock is overvalued by the

(13)

market and cash when their stock is undervalued. Moreover, the shareholders of the acquiring company perceive a lower dilution of their voting rights after an increase in the stock price of the acquirer by using stock in an M&A transaction. A proxy to measure the over- or undervaluation perception of the target company for the fundamentals of the acquiring company used by Faccio and Masulis (2005) and Martin (1996) is the stock performance over the year preceding the announcement month. They provide significant evidence for a negative relationship between this stock performance measure and a cash payment.

Furthermore, the return volatility of the acquirer over the year preceding the announcement month is also something to control for. Faccio and Masulis (2005) looked at the effect of the volatility of the acquirer’s stock the year preceding the announcement month on the method of payment and found a significant negative relation with cash payments. They argue that in periods of high return volatility, acquirers are more reluctant to pay with debt (cash financing) because of higher expected bankruptcy costs and lower expected tax benefits related to debt. Moreover, higher return volatility increases opportunities for acquirers to exploit their information asymmetry by paying with stock. From the target’s point of view, greater return volatility of the acquirer makes a stock payment less attractive. However, they find evidence which suggests the preferences of the acquirer to dominate the payment method choice and thus the expected relation between return volatility and cash payments is negative.

Faccio and Masulis (2005) argue that the asymmetric information problem in mergers and acquisitions is bigger for diversifying (intra-industry) deals relative to non-diversifying deals. This can be explained by the fact that the management of a target company in an intra-industry deal has more knowledge regarding the risks and prospects in that industry and thus less asymmetric information is present. So, intra-industry deals are expected to be positively correlated with stock payments in M&A transactions.

According to Coval and Moskowitz (1999), investors have a home country bias in their portfolio decisions. Such a home bias could lead to higher trading costs and lower volume of trading. Besides that, investors also face exchange rate risk7_{and are disadvantaged by the accessibility of}

information about the company (information asymmetry) if the deal is cross-border. Subsequently, targets will be more reluctant by accepting acquirers’ stock in case of a cross-border M&A transaction. Including a cross-border dummy will control for this effect.

Fishman (1989) argues that paying with cash in an M&A transaction increases the probability that an offer will be accepted relative to paying with equity, assuming the same acquisition price. This subsequently reduces the probability of a competitive offer. So, in case the pace of closing the deal is important, for example when the acquirer has a high valuation of a target, the acquirers’ preferred method of payment would be cash. So, the risk of competitive offers and takeover defenses against

(14)

hostile offers is reduced by using cash as payment method.

Companies with a high market-to-book ratio, generate more value using capital than

companies with a lower market-to-book ratio. The market value of the company should be higher than the replacement cost of capital8_{in order not to waste some of its capital. The higher the}

market-to-book ratio, the more reluctant the company is expected to be to borrow money. One can argue that shareholders oftentimes don’t want to give away monitoring power to debt holders, because debt holders are more risk-averse than the shareholders. Both Martin (1996) and Faccio and Masulis (2005) provide evidence for a significant positive relation between market-to-book value of a company and stock payments.

The liquidity for the shares of the acquiring company could also affect the method of payment in a way that the target company is more willing to accept a stock payment if the shares are very liquid. In the study of Faccio and Masulis (2005) liquidity is defined as the number of shares traded in a particular month over the average number of shares outstanding at the beginning and end of the same month, averaged across the 24 months prior to the acquisition announcement month. However, they did not find significant positive evidence with stock payments.

2.2.1.3 Managerial Control Theory

The structure of ownership of the acquiring company is affected by M&A activity when at least part of the transaction is paid in stock. Harris and Raviv (1988) and Stulz (1988) provide theoretical evidence that managers act in their own interest to protect personal private benefits from being in control. In particular, the extent to which management has voting right shares is an important factor to consider when looking at the payment method in M&A. Managers are reluctant giving up (part of) their control of the combined company. Empirical evidence9_{on the relationship between acquiring}

company’s structure of ownership and the method of payment are mostly in line with each other, namely that the fraction of control by the management of the acquiring company is positively related to cash payments. However, Zhang (2003) could not find a significant relationship on the ownership structure with cash payments in M&A. This insignificant result by Zhang (2003) could be due to the fact that they have a small dataset with relative low fractions of ownership, according to Swieringa and Schauten (2008).

Furthermore, besides the positive relationship between ownership structure of the acquiring company and cash payments in M&A, the target’s ownership structure could also be arguably having a relationship with the payment method. In contrast to public target companies, private and subsidiary

8_{Price that a company would have to pay on the market for capital, however book-value is often used because}

of data availability.

9_{Evidence provided by studies from Amihud et al. (1990), Martin (1996), Faccio and Masulis (2005) and}

(15)

target companies oftentimes have an ownership structure in which only one or a few shareholders fully control the company. Shareholders of the private and subsidiary target companies might be more reluctant to accept stock offers in order not to become a minority shareholder and deal with moral hazard problems, according to Faccio and Masulis (2005). One could also argue that the more concentrated the ownership structure of the target is, the higher the risk of losing control to only one or a few (new) shareholders (blockholders) by paying with stock from the acquirer’s point of view (Swieringa and Schauten, 2008). Moreover, Faccio and Masulis (2005) argue that the owners of a private standalone company in many cases have liquidity incentives to sell. For instance, a controlling shareholder manager that retires and would like to liquidate his company for cash to enjoy his old days. Furthermore, owners of these private standalone companies that would like to sell their company, are oftentimes affected by financial distress concerns or a longing to restructure towards their prioritized business segment. They use the same arguments for target companies that are subsidiaries. Subsidiaries also have liquidity incentives to sell their companies, mostly due to

financial distress concerns or the desire to restructure. So, this will lead to a higher probability of cash payments when the target is a subsidiary from the target’s perspective.

2.2.1.3.1 Variables controlling for ownership structures

The concentration of ownership by the management of the acquirer is expected to be positively related with cash payments what has become clear from the above. In this thesis, the fraction of closely held shares (shares held by insiders) over the total amount of shares outstanding (control) will be used as a proxy for the degree of concentrated ownership in a company.

The section above made the preference to pay for a private standalone - or subsidiary company (both unlisted) with cash clear from both the perspective of the acquirer as well as the perspective of the target. This thesis controls for the ownership structure of the target company by including 2 dummy’s, namely one if the target is a private standalone company and one if the target is a subsidiary.

2.2.1.4 Tax Theory

The tax theory implies that target shareholders will receive a higher takeover premium in cash only offers than in stock only offers, because target shareholders can defer their capital gains taxes when the merger or acquisition is paid by more than 50% with equity. Research conducted by Frank et al. (1988) provided evidence that takeover premiums are significantly higher in all cash deals than in all stock deals in the UK market. So, from this perspective a plausible hypothesis can be constructed which states that cash deals may be relatively costly compared to stock only deals, because target shareholders cannot defer the capital gains taxes in such a transaction and thus require a higher premium. However, they also provided evidence that before the introduction of capital gains taxes,

(16)

these takeover premiums in the UK were higher in cash only deals than stock only deals. Moreover, Eckbo and Langohr (1989) provided evidence that the approximated value of the option to buy shares from a target company do not differ between cash only and stock only offers. Concluding, the

consistency of the hypothesis based on this theory from a tax-point of view on the method of payment in an M&A transaction is questionable. Moreover, the taxation of M&A transactions is treated

differently across countries, and they are subject to a dynamic and complex environment. So, for these reasons I leave this theory out of the scope for this thesis.

2.2.1.5 Macro-Economic Determinants

De Jong et al. (2008) provide evidence that GDP growth consistently shows statistically significant positive results on the degree of leverage of companies over 42 countries. This implies that companies incorporated in countries that face high GDP growth are likely to take on more debt. From these findings, one can induce a positive relation with cash payments in M&A transactions because more debt means more cash to finance potential M&A transactions.

Faccio and Masulis (2005) use the market performance over the year preceding the

announcement month as a proxy for the effects of business cycles on the method of payment in M&A transactions. The paper of Swieringa and Schauten (2008), in which they examine the methods of payment and its determinants in M&A transactions with a Dutch acquirer between 1996 and 2005, follows the same methodology of Faccio and Masulis (2005). Accordingly, this thesis uses the same measure to proxy the effect of business cycles on the payment method in M&A transactions.

According to the behavioral theory, targets are more likely to overestimate synergies amid periods of business cycle peaks (market performance as proxy). Subsequently, it can be induced that the market performance in the acquirer’s country of incorporation is positively related with stock payments in M&A transactions.

2.2.1.6 Framework Determinants Method of Payment

A framework of the variables that determine the method of payment in M&A transactions based on the theories explained in this section is set out in Table 1 below. The variables are categorized by expected positive relationship with either cash or stock payment in M&A transactions.

(17)

Table 1: Expected relation company-, deal- and country specific variables with the method of payment

This table provides an overview of the variables that determine the method of payment. The variables under Cash (Stock) are expected to be positively correlated with cash (stock) payments.

Cash Stock Collateral Size Dividend Pay-Out Control Private Target Subsidiary Target Cross-Border Unfriendly Credit Rating Financial Leverage Relative Size Stock Performance Return Volatility Intra Industry Liquidity Market-to-Book GDP Growth (Yearly) Market Performance

2.3 Uncertainty and the Source of Funding

It is important to distinguish the definitions of “method of payment” and “source of funding”, because sometimes they are erroneously used interchangeably. The method of payment is about paying for an M&A transaction with cash, stock or a mix of these, while the source of funding is about the funding structure of an offer (partially) paid in cash. This funding structure of cash payments can be

categorized into debt, non-debt and internal funds.

Martynova and Renneboog (2009) provided evidence that the factors determining the payment method in an M&A transaction differ from the factors determining the source of funding conditional on a (partially) cash offer. They argue that the source of funding conditional on a cash offer is influenced by the cost of capital at the company level and at the country level. Moreover, in their research they evince the financing source in (partial) cash offers to be an important determinant for the post-announcement performance. This indicates the importance of studying the funding source in (partial) cash offers. Consistent with the pecking order theory, they find that cash-rich acquiring companies prefer to use internal funds. Acquiring companies will make use of external funds when they do not have sufficient internal funds. Debt funding will be used if the debt capacity is high (proxies are the amount of leverage and collateral) and non-debt funding will be used if investor sentiment (proxy is stock performance prior to deal announcement) about the acquiring company is positive. They emphasize that the corporate governance environment10_{by making such decisions play}

a big role in their funding decision.

(18)

Vladimirov (2015) argues that endogenizing the choice of financing (source of funds) for cash offers is just as important as the choice whether to pay with cash, stock or a mix of these in M&A transactions. He implies that companies with limited access to capital markets (e.g. smaller and private companies) will finance their cash offers by issuing more information-sensitive securities (e.g. equity) and companies with full access to capital markets (larger and public companies) finance their cash offers by issuing debt. Another implication made by Vladimirov (2015), is that lower supply of competitive financing (debt financing) and less-developed capital markets induce higher demand by financiers for more-information-sensitive securities. In his research he finds empirical evidence that, when endogenizing the financing decision, cash offers financed with non-debt funding sources are lower compared to internally financed and debt financed cash offers. Consequently, underbidding is more likely in cash offers that are funded by non-debt sources. Accordingly, an expected decrease in non-debt sources due to a deteriorated investor sentiment implies that underbidding is less likely.

2.3.1 Determinants non-debt funding sources

The main determinants in the paper of Vladimirov (2015) for the choice of non-debt funding in cash offers are the acquirers’ size (continuous and categorized in 5 quintiles), age, public or private status (this study contains only public acquirers), and whether they have a credit rating. He argues that these variables are good proxies for the accessibility of debt financing, and a lack of this accessibility causes acquirers to finance cash deals with non-debt sources. He also controls for the degree of competition (if there are multiple observed bidders) and characteristics of the acquiring company in the models: EBIT over sales, EBITDA over total assets, total liabilities over total assets (Financial Leverage), and Property, Plant and Equipment over total assets (Collateral). The main findings in his research are that large acquiring companies (largest 20% of the sample) have a 20% higher

probability using non-debt financing than small acquiring companies (smallest 20% of the sample) in (partial) cash offers. Furthermore, acquirers with a credit rating are 2% to 5% less likely to use non-debt financing in cash offers. This thesis uses the same determinants to control for the effect of uncertainty (after the Brexit referendum) on non-debt funding sources in cash offers.

2.4 The Brexit (referendum)

Ever since the establishment of the EU on the 1st_{of November 1993 in Maastricht, no country has}

ever left the European Union11_{(EU). The nationwide referendum in the UK with the commitment to}

leave the EU, which was held on the 23th_{of June 2016, turned out to be (slightly) in favor of the}

people who voted to leave the EU. This result had all the appearance not to be expected, because of

11_{The European Union is a political and economic union and has expanded several times throughout its history}

by way of accession of new member states. The European Union nowadays exists of 28 member states (including the United Kingdom)

(19)

the fierce market reactions and the slight victory for the people in favor to leave the EU. Besides the direct implications, triggered by the Brexit referendum, this referendum is expected to cause some long-term consequences for the UK economy in particular. The long-term implications are a consequence of the inability to assess how several agreements between the UK and the EU will change after the Brexit. Next, the direct implications of the Brexit Referendum will be set out to highlight its exogenous features, followed by a dense overview of potential scenarios when the Brexit becomes a fact in the future and evidence on distinct exposures to the Brexit by international activity.

2.4.1 Direct Implications Brexit referendum

Several direct effects on important financial and economic variables were the consequence of the outcome of the Brexit Referendum. the Brexit referendum has had a fierce impact on the currency exchange rate of the pound relatively to the other main currencies. A depreciation of the pound relatively to the U.S. dollar of approximately 8% was the impact after the outcome of the Brexit Referendum was known by the public (1-day market reaction). The currency exchange rate of the pound relatively to the U.S. dollar for the period 2016 is displayed in Figure 1.

Figure 1: Effect Brexit referendum on the exchange rate (£/$)

This graph displays the effect on the outcome of the Brexit referendum on the currency exchange rate of the pound relatively to the U.S. dollar.

Source: Datastream

Next to the market reactions on the currency exchange rate, the FTSE 100 Index and the FTSE 250 Index12_{reacted fiercely on the outcome of the Brexit referendum in the short-run.}

However, these indices quickly recovered and even sustain a higher level than before the

12_{The FTSE 100 and the FTSE 250 are the capitalization-weighted indices consisting of the 1}st_{to 100}st_{and the}

101st_{to the 350}st_{largest companies on the London Stock Exchange, respectively.} Brexit referendum Outcome

June 24, 2016 1.2 1.25 1.3 1.35 1.4 1.45 1.5 1.55 E x cha nge R at e ( £ / $) Date

(20)

announcement. It should however be mentioned that the FTSE 100 and the FTSE 250 are largely composed of companies that make a big part of their revenues internationally. So, the fierce depreciation of the pound resulted in an improved earnings pattern internationally (in pounds). Accordingly, they sustain a higher level than before the announcement. The FTSE 100 Index and the FTSE 250 Index for the period 2016 are displayed in Figure 2a and 2b, respectively. Moreover,

Figure 2c provides the FTSE 100 volatility index in order to show that the implied volatility in the

period around the Brexit referendum was very high, indicating there was a lot of speculation on the outcome of the Brexit referendum.

Figure 2: Market reactions Brexit Referendum.

These graphs display the effect on the outcome of the Brexit Referendum on the Stock Market Index (2a and 2b) and the increased volatility surrounding the Brexit Referendum (2c).

Figure 2a

Figure 2b

Brexit referendum Outcome June 24, 2016 5250 5450 5650 5850 6050 6250 6450 6650 6850 7050 7250 P ri ce I nde x ( F T S E 100 ) Date

Brexit referendum Outcome June 24, 2016 14500 15000 15500 16000 16500 17000 17500 18000 18500 P ric e Inde x ( F T S E 250) Date

(21)

So, based on the fierce effect caused by the outcome of the Brexit referendum on the U.K. stock market and the exchange rate of the pound relatively to the U.S. dollar, it can be induced that market participants did not expect the outcome of the Brexit referendum to be in favor of those who voted to leave the EU. From this perspective, one can conclude that the Brexit referendum can be treated as an exogenous shock to the U.K. economy.

2.4.2 Brexit Scenarios (source of uncertainty)

Until now, no one knows what will happen with the relationship of the UK and the EU. The Lisbon treaty, which came in force in 2009, stated that the country wishing to leave the EU should notify the EU of its intention to leave the EU and subsequently trigger negotiations over a withdrawal agreement between the country (U.K. in this case) and the rest of the EU member states. If the withdrawal agreement comes into effect or if no agreement is reached within two years after the notification, the country could leave the EU. There is no relevant precedent leaving the European Economic

Community (EEC)13_{nor a country leaving the EU, which makes it difficult to understand the details}

of how such a withdrawal process would work and how the EU would optimally treat the exiting country. Hitherto, it is uncertain under what conditions the UK will leave the EU. Dhingra and Sampson (2016a) set out four scenarios on how the relations between the U.K. and the EU would continue doing business with each other and the economic and political consequences of these scenarios.

The scenarios that Dhingra and Sampson (2016a) elaborates on are the Norwegian-, the Swiss-, the re-joining of the EFTA-, and the WTO-scenario, which are ordered in their degree of harmfulness for the UK economy, respectively. The extent to which these scenarios differ in

13_{The predecessor of the EU.}

Figure 2c

Source: Datastream

Brexit referendum Outcome June 24, 2016 10 15 20 25 30 35 V o la ti li ty I nde x ( F T S E 100)

Date

(22)

harmfulness for the UK economy depend on whether certain agreements still hold after the Brexit. The most important agreements that have to be revised when the Brexit becomes a fact are: remaining part of the single market, the free trade in goods, the free movement of people throughout Europe. So, the outcome of the Brexit referendum caused uncertainty about various regulations and laws, which are currently being governed by the EU and need to be revised14_{. This uncertainty has its}

consequences on future operations for companies incorporated in the UK. Since almost half 15_{of U.K.}

goods exports went to the EU in 2016, one can imagine a negative effect on the UK economy when the free trade of goods with the EU disappears (WTO scenario). In a follow up study, Dhingra et al. (2016b) try to quantify the effects of the Brexit on the living standards by assessing an optimistic estimate and a pessimistic estimate. They imply that in the optimistic scenario there is a fall in income per capita of 1.28%, which is largely driven by trade effects. In the pessimistic scenario the fall in income per capita is estimated to be 2.61%. However, these estimates are based on a static trade model and do not account for the dynamic effects of trade on productivity. Bloom et al. (2014) and Sampson (2016) provide evidence that these dynamic effects may double or triple the size of the static effects. This dynamic (long-run) case is estimated to affect the income per capita negatively by in between 6.3% in the optimistic scenario and 9.5% in the pessimistic scenario. Due to the long-lasting period between the announcement of the UK leaving the EU and the agreement on which terms this is going happen, this event provides a perfect setting to test whether uncertainty affects the way UK companies pay for M&A and fund their cash offers.

2.4.3. Distinguishing Brexit Exposure

Hill et al. (2017) provide evidence that the extent in which a UK company is exposed internationally, is an important determinant that captures the exposure to the uncertainty of the Brexit. They use 3 proxies to measure international exposure, namely foreign sales, foreign assets and the number of foreign countries mentioned in the company’s annual reports. They find that UK companies with greater international exposure coincide with less exposure to uncertainty regarding Brexit. The diversification benefits of international activities are consistent with their findings because they rule out that these results are only driven by the depreciation of the pound. This determinant, which distinguishes the Brexit exposure between companies incorporated in the UK will be used in this study to verify whether the effect on the payment method is different across the degree of

international activity. This provides another ideal setting to test the effect of the uncertainty after the referendum on the payment method.

14_{Throughout the thesis, this is the definition of uncertainty when referring to uncertainty after the Brexit}

referendum.

15_{Retrieved from the Office for National Statistics (ONS). The absolute amount corresponding to the 48%}

equals £145 billion. Website ONS: https://www.ons.gov.uk/businessindustryandtrade/internationaltrade/articles /whodoestheuktradewith/2017-02-21

(23)

3 Hypotheses

As it has become clear from the theoretical framework, the Brexit referendum is the start of the source of uncertainty about the future relation of the UK with the EU. This uncertainty has its effects on companies that are exposed to the consequences of the Brexit. The uncertainty leads to more ambiguity about the fundamentals of these companies. Due to this uncertainty, it is more difficult to predict their future cash-flows after the Brexit referendum, which makes the underlying fundamentals of companies exposed to the Brexit more difficult to assess. Companies incorporated in the UK are expected to be exposed significantly more to the consequences of the Brexit than other European countries.

The Brexit referendum increased the amount of uncertainty for all market participants about the underlying fundamentals of companies exposed to the Brexit. So, the assumption is that no superior information is gained due to this event by either the target or the acquirer. Luypaert and Van Caneghem (2017) argue that greater uncertainty about the underlying fundamentals of the acquirer offers opportunities to exploit short-term relative overvaluation and found evidence in favor of this by using implied volatility and idiosyncratic volatility as proxies for uncertainty. It is assumed that managers have more information regarding the fundamentals of their company than the financial market. Accordingly, the greater uncertainty about the fundamentals of companies exposed to the Brexit referendum, created opportunities to take advantage of this short-term relative overvaluation. So, these acquirers are expected to be more inclined using stock as payment method in M&A

transactions. For this hypothesis to hold, targets must be willing to accept relatively overvalued stock, which has been empirically proved (Rhodes-Kropf et al., 2005; Dong et al., 2006) to be a valid statement and can be argued by: top management of targets have either a relatively short-time horizon, get paid individually for deal agreement, are offered an attractive position in the newly combined company (Hartzell et al., 2004; Shleifer and Vishny, 2003), or overestimate synergies amid periods of high market valuations (Rhodes-Kropf and Viswanathan, 2004). According to the

aforementioned arguments and assumptions, the first hypothesis reads:

H1: After the Brexit referendum UK acquirers are more inclined to use stock as a payment

method in M&A transactions.

Moreover, Luypaert and Van Caneghem (2017) argue that acquirers are more inclined to use stock as payment method in M&A when the underlying fundamentals of the target company become more uncertain. This effect is explained by the risk-sharing motive of post-acquisition loss

(overvaluation of the target or not realizing the synergies). A valid assumption here is that UK targets in general are exposed to the Brexit. Following this argument and assumption, it is expected that greater uncertainty about the underlying fundamentals of UK target companies after the Brexit

(24)

referendum induces acquirers to be more inclined using stock as a payment method in these M&A transactions. This leads to the formulation of the second hypothesis:

H2: After the Brexit referendum acquirers of UK targets are more inclined to use stock as a

payment method in M&A transactions.

It is expected that M&A transactions where both the acquirer and the target are incorporated in the UK are more inclined to use stock as a payment method than cross-border deals with any UK involvement. Luypaert and Van Caneghem (2017) demonstrated that greater uncertainty for both the acquirer and the target induces the lowest fraction of cash payments. According to these findings and assuming hypothesis 1 and 2 are correct, a reinforcing effect is expected towards acquirers being more inclined to use stock as payment method in M&A transactions. Subsequently, this leads to the third hypothesis:

H3: After the Brexit referendum UK domestic deals are more inclined to use stock as

payment method for M&A transactions than cross-border deals with any UK involvement.

Furthermore, Hill et al. (2017) demonstrated that UK companies that are more globally diversified, are less prone to the consequences of the Brexit than less globally diversified UK

companies. Accordingly, it is expected that globally diversified UK companies are expected to be less affected by the uncertainty generated by the Brexit referendum than UK companies depending more on the UK economy. A fourth hypothesis is formulated based on this evidence and the arguments used for hypothesis one:

H4: After the Brexit referendum, UK acquirers that are globally diversified are less inclined

to use stock as payment method in M&A transactions than UK acquirers that generate their

revenues more nationally.

A last hypothesis is based on the effect of the resulting uncertainty by the Brexit referendum on the source of funding in (partial) cash offers. When looking at (partial) cash offers only for UK acquirers, it is expected that the likelihood of being funded by non-debt sources is lower after the Brexit referendum. This conjecture is based on the deteriorated confidence of investors about UK businesses (investor’s sentiment). Martynova and Renneboog (2009) argue that in absence of sufficient internal funds to finance an M&A transaction, conditional on that the M&A transaction is (partially) paid with cash, acquiring companies rely on external funds in the form of debt and non-debt. The latter is used if the sentiment of investors about the acquiring company is positive.

(25)

Accordingly, due to the domestic political uncertainty and deteriorated prospects about the purchasing power for UK households after the Brexit referendum, this investor sentiment (proxy is stock

performance prior to deal announcement) is deteriorated. These aforementioned arguments lead to the 5th hypothesis:

H5: After the Brexit referendum the likelihood to use non-debt funding sources in (partial)

cash offers for UK acquirers is reduced.

4 Methodology

In the methodology section, the methods used to answer the hypotheses are elaborated on. In order to look at the effect of the Brexit referendum on the method of payment (MoP) in M&A transactions and the non-debt funding source (SoF) in (partial) cash offers, a distinction is made between deals before and after the 24th_{of June 2016. This distinction is made by introducing a post-referendum dummy,}

which is equal to 1 if the deal is announced after the 24th_{of June and 0 otherwise. Moreover, non-UK}

acquiring companies are companies listed in one of the 16 non-UK European countries16_{in the data}

sample. Non-UK target companies relate to the companies that are acquired by companies listed in one of the 17 European countries (including UK) and which are not incorporated in the UK. In order to test hypotheses 1 and 2, both repeated cross-sectional models and difference-in-difference (DiD) models are conducted, which are normally distributed Ordinary Least Squares17

models. Hypotheses 3 and 4 are tested by DiD models. For the source of funding hypothesis (H5), both a linear probability model and a DiD model are conducted. Non-linear models like the tobit (for MoP) or the logit / probit (for SoF) are not considered in this study, because problems arise when including many dummy variables (e.g. fixed effects). The asymptotic properties (consistency, unbiasedness and normality) for these non-linear models do not hold when adding fixed effects. In case of the tobit model a bias arises due to problems with the disturbance variance (Greene, 2004). In case of the logit and probit model, the incidental parameters problem18_{causes the bias. The trade-off}

by using linear models instead of non-linear models is that the predictions are unbounded and are not guaranteed to lie in the interval [0, 100] in case of models where “MoP” (percentage paid in cash) is the dependent variable and [0, 1] in case of models where “SoF” (probability non-debt funding) is the dependent variable.

16_{Sample of non-UK acquiring countries: Austria, Belgium, Denmark, Finland, France, Germany, Greece,}

Ireland, Italy, Netherlands, Norway, Poland, Portugal, Spain, Sweden, Switzerland

17_{Ordinary Least Squares is a widely used method in academic work that minimizes the sum of the squares of}

the differences between the data points of the dependent variable and a linear line in order to estimate relations between variables.

18_{The maximum likelihood estimator (MLE) is inconsistent in the presence of fixed effects when the “time” is}

The effect of uncertainty on the method of payment in M&A with a special focus on the source of funding in cash offers : an analysis based on the Brexit referendum

Master Thesis