Cash Holdings, Governance and the Method of Payment
Choice in European Acquisitions.
Abstract
This paper examines the relationship between the cash richness of a firm, governance and the propensity to use equity or cash as the method of payment within European transactions. Strong corporate and country level governance have a positive impact on the probability to use cash as a method of payment. This supports the notion that the level of cash is influenced by agency conflicts, and acquisitions are a means to reduce cash holdings. The findings are robust to alternative measures for cash holdings as well as governance. The analysis furthermore shows that ownership structure is only significant for the method of payment decision in continental Europe, but not in Anglo-Saxon countries. My findings do not support the hypothesis that cash rich firms use significantly more equity than non-cash rich firms to compensate the vendor. JEL classification:
G32; G34
Keywords:
Acquisitions; Cash holdings; Governance; Method of payment
Supervisor: Dr. Halit Gonenc
Co-assessor: Dr. Wim Westerman
Author: Frederik Pfeil
MSc International Financial Management Faculty of Economics and Business
University of Groningen
1. Introduction
Corporate cash holdings are at record highs and companies expect the global Mergers and Acquisitions (M&A) activity to be booming again (KPMG, 2015). KPMG’s recent survey reports that the current level of cash holdings will fuel corporate acquisitions all over the world. Previous research underlines this expectation as it finds, that the level of cash holdings is positively related with the amount of acquisitions a firm conducts1. The question however is, if extraordinary levels of cash affect the mode of sizable corporate investments such as acquisitions. Pinkowitz, Sturgess and Williamson (2013) analyse 6,302 acquisitions of US firms between 1984 and 2006 to test whether cash holdings also affect the method of payment decision. They find that cash rich firms are significantly more likely to use equity instead of cash as the method of payment than non-cash rich firms. The authors argue that these findings cannot be explained with agency theory or financial constraints and consequently attribute the findings to financial flexibility theory. My aim is to test whether this relationship holds in an environment of more diverse corporate governance regimes and ownership structures such as Europe.
This paper examines the effect of cash holdings and governance on the method of payment decision in acquisitions of European firms. Liquidity is valuable to the firm as it provides financial flexibility for investments as well as protection against the dependence on external finance that can be negatively affected by market conditions. If firms pay the target’s shareholder (vendor) with cash this will reduce the financial flexibility, whereas equity payment does not reduce the acquirer’s level of cash holdings. Thus, cash rich firms will be particularly interested in maintaining their flexibility by using equity as the method of payment. However, corporate liquidity also results in a large degree of managerial discretion as cash can be spend faster and easier in a discretionary manner than cash invested in fixed assets (Myers and Rajan, 1998). Coherently, agency theory predicts that agency problems increase in line with cash holdings. The firm will reduce agency costs if it reduces its liquidity by using cash as the method of payment. Thus, the method of payment choice results in a trade-off decision2 between the value of financial flexibility to the firm and the costs of agency conflicts which may arise due to increased liquidity. Strong corporate governance mitigates agency problems as it protects shareholders from the potential expropriation through insiders (management) and increases the alignment of
1 For European acquisitions this are in particular the findings of Faccio and Masulis (2005).
2 The trade-off model for cash holdings relates to the costs and benefits of cash holdings regarding multiple
interests. Governance regimes and levels within Europe are not homogenous and thus more divergent than governance within as single market such as the US, which is likely to affect the method of payment decision. Furthermore, European firms have more concentrated ownership than US firms. This influences the method of payment decision as dominant shareholders (blockholders) will prefer cash over equity as acquisition currency to remain in control over the firm (Faccio and Masulis, 2005). Thus, my research question is:
Are cash rich firms significantly more likely to use equity as a method of payment than non-cash rich firms, and does governance significantly influence the method of payment decision?
For this research I combine a sample of firm- and transaction specific data from the databases Zephyr, Orbis and Datastream. The sample consists of 7,940 firm-year observations from 16 countries between 2005 and 2014 and acquisition-related data for 836 European acquisitions between 2006 and 2015. In line with agency theory, I find that strong governance on firm- and country level significantly increases the use of cash as the method of payment. In Anglo-Saxon countries strongly governed cash rich firms are significantly more likely to use equity as a method of payment. In continental Europe ownership structure influences the method of payment decision by increasing the use of cash. The interaction between strong country level governance and cash richness significantly increases the probability of equity as the method of payment. When testing if this effects explains the findings of Pinkowitz et al. (2013), my results indicate that the effect does not hold in Anglo-Saxon countries. Overall, my findings do not support that cash rich firms are significantly more likely to use equity as method of payment.
This research advances the existing literature due to multiple aspects. First, it shows how governance influences the spending of cash holdings.3 Hence, it offers an in depth understanding of the relationship between cash holdings, governance and the mode of corporate investments, based on the extant literature of cross-country research regarding cash holdings and governance.4 Second, the research setting in Europe offers a much more diverse setting than the US study of Pinkowitz et al. (2013), particularly regarding different levels of corporate governance, institutional ownership and cross-border effects which are expected to influence the method of payment decision. Third, this paper contributes to the theory of financial flexibility by directly
3 Dittmar and Mahrt-Smith (2007) argue that governance affects the utilisation of cash rather than the
accumulation. However, they do not examine how this occurs. This aspect is addressed through this research.
testing mechanisms that govern the corporate choice concerning cash management, as demanded by Denis (2011).
This paper is structured as follows. In the beginning, I outline the theoretical rationale behind the research and derive hypotheses based on theory and previous findings. Afterwards, I present the methodology and discuss the results from the regression analysis. The last section concludes with a summary and outlook for further research.
2. Theory
To determine how firms finance their acquisitions it is a prerequisite to understand the underlying reasons and mitigating factors of the firm’s capital structure. If firms hold cash for a certain reason, this is likely to influence the method of payment decision. In the following, I discuss the determinants of cash holdings and the value of financial flexibility for the firm. Afterwards, I outline the impact of agency conflicts on cash holdings and present the literature regarding cash holdings, governance and acquisitions as a basis for the hypotheses development. Finally, I develop three hypotheses on the relationship between cash holdings, governance and the method of payment decision.
2.1. Why do firms hold cash?
2.1.1. Transaction costs and taxes
Transaction costs are associated with the conversion of non-cash assets into cash. Due to these costs and economies of scale, larger firms hold less cash than smaller firms (Mulligan, 1997). Nevertheless, transaction costs arise when firms issue debt on financial markets, pay taxes or face costs of financial distress (Gamba and Triantis, 2008). In this situation cash holdings are beneficial to the firm as they reduce transaction costs. Second, the tax burden5 on the repatriation of profits may induce companies to increase their cash holdings in overseas subsidiaries rather than spending them. Accordingly, multinational companies have larger cash holdings than domestic companies as they would incur significant additional costs for reducing them (Foley, Hartzell, Titman and Twite, 2007).
2.1.2. Precautionary motives
Cash holdings can serve as a buffer stock for companies when the access to external finance is disturbed or costly (Campello et al., 2010). Faulkender and Wang (2006) show that firms with better access to capital markets have lower cash holdings than firms that have poor access. In addition, low previous liquidity and good investment opportunities increase the value of cash to the firm. The firm will benefit more from holding cash when it can invest positive net present value projects. Fresard (2010) empirically underlines this reasoning by showing that firms with high cash holdings are able to capitalize benefits in the product market in terms of market share. On the other hand, liquidity without corresponding investment opportunities is less valuable as the return on cash is considerably low. Gamba and Triantis (2008) confirm the findings of Faulkender and Wang (2006) and extend the model by showing that taxes and distress costs also affect the value of cash holdings.
Moreover, internal finance can be preferred over external finance if there is a high degree of information asymmetry between corporate insiders and outsiders regarding the investment opportunities (Myers and Majluf, 1984). Accordingly, cash is particularly valuable to firms that have large investment opportunities, variable (risky) cash flows, and limited access to external finance, as it helps to avoid underinvestment (Opler, Pinkowitz, Stulz and Williamson, 1999). This is supported by Duchin (2010) who finds that firms which are more diversified, and thus less prone to cash flow volatility, have significantly lower cash holdings. Riddick and Whited
5 This is particularly relevant for the USA which is the geographically and legally determining area the Gamba
(2009) find similarly that the risk of a firm measured by income uncertainty as well as financial constraints positively relates to the level of cash holdings.
Harford, Klasa and Maxwell (2014) analyse the relationship between financial constraints and corporate cash holdings within US industrial firms from 1980 until 2008. They find that refinancing risk measured by debt with a short term maturity increases the level and value of cash holdings to the firm as the liquidity helps to mitigate the problem of underinvestment. This link is even stronger in years with weak credit market conditions, which proves the interdependence of corporate financial policy and market conditions. Denis and Sibilkov (2010) show that cash holdings are valuable for financially constrained firms as external financing is too costly. Pinkowitz, Stulz and Williamson (2014) compare the level of cash holdings measured by cash divided by total assets of US and foreign firms. They find that foreign firms’ cash mean level of cash holdings do not differ from those of comparable US firms. The level of cash holdings is rather determined by firm level characteristics. Furthermore, Pinkowitz et al. (2014) show that cash holdings have been reduced during the crisis and increased since the end of the crisis. Hence, cash holdings are particularly valuable for firms to finance investments in years with market disruptions.
Finally, several studies have found that cash is complementary to debt. Thus, it is valuable for the firm to simultaneously be indebted and maintain cash holdings because both serve different functions, i.e. are no perfect substitutes. This is especially the case for firms with financial constraints. To them it will be more costly and difficult to draw on external finance in a timely manner. These firms use debt to finance investment opportunities in economically good times when the access to external finance is undisturbed. Non-operational cash holdings serve as a source of funding for investments when market frictions occur (Gamba and Triantis, 2008; Lins, Servaes and Tufano, 2010; Harford et al., 2014).
2.2. What problems does cash cause?
agency costs. The principal will therefore engage in monitoring to reduce potential misbehaviour, which incurs costs on its own (Jensen and Meckling, 1976).
2.2.1. Corporate governance and agency problems
A firm does not operate in isolation. It is affected by the environment it operates in. Corporate governance is thereby an important factor as it directly reflects on the firm’s actions and mitigates potential agency conflicts. Corporate governance functions as a mechanism that protects outside investors from the risk of expropriation through insiders (LaPorta, Lopez-de-Silanes, Shleifer and Vishny, 2000b; Pinkowitz, Stulz and Williamson 2006). According to agency theory, agency problems may result in the extraction of private benefits of insiders at the cost of outside investors. Compared to the US institutional setting, Europe is different as a second kind of agency problem exists. In Europe concentrated ownership and dominant shareholders are more common and thus majority shareholders may expropriate minority shareholders (Schauten, Dijk and Waal, 2013). In the US the relationship between management and ownership is at the centre of attention.
As a consequence cash holdings can be problematic if corporate governance is weak, because firms with large cash holdings tend to overinvest and execute non-beneficial acquisitions (Harford, 1999; Harford, Mansi and Maxwell, 2008). Additionally, in the absence of disciplinary functioning capital markets and with poor corporate governance, firms misallocate their cash holdings which results in subsequent underperformance measured by operating performance (Schauten et al., 2013). Nikolov and Whited (2014) find that agency problems resulting from managerial perquisites are particularly important in determining corporate cash holdings. Investors demand insiders to reduce cash holdings as they fear misuse of the cash holdings. This link is especially strong in smaller firms. Current research by Harford, Humphery-Jenner and Powell (2012) shows that entrenched managers destroy value for shareholders through non-beneficial acquisitions. The value reduction results from a target selection bias towards publicly listed companies. Moreover, entrenched managers are found to overpay and to limit their transaction scope to low synergy targets.
2.2.2. Corporate governance and the level of cash holdings
variation of firm specific governance within a specific country. The findings for the relationship between cash holdings and both different governance measures are not consistent.
Cross country based research conducted by Dittmar, Mahrt-Smith and Servaes (2003) and Pinkowitz, Stulz and Williamson (2006) finds that firms in countries with poor investor protection hold significantly more cash than firms in countries with good investor protection. They argue that cash holdings give management more discretion and spare them from public scrutiny, as they do not have to rely on external finance. Moreover, poor shareholder rights hinder the principals in exerting pressure on management to reduce firms’ cash holdings. Gao, Harford and Li (2013) study the determinants of corporate cash policy by comparing 54,404 public to 10,596 private US firms from 1995 until 2011. They find that private firms generally have lower cash holdings. According to them, this is due to agency problems being not as severe as in publicly listed firms. Reduced agency problems are explained by greater monitoring incentives for the shareholders, as the ownership is illiquid (it is harder to sell private shares than publicly traded) and owners often function as managers within the firm. Furthermore, if mangers are limited in their potential misspending it is less valuable for them to maintain sizable cash holdings. Seifert and Gonenc (2015) analyse cash holdings of 15,000 firms across 47 countries in the period from 1996 to 2006. They find that the interaction between strong creditor rights and strong country governance decreases firms cash holdings significantly. They argue that strong governance and creditor rights reduce the risk for lenders and thus enable the firm to easily access financing in the future. Thus, the need for maintaining significant cash holdings in the presence is reduced. In line with previous research the authors find that overall better creditor rights reduce as well as varying country specific institutional differences influence the level of corporate cash holdings.
firm level corporate governance to better understand the relationship between governance and cash holdings (Ginglinger and Saddour, 2012).
2.2.3. Corporate governance and the value of cash
When managers are expected to act in their own interest and spend cash holdings discretionary or value reducing, investors are likely to assign a low value to corporate cash holdings. Several studies confirm the relationship between corporate governance and the value of cash holdings. Faulkender and Wang (2006), Pinkowitz et al. (2006), Dittmar and Mahrt-Smith (2007) and Schauten et al. (2013) show that a Dollar (Euro) of cash reserves on corporate balance sheets is valued at less than book value when governance levels are low. Dittmar and Mahrt-Smith (2007) argue that low values for excess cash holdings result from investments in low return projects as well as reduced incentives for the management to increase capital efficiency, profitability and control of costs.
2.2.4. Country level corporate governance and the value of firms and cash holdings
Further support for the importance of country or market specific governance arises from the extant literature on cross-listing effects e.g. (Doidge, 2004; Doidge, Karolyi and Stulz, 2004; Doidge, Karolyi and Stulz, 2009; Hail and Leuz, 2009; Fresard and Salva, 2010). These studies show that cross-listing is beneficial to the firms and its investors, as firm values in general and the value of cash holdings6 increase significantly. The underlying logic is that better monitoring and bonding to the better governance regime of the respective stock exchange contributes to the observed effect of increasing firm value.
2.3. What is the expected impact on acquisitions?
According to the pecking order theory, firms finance their investments primarily with internal funds, before utilising debt, and lastly equity (Myers and Majluf, 1984). Similarly, Jensen (1986) theorizes that large amounts of cash or cash flow induce firms to pay for their acquisitions in cash. Acquisitions are thereby an ideal scope of research as they represent sizeable and observable corporate investments (Masulis, Wang and Xie, 2009; Harford, Klasa and Walcott, 2009).
2.3.1. Cash holdings, governance and acquisitions
Harford (1999) researches the relationship between corporate cash reserves and acquisitions in the US from 1950 to 1994. He finds that cash rich firms acquire significantly more companies than firms which are not cash rich. As these investments are value decreasing measured by market reactions, he concludes that agency costs related to free cash significantly affect corporate acquisition behaviour. Cash holdings increase managerial freedom and discretion as managers do not necessarily rely on external sources to finance investments and are thus not as critically monitored by capital market participants. Opler et al. (1999) similarly find for their US sample from 1971 until 1994 that the level of corporate cash holdings and the number of acquisitions are significantly and positively linked.
As presented before, Gao et al. (2013) show that poorly governed firms reduce their cash holdings quicker and different than better governed firms. The authors use insider ownership and an entrenchment index as governance proxy and find that weakly governed firms prefer investments within the firm or external through acquisitions rather than re-distributing cash to the shareholders.
2.3.2. Cash holdings, governance and the method of payment
Despite the finding that cash holdings increase the number of acquisitions, few authors empirically research the link between corporate cash holdings, governance and the method of payment decision. The existing literature can be summarised as follows:
Martin (1996) examines the impact of cash holdings, managerial ownership, and investment opportunities on the method of payment in corporate acquisitions in the US for the period from 1978 until 1988. He finds that the acquirer’s availability of cash, measured by the level of cash holdings, decreases the probability of the firm to use equity as a method of payment. Martin (1996) reports different findings according to shareholders as governance mechanisms. Non-management related blockholders are found to be not significantly influencing the method of payment decision. Nevertheless, institutional shareholders and other blockholders increase the probability of cash as a method of payment.
Faccio and Masulis (2005) analyse multiple factors that influence the method of payment of European acquisitions. They find that the method of payment is significantly influenced by corporate governance and the ability to finance an acquisition with debt. The ownership structure of the acquirer is also influencing the method of payment. In the presence of large shareholders, firms tend to use less equity as the blockholder fears that his voting power will be diluted. The authors thereby find a linear positive relationship between concentrated control and cash payment in continental Europe. This is in line with early research of Amihud, Lev and Travlos (1990) who find a similar link between managerial ownership and the method of payment within the US. Moreover, cash holdings measured as cash and securities deflated by total assets have a negative impact on the propensity to use cash as a method of payment. Nevertheless, the authors only use a timeframe of four years and do not control for time trends in the method of payment choice, which current research proves to be significant (Boone, Lie and Liu, 2014). Especially for the last ten years, Boone, Lie and Liu (2014) find a higher use of cash as method of payment compared to the years 1997-2000, in which Faccio and Masulis (2005) conducted their research. Furthermore, market dependent financial constraints are likely to impact the method of payment decision similarly as discussed above regarding the value of financial flexibility.
according to personal interests. Hence, entrenched managers prefer cash over equity as method of payment to avoid dilution of control.
Pinkowitz et al. (2013) examine the method of payment decision for domestic acquisitions of US firms from 1984 until 2006. They find that firms ranked in the upper third of cash holdings are significantly more likely to choose equity over cash as method of payment. Consequently, those firms remain cash rich subsequent to the acquisition. According to the authors, this can be explained by the argument that firms prefer financial flexibility and thus maintain large cash holdings. This is based on the observation that neither agency conflicts, nor capital structure or financial constraints reduce the significance of their findings.
2.4. Hypotheses development
European firms are significantly different from US firms concerning multiple aspects which offers the advantage of studying a relationship in an environment with various institutional factors (Faccio and Masulis, 2005). Europe is particularly diverse due to multiple corporate governance rules, legal requirements, enforcement and the role of financial markets (LaPorta, Lopez-de-Silanes, Shleifer and Vishny, 1997; LaPorta et al., 2000a). Moreover, European firms have a different ownership structure than US firms. In general, firms tend to be less widely held than their US counterparts, i.e. they have one large shareholder. Within Europe, this holds in particular in regard to continental European firms who are less widely held. On the contrary firms from the UK and Ireland tend to be more widely held (Faccio and Lang, 2002; LaPorta, Lopez‐de‐Silanes and Shleifer, 1999). As previous studies have established a positive link between excess cash holdings and equity as the method of payment, I want to test whether this relationship holds also in the recent European environment.
to be less widely held. If a firm uses equity as method of payment the ownerhship and control of the previous blockholder will be diluted. Hence, the blockholder will prefer cash as the method of payment over equity. This particular aspect of corporate governance weakens the expected use of equity for cash rich firms in Europe compared to the US. Nevertheless, controlling for firm- and transaction specific characteristics, I expect this relation based on financial flexibility theory to hold for European companies.
Therefore, I propose:
Hypothesis 1: Cash rich acquirers will be significantly more likely to use equity as a
method of payment (and vice versa).
Dittmar and Mahrt-Smith (2007) find that corporate governance affects corporate liquidity decisions through the utilisation rather than the accumulation of cash. Hence, governance is particularly relevant for investment decisions because managerial decisions can be discretionary if governance is weak. In weakly governed firms managers have more discretion about corporate investment decisions because shareholders have less means to influence and control managerial actions. To increase their influence and remain in control over the firm, managers will acquire using cash as method of payment. In addition, this prevents further external monitoring and potential competition for the management of the acquirer. Furthermore, the existence of blockholders will similarly increase the likeliness to choose cash as method of payment to avoid dilution of control. Harford et al. (2008) find that cash holdings and governance are positively related, which implies larger cash holdings for strongly governed firms. Thus, strongly governed firms may prefer to use equity as method of payment to maintain sizable cash holdings. In addition to managerial preferences for cash as method of payment, poorly governed firms may be pressured by their shareholders to disgorge cash as they fear expropriation and misspending of cash holdings.
than with weak governance. In strongly governed firms the interests between shareholders and managers are aligned. Hence, managers decide on the method of payment in the best interest of the firm. They choose equity to maintain financial flexibility and can adjust capital structure through acquisitions using cash as the method of payment.
Taking into account the opposite effects described above there is no clear direction to be expected upfront. However, governance is expected to significantly affect corporate decision taking. Thus, I propose:
Hypothesis 2: Acquirer governance significantly influences the method of payment
decision.
Cash rich firms are likely to have higher agency problems than non-cash rich firms as management can spend cash more easily and in a discretionary manner. This implies that a cash rich firm is particularly prone to shareholders pressures to disgorge cash through acquisitions. Accordingly, poorly governed cash rich firms will be more likely to use cash as the method of payment as both governance and cash levels posit the threat of expropriation. When corporate governance is strong, shareholders fear less expropriation through management as they have more information and control about managerial decisions and actions. Moreover, the interests of shareholders and management are aligned. Hence, cash rich firms with good governance face less pressure than poorly governed firms to disgorge cash. This will result in an increased use of equity as the method of payment. Overall, cash rich firms with poor governance will reject equity as the method of payment even if it is beneficial to the firm. Both, high cash and poor governance lead to sizable conflicts of interest and hence, increase the shareholder demand for a reduction of cash holdings. Therefore, I expect to find that cash rich and strongly governed firm are more likely to use equity as the method of payment.
Thus, I propose:
Hypothesis 3: Cash rich acquirers with strong governance will be significantly more
3. Methodology
3.1. Data collection
At first I utilise the Asset4 Database available on Datastream which contains firm specific governance ratings and criteria for 4,608 publicly listed companies worldwide. To use publicly listed firms offers the advantage that the data quality is higher than for private companies. More importantly, public firms are free to use equity as a method of payment which is less applicable to private firms. Filtering the data for firms from Western Europe and Scandinavia results in a total of 1,068 observations. Included countries are: Austria, Belgium, Denmark, Finland, France, Germany, Ireland, Italy, Luxembourg, The Netherlands, Norway, Portugal, Spain, Sweden, Switzerland and the United Kingdom. The companies are then assigned SIC codes to classify the industry of the firm’s operations. Similar to Pinkowitz et al., (2013), I exclude finance related companies (SIC codes 60-67) as they are expected to be different in terms of cash utilisation than other industrial firms. This step reduces the sample size to 794 firms. As displayed in table 1, most of these firms belong to the manufacturing industry (41.69%), followed by transportation (18.89%) and services (14.99%). Thereafter, I download historic firm specific governance, balance sheet and income statement data from Datastream for the last ten years and all firms classified before. The firm specific data thus contains 7,940 firm year observations. The cash rich ranking is based on this data set.
Table 1: Industry distribution
This table shows the distribution and SIC classification of industries for the 794 companies identified via the Asset4 database and used in the analysis. Number indicates the number of the respective industry dummy used in the regression analysis.
Number SIC Code Number of firms In percent of the sample
1 01-09 Agriculture, Forestry, Fishing 1 0.13%
2 10-14 Mining 68 8.56%
3 15-17 Construction 45 5.67%
4 20-39 Manufacturing 331 41.69%
5 40-49 Transportation and Public Utilities 150 18.89%
6 50-51 Wholesale Trade 22 2.77%
7 52-59 Retail Trade 56 7.05%
8 60-67 Finance, Insurance, Real Estate 0 0.00%
9 70-89 Services 119 14.99%
10 91-99 Public Administration 2 0.25%
In the next step I insert the 794 firms into the Zephyr M&A database by using their ISIN numbers to collect transaction specific data. I select all completed acquisitions by the pre-specified firms in the timeframe from 2006 until 2015. The method of payment is cash or shares. Moreover, I exclude all acquisitions that are smaller than one million US Dollar and bidders that own more than 50% of the target previous to the attempt. This results in a sample of 2,606 transaction observations. Thereafter, I eliminate all transactions with not confirmed and unknown methods of payment and only keep the first transaction of every firm per year. This results in a total of 863 transaction specific observations. Finally, I merge the transaction and firm specific data by matching firms and acquisitions by their ISIN numbers.
3.2. Variable description
The dependent variable is the method of payment within an acquisition – equity or cash based vendor compensation – measured through the dummy variable DMOP. The variable has the value zero if the method of payment is equity and one if the method of payment is cash. To account for the case of multiple acquisitions within a year, I use the first acquisition of the respective year, as the explanatory variables cannot be observed at different points in time within a year. This is in line with the method of Pinkowitz et al. (2013).
The first independent variable – the cash richness of a firm (DCR) – is expected to have a significant impact on the method of payment. Hence, the sample is divided into cash rich and non-cash rich firms. To achieve this segmentation, I apply the basic cash rich ranking procedure of Pinkowitz et al. (2013) which is a variation of the DeAngelo, DeAngelo and Stulz (2010) approach. Firms are grouped according to the 2-digit SIC industry classifications first. Then, within each of group firms are ranked according to their cash holdings measured by cash and equivalents deflated by total assets (CTA). Subsequent, I assign the top third firms a dummy variable with the value of one (cash rich) if the firm is in the top third, or zero (non-cash rich) if the firm is in the lower two thirds of the respective industry.
On the opposite, firms that have a shareholder that owns more than 50% directly are classified as a subsidiary.
Furthermore, based on the findings of previous research I include firm and transaction specific control variables that are expected to influence the method of payment decision. They are described in the regression model section below. For a comprehensive overview of all variables, their measurement and description please refer to Appendix A.
3.3. Regression models
I use a logistic regression analysis as my primary regression model to determine the probability of a firm to use different methods of payment within an acquisition, because the dependent variable can only take on the values zero or one. The probability (𝑃𝑖) of using cash as a method of payment is thus given by the function:
𝑃𝑖 = 1 1 + 𝑒−𝑍𝑖
My primary regression model to determine the influence of cash richness on the method of payment choice (hypothesis 1) is:
𝑙𝑛 ( 𝑃𝑖
1−𝑃𝑖) = 𝑍𝑖 = 𝐷𝑀𝑂𝑃 = 𝛼 + 𝛽1𝐷𝐶𝑅𝑖𝑡−1+ 𝛽2𝐼𝑁𝐷𝑖𝑡−1+ 𝛽3𝐺𝑅𝑂𝑊𝑇𝐻𝑖𝑡−1+
𝛽4𝑁𝑊𝐶𝑖𝑡−1+ 𝛽5𝐿𝐸𝑉𝑖𝑡−1+ 𝛽6𝐶𝑂𝐿𝑖𝑡−1+ 𝛽7𝑆𝐼𝑍𝐸𝑖𝑡−1+𝛽8𝑀𝑇𝐵𝑖𝑡−1+ 𝛽9𝑅𝑉𝐴𝐿𝑖𝑡+ 𝛽10𝐷𝑃𝑅𝑖𝑡+ 𝛽11𝐷𝑂𝐼𝑖𝑡+ 𝛽12𝐷𝐶𝐵𝐴𝑖𝑡+ 𝛽 ∑𝐷𝐼𝑁 + 𝛾 ∑𝐷𝑌𝐸 + 𝜀𝑖,𝑡 (I)
acquisition, measured by the deal value divided by the sum of the acquirer’s market value of equity and the deal value. DPR is a dummy variable that takes on the value one, if the target is private and zero elsewise. DOI is a dummy variable that takes on the value one, if the target is in a different industry measured by SIC codes. DCBA is a dummy variable for the case that the target is from another county than the acquirer. ∑ DIN and ∑ DYE represent industry dummies differentiated by SIC codes (as displayed in table 1) and year dummies. 𝜀 is the error term of the regression model. All firm specific explanatory variables are lagged by one year to account for the fact that the execution of a transaction is a process that takes multiple months in preparation. Moreover, the data of the previous year is the most recent data preceding the acquisition.
In the second regression model, I exchange DCR for the Asset4 firm specific governance measure CG to include the influence of governance on the method of payment decision (hypothesis 2).
𝑙𝑛 ( 𝑃𝑖
1−𝑃𝑖) = 𝑍𝑖 = 𝐷𝑀𝑂𝑃 = 𝛼 + 𝛽1𝐶𝐺𝑖𝑡−1+ 𝛽2𝐼𝑁𝐷𝑖𝑡−1+ 𝛽3𝐺𝑅𝑂𝑊𝑇𝐻𝑖𝑡−1+
𝛽4𝑁𝑊𝐶𝑖𝑡−1+ 𝛽5𝐿𝐸𝑉𝑖𝑡−1+ 𝛽6𝐶𝑂𝐿𝑖𝑡−1+ 𝛽7𝑆𝐼𝑍𝐸𝑖𝑡−1+𝛽8𝑀𝑇𝐵𝑖𝑡−1+ 𝛽9𝑅𝑉𝐴𝐿𝑖𝑡+ 𝛽10𝐷𝑃𝑅𝑖𝑡+ 𝛽11𝐷𝑂𝐼𝑖𝑡+ 𝛽12𝐷𝐶𝐵𝐴𝑖𝑡+ 𝛽 ∑𝐷𝐼𝑁 + 𝛾 ∑𝐷𝑌𝐸 + 𝜀𝑖,𝑡 (II)
4. Results
4.1. Descriptive statistics and correlations
The descriptive statistics (table 2) and correlation tables (table 3) below describe the sample specification and distribution for the complete sample of transactions from 2006 until 2015. Firm specific variables are constructed and matched to transaction data and generally lagged by one year. Thus, the firm specific data corresponds to the years 2005 until 2014. To control for extreme observations and outliers while maintaining all observations, the entire dataset is winsorised at the 0.5% level on both tails of the distribution.
The descriptive statistics are shown below in table 2. The dependent variable for the method of payment (DMOP) has a median value of one and a mean value of 0.912. This means that 91.2% of the 566 transactions are settled with cash and 8.8% of the transactions are settled with equity which is lower than the 25.0% Pinkowitz et al. (2013) find for the time period from 1984 to 2006. However, when referring to the most recent years of the Pinkowitz et al. (2013) data, (namely 2000 to 2006) the amount of acquisitions settled with equity (11.4% of total cash and equity bids) is considerably lower and thus comparable to the sample I use. This is also in line with Boone, Lie and Liu (2014) who show that the amount of equity settled transactions declined in the past years. The first independent variable, cash richness (DCR) of a firm, has a mean value of 0.383. This is in line with previous research (Harford, 1999; Pinkowitz et al., 2013) as it shows that cash rich firms acquire more often than non-cash rich firms. If cash rich and non-cash rich firms would be equally likely to pursue acquisitions, the mean value should be 0.333 which is the cut-off point for the firm’s classification as cash rich. On average the firms in the sample hold 9.2% of their total assets in cash compared to significantly lower median cash holdings of 6.7%, which implies a right-skewed distribution. Few firms with very large cash holdings increase the average cash holdings significantly. Cash holdings are slightly lower than those reported in cash holdings literature7. Nevertheless, this can be explained by the fact that the sample firms are relatively large and thus have lower cash holdings than smaller firms. The second independent variable, corporate governance (CG), has a potential variation between the value 0 and 100. The sample mean value is 65.590 which implies that the sample firms are relatively strongly governed. Moreover, the maximum value is 95.399 and the minimum value 5.275 which implies that the firm governance within the sample is heterogenic.
The statistics for the ownership variable IND indicate a mean value of 2.426. Given a potential variation between zero (subsidiary) and three (independent), this indicates that most of the sample firms have no blockholder. Hence, the sample firms are rather independent than dependent.
Table 2: Descriptive statistics
This table shows the descriptive statistics for the sample of 863 transaction- and firm specific observations in the period from 2006 to 2015, thereof 566 observations are available for all variables. It includes: the categorical variable for the method of payment (DMOP), cash richness (CR), cash to total assets (CTA), firm specific governance rating from Asset4 (CG), World Banks country specific governance rating (WGI), independence rating provided by BvD (IND), sales growth (GROWTH), working capital minus cash deflated by total assets (NWC), book value of debt divided by the sum of market value of equity and book value of debt (LEV), property, plant and equipment deflated by total assets (COL), natural logarithm of total assets (SIZE), market value of equity divided by book value of equity (MTB), deal value divided by the sum of deal value and acquirers market value of equity (RVAL). In addition dummy variables indicate: if the target is private (DPR), if the target is from another industry measured by 2-digit SIC codes (DOI), if the target is from another country than the acquirer (DCBA). Dummy variables for every industry classified by 2-digit SIC codes and year dummy variables for the year of transaction are not displayed here for the sake of clarity.
Mean Median Maximum Minimum Std. Dev. Observations
DMOP 0.912 1.000 1.000 0.000 0.284 566 CTA 0.092 0.067 0.556 0.000 0.085 566 DCR 0.383 0.000 1.000 0.000 0.487 566 CG 65.590 71.090 95.399 5.275 22.518 566 WGI 1.441 1.421 1.906 0.499 0.232 566 IND 2.426 3.000 3.000 0.000 1.041 566 GROWTH 0.116 0.082 2.907 -0.605 0.234 566 NWC 0.025 0.025 0.585 -0.589 0.168 566 LEV 0.286 0.197 2.156 0.000 0.329 566 COL 0.230 0.182 0.829 0.004 0.187 566 SIZE 15.068 14.803 19.407 10.869 1.705 566 MTB 3.067 2.630 36.920 -35.790 5.465 566 RVAL 0.078 0.026 0.771 0.000 0.121 566 DPR 0.742 1.000 1.000 0.000 0.438 566 DOI 0.458 0.000 1.000 0.000 0.499 566 DCBA 0.668 1.000 1.000 0.000 0.471 566
Table 3: Correlations
This table shows the correlations of the variables used for the regression analysis. Most importantly: method of payment (DMOP), cash to total assets (CTA), cash richness (DCR), corporate governance (CG) as well as other firm and transaction specific control variables used for the regression and robustness checks. World Banks country specific governance rating (WGI), independence rating provided by BvD (IND), sales growth (GROWTH), working capital minus cash deflated by total assets (NWC), book value of debt divided by the sum of market value of equity and book value of debt (LEV), property, plant and equipment deflated by total assets (COL), natural logarithm of total assets (SIZE), market value of equity divided by book value of equity (MTB), deal value divided by the sum of deal value and acquirers market value of equity (RVAL), deal value (AVAL). In addition, dummy variables indicate: if the target is private (DPR), if the target is from another industry measured by 2-digit SIC codes (DOI), if the target is from another country than the acquirer (DCBA). Industry- and year- specific control variables are omitted for the sake of clarity.
DMOP CTA DCR CG WGI GROWTH NWC LEV COL SIZE MTB IND RVAL DPR DOI DCBA
4.2. Regression results
First, I test for the normality of the sample distribution with the hypothesis of normal skewness and kurtosis. The null hypothesis of normality is rejected, however this is not problematic as the sample size is sufficiently large. Second, I test for heteroscedasticity i.e. that the error terms are constant and do not vary with the independent variables as this could bias the regression coefficient estimates. Again, the null hypothesis is rejected. Thus, I use heteroscedasticity consistent estimates (Huber/White standard errors) for my regression analysis which increases the requirements for the corresponding critical values of the regression estimates to be statistically significant.
Moreover, to control for model fit I use the likelihood ratio test (LR test) to validate the general fit. It tests the null hypothesis if the model fit is better when all independent variables are set to the value of zero. For all regression models this can be rejected, as the corresponding Chi-square value is statistically highly significant at the 1% level. Thus, the regression specification explains the sample probabilities better than zero values.
Table 4 displays the results of the logistic regression analysis. Model (I), (II) and (III) thereby represent hypothesis one, two and three. The regression coefficient estimates of the independent variables are displayed below the respective model indication. Values in parentheses below indicate the value for the z-statistic and asterisks indicate the statistical significance at the 10%, 5% and 1% level. In addition to the displayed coefficients the regression includes binary control variables for firm years as well as industry of the acquirer. Next to the coefficients, I show the change in odds8 in square brackets for an increase of one standard deviation for every discrete independent variable. Binary (continuous) independent variables are increased from zero to one respectively.
Model (I) tests the hypothesis that cash rich firms are significantly more likely to use equity as a method of payment by including a binary variable. The corresponding coefficient estimate of the variable DCR is negative (-0.146), as expected. This can be interpreted as the relative effect of a firm’s cash richness on the method of payment. Thus, the partial effect of DCR for taking on the value one, is an odds ratio decrease by 13.6% for cash as the method of payment. This shows that cash richness decreases the probability to use cash as the method of payment.
8 The change in odds is calculated in accordance to Pinkowitz et al. (2013:134) as 𝑒𝑥𝑝(𝛽
𝑘∗ 𝛿) − 1. Whereas 𝛽𝑘
Table 4: Regression results
This table shows the logistic regression analysis for the three hypotheses formulated above. Variables include: method of payment (DMOP), cash richness (CR), firm specific governance rating from Asset4 (CG), interaction between governance and cash richness (CG*DCR), independence rating provided by BvD (IND), sales growth (GROWTH), working capital minus cash deflated by total assets (NWC), book value of debt divided by the sum of market value of equity and book value of debt (LEV), property, plant and equipment deflated by total assets (COL), natural logarithm of total assets (SIZE), market value of equity divided by book value of equity (MTB), deal value divided by the sum of deal value and acquirers market value of equity (RVAL). In addition dummy variables indicate: if the target is private (DPR), if the target is from another industry measure by 2-digit SIC codes (DOI), if the target is from another country than the acquirer (DCBA). Moreover, dummy variables for every industry classified by 2-digit SIC codes and year dummy variables for the year of transaction. Change in Odds represents the change of the probabilities for one standard deviation increase for independent variables, and an increase from zero to one for dummy variables. Values displayed are the regression coefficients, where parentheses show the z-statistic. *,** and *** indicate statistical significance at the 10%, 5% and 1% level.
Model (I) Change in Odds (II) Change in Odds (III) Change in Odds C 0.636 1.438 1.905 (-0.279) (0.600) (0.729) DCR -0.146 [-13.6%] -1.074 [-65.8%] (-0.486) (-1.136) CG 0.017** [0.1%] 0.013 [0.1%] (2.294) (1.139) CG*DCR 0.011 [0.1%] (0.840) IND -0.127 [-2.0%] -0.088 [-1.6%] -0.103 [-1.9%] (-0.806) (-0.483) (-0.561) GROWTH -0.779** [-25.2%] 0.070 [6.5%] 0.261 [27.5%] (-2.094) (0.078) (0.281) NWC 0.666 [81.3%] 1.445 [338.2%] 1.428 [329.2%] (0.746) (1.413) (1.401 LEV -1.371*** [-45.5%] -1.226*** [-43.6%] -1.242*** [-4.0%] (-3.094) (-2.621) (-2.659) COL 1.881 [771.3%] 0.556 [95.2%] 0.572 [100.5%] (1.634) (0.462) (0.470) SIZE 0.195 [3.0%] 0.080 [1.2%] 0.072 [1.2%] (1.306) (0.522) (0.447) MTB -0.029 [-0.1%] -0.032 [-0.1%] -0.032 [-0.1%] (-0.996) (-1.400) (-1.446) RVAL -3.763*** [-98.0%] -4.644*** [-99.7%] -4.467*** [-99.7%] (-3.604) (-3.790) (-3.641) DPR 1.171*** [222.4%] 0.860** [136.2%] 0.919** [150.6%] (2.890) (1.996) (2.128) DOI -0.155 [-14.4%] 0.287 [33.3%] 0.303 [35.4%] (-0.504) (0.806) (0.823) DCBA 0.588 [80.1%] 1.115*** [205.0%] 1.100*** [200.3%] (1.569) (2.764) (2.631)
Year/ Industry dummies yes yes yes
Observations 643 591 583
Compared to the findings of Pinkowitz et al. (2013) this is relatively low. The authors find a probability reduction of 23.0%. Nevertheless, the negative effect observed within the European sample is not statistically significant as indicated by the asterisks. Accordingly, I cannot reject the null hypothesis that being cash rich has no impact on the method of payment. A possible explanation could be, that European firms within my sample have on average lower cash holdings than the US sample. Furthermore, the authors use a time period that has a relatively large fraction of equity transactions. In addition, the ownership structure (IND) negatively influences the use of cash as method of payment. This implies that firms without a blockholder are more likely to use equity than firms controlled by a blockholder. Nevertheless, this effect is insignificant.
expected to increase the use of cash. This effect cannot be confirmed. Further, MTB as proxy for growth opportunities does not significantly increase cash the method of payment choice, contrary to Pinkowitz et al. (2013) who find a negative and significant relationship. Similarly, the deal specific variables for outside industry (DOI) and cross-border acquisitions (DCBA) are insignificant. A diversifying acquisition is likely to come with increased uncertainty about the future value of the acquirers’ equity which results in a preference for cash of the vendor. In accordance with Pinkowitz et al. (2013), I do not find significant proof for this relationship. Finally, vendors prefer cash over equity in cross border transactions because they face less risk of exchange rate fluctuations, language barriers and higher trading costs associated with foreign equity. Opposite to Faccio and Masulis (2005) who find a significant increase in cash as method of payment, my results for model (I) are not significant. The overall regression model fit measured by Pseudo R2 (McFadden R2) is 0.231 which indicates a moderate model fit, as 23.1% of the sample variation can be explained through the variables.
Model (II) tests the hypothesis that firm specific governance affects the method of payment decision. Therefore, I exchange the variable DCR for the firm specific corporate governance measure CG. As expected in hypothesis two, I find a significant influence of corporate governance on the method of payment choice. Contrary to Pinkowitz et al (2013) who find that strong governance increases the use of equity, the findings show that strongly governed firms are significantly more likely to acquire with cash than with equity. Being strongly governed increases the odds ratio of using cash by 0.1% when increasing CG by one standard deviation. Thus, I cannot reject hypothesis two. This is in line with agency theory and findings from Dittmar et al. (2003), Pinkowitz et al. (2006) and Seifert and Gonenc (2015) that better governed firms have lower cash holdings. If strongly governed firms are pressured by their shareholders to reduce cash holdings, acquisitions are one option for management to align with shareholder expectations. As a consequence strongly governed firms will hold less cash.
To test hypothesis three, I include the cash richness of a firm, corporate governance and the interaction between both variables (CG*DCR) in regression model (III). Consistent with model (I) the coefficient for being cash rich remains to be negative but insignificant. However, the coefficient takes on a higher value and thus increases the negative change in probability to use cash as a method of payment. Corporate governance becomes statistically insignificant. The interaction term (CG*DCR) is also statistically insignificant. Thus, I cannot reject the null hypothesis that the interaction between firm governance and being cash rich has no impact on the method of payment. Overall, model (III) has the best fit of all models measured by Pseudo R2 (0.273).
4.3. Robustness checks
To test for the robustness of the measures CG and DCR I use alternative variables. Instead of the dummy measure for cash richness, I use the underlying metric of cash holdings deflated by total assets (CTA). This is comparable to the method of Faccio and Masulis (2005) as well as Pinkowitz et al. (2013). As show in table 2, the firm with the most sizable cash holdings holds 55.6% of its total assets in cash, compared to the smallest cash holdings of 0.00%. Arguably there is more variation in CTA than for the dummy variable DCR. For corporate governance, I use the World Banks country level governance measure (WGI). WGI represents the average governance level expectation for each firm and year in a given country. The variable WGI represents the average value of six governance subcategories. It shows a similar variation to CG in the range from 0.499 to 1.906 (out of 2.00).
determinants.
Table 5: Governance and cash holdings robustness checks
This table shows the logistic regression analysis for the three hypotheses formulated above with alternative variables for the main estimators. These variables are: cash to total assets (CTA), World Banks country specific governance rating (WGI) and the interaction between governance and cash holdings (WGI*CTA). Values displayed are the regression coefficients, where parentheses show the z-statistic. *,** and *** indicate statistical significance at the 10%, 5% and 1% level.
Model (I) (II) (III)
C 1.211 -0.129 -2.049 (0.516) (-0.051) (-0.646) CTA -2.081 24.182* (-1.331) (1.818) WGI 1.294* 2.898*** (1.765) (2.658) WGI*CTA -18.373** (-2.069)
Firm and transaction controls yes yes yes
Year/ Industry dummies yes yes yes
Observations 640 643 632
Pseudo R2 0.230 0.240 0.262
Different to the base model, WGI is only significant at the 10% level in model (II) compared to CG at the 5% level. This implies that firm specific governance is a more precise measure than country specific governance in relation to the influence on the method of payment decision. The effects and significance of IND and the control variables remains unchanged. Moreover, the model fit when including alternative variables is slightly lower than in the original model which implies a higher explanatory power of the base model.
The fit of the alternative model (III) is slightly lower than the base model. Hence, I conclude that the cash holdings and governance variables chosen in the primary model are robust as the results remain to hold.
As shown above, country specific governance has a significant influence on the method of payment decision. Furthermore, LaPorta et al. (1997) show that the legal origin of a country is an important determinant in finance. Faccio and Masulis (2005) also report significant differences in terms of ownership concentration, which influence corporate governance, too. Thus, I further subdivide my sample into two specific groups of relatively equal size and similar governance (Table 6). Thereby, I allocate all acquisitions of acquirers from continental western and northern European companies to the first group (Panel A). The second group (Panel B) contains all acquisitions of Anglo-Saxon firms (from Great Britain and Ireland) which are expected to be alike in terms of governance, common-law legal system and ownership concentration. In addition Faccio and Masulis (2005) argue that common law countries have different M&A financing preferences and better access to capital markets.
In Panel A of table 6, I repeat the logistic regression for models (I), (II) and (III) for acquisitions executed by continental European firms. As shown below, the null hypothesis of insignificance cannot be rejected for all three hypotheses. Neither cash richness nor corporate governance have a significant impact on the method of payment decision. Though, the effect of cash richness on the probability of acquiring with cash remains negative. The insignificant estimate for corporate governance has a negative effect, implying a reduced propensity to use cash if a firm is stronger governed. However, the ownership structure of the acquirer is highly significant and negatively related to the use of cash as method of payment. Hence, acquirers controlled by a blockholder are less likely to use equity as method of payment. This underscores the findings of Faccio and Masulis (2005) that concentrated ownership structures (measured by firm independence) are important for corporate decision making within Europe. Furthermore, the controls for leverage, firm size, relative deal value and cross-border acquisition remain significant. The Pseudo R2 has a value of 0.330 (Model I) to 0.345 (Model III) which is above the fit of the entire sample.
Table 6: Regression results for split sample
This table shows the logistic regression analysis for the subdivided sample. Panel A includes continental western and northern European firm’s acquisitions. Panel B includes acquisitions of firms from Great Britain and Ireland. Variables include: method of payment (DMOP), cash richness (CR), firm specific governance rating from Asset4 (CG), interaction between governance and cash richness (CG*DCR), independence rating provided by BvD (IND), sales growth (GROWTH), working capital minus cash deflated by total assets (NWC), book value of debt divided by the sum of market value of equity and book value of debt (LEV), property, plant and equipment deflated by total assets (COL), natural logarithm of total assets (SIZE), market value of equity divided by book value of equity (MTB), deal value divided by the sum of deal value and acquirers market value of equity (RVAL). In addition dummy variables indicate: if the target is private (DPR), if the target is from another industry measured by 2-digit SIC codes (DOI), if the target is from another country than the acquirer (DCBA). Moreover, dummy variables for every industry classified by 2-digit SIC codes and year dummy variables for the year of transaction. Change in Odds represents the change of the probabilities for one standard deviation increase for independent variables, and an increase from zero to one for dummy variables. Values displayed are the regression coefficients, where parentheses show the z-statistic. *,** and *** indicate statistical significance at the 10%, 5% and 1% level.
Panel A Panel B
Model (I) (II) (III) (I) (II) (III)
C -1.065 -1.404 -0.729 -10.373** -11.550 -16.830*** (-0.678) (-0.865) (-0.413) (-2.004) (-1.365) (-2.805) DCR -0.203 -0.924 0.950 10.713*** (-0.860) (-1.591) -1.297 (3.066) CG -0.004 -0.007 -0.014 0.043 (-0.744) (-1.134) (-0.360) (0.781) CG*DCR 0.012 -0.135*** (1.238) (-3.075) IND -0.234** -0.186* -0.394** -0.078 0.484 0.302 (-2.386) (-1.785) (-2.004) (-0.130) (0.534) (0.325) GROWTH -0.209 -0.293 -0.264 -1.964*** 6.896* 5.634 (-0.505) (-0.682) (-0.572) (-3.338) (1.646) (1.567) NWC 1.048 0.994 3.475 4.480** 6.845** 8.189** (1.405) (1.311) (1.231 (2.108) (2.127) (2.035) LEV -0.890*** -0.990*** -1.553*** 1.258 -0.297 -0.963 (-2.932) (-3.191) (-3.094) (0.440) (-0.125) (-0.760) COL -0.540 -0.625 -2.046 6.905 3.706 6.269 (-0.678) (-0.778) (-0.981) (1.457) (0.822) (1.148) SIZE 0.213** 0.266*** 0.417** 1.089** 1.242* 1.364*** (2.170) (2.662) (2.234) (2.513) (1.738) (2.873) MTB -0.022 -0.030 0.047 -0.053 -0.036 0.008 (-0.620) (-0.909) (-1.052) (-1.261) (-0.890) (0.167) RVAL -2.661*** -2.611*** -4.799** -4.875** -8.034*** -7.826*** (-3.014) (-2.684) (-2.451) (-2.231) (-3.097) (-3.050) DPR 0.055 -0.141 -0.090 3.422*** 4.171*** 5.189*** (0.208) (-0.509) (0.401) (3.586) (3.656) (3.981) DOI -0.118 0.097 -0.100 -0.319 0.018 -0.008 (-0.520) (0.414) (0.794) (-0.456) (0.016) (-0.006) DCBA 1.106*** 1.109*** 2.320*** -0.922 0.080 0.305 (4.202) (4.284) (4.053) (-1.191) (0.108) (0.446)
Year/ Industry dummies yes yes yes yes yes yes
Observations 286 265 262 357 326 321
In model (III) the coefficients for cash richness and the interaction term of firm specific governance and cash richness are significant at the 1% level. In stark contrast to the base model and the findings of Pinkowitz et al. (2013) the effect of being cash rich on using cash as a method of payment is positive which implies that cash rich firms would be more likely to disgorge cash via acquisitions than non-cash rich firms. Even though country level governance in common-law countries is relatively strong, cash richness increases agency conflicts. To avoid these, shareholders force management to reduce cash holdings through financing acquisitions with cash. The interaction term CG*DCR has a negative effect on the probability to use cash as a method of payment. This implies that cash rich, strongly governed firms are less likely to use cash as a method of payment than weakly governed cash rich firms. Within Anglo-Saxon countries the level of governance is higher and thus agency problems are expected to be lower (assuming an inverse relationship between governance and agency problems). This would also explain the insignificance of firm governance alone, as it may be less important if the general governance level is sufficiently high. Management does not fear external monitoring (that is already high) and shareholders are less concerned about agency conflicts arising from cash holdings. Hence, firms can capitalise on the benefits of financial flexibility by maintaining their cash holdings. Accordingly, even though firms are cash rich they are more likely to use equity than non-cash rich firms when they are strongly governed.
The control variables for growth (except for model (III)), net working capital, size, relative deal value and private targets are significant in all three models. Different than in Panel A, independence does not significantly influence the method of payment decision. This can be explained through less concentrated ownership in Anglo-Saxon countries. This underscores the importance of ownership specifications that are variant across countries. The Pseudo R2, and thus the model fit and explanatory power is very high for all three models. Model (I) has a value of 0.563, Model (II) 0.633 and Model (III) 0.662.
5. Conclusion
The theory of financial flexibility argues that cash holdings are valuable for the firm. Thus, firms should pursue to maintain sufficiently large cash holdings over time even when investing. Former research provides evidence for the importance of financial flexibility for corporate decision taking. I analyse this relationship on the basis of acquisitions as they are an ideal object to observe and analyse the corporate decision making and the trade-off between financial flexibility and potential agency conflicts. I hypothesise that cash rich firms are more likely to use equity as a method of payment as they target remaining financially flexible. Moreover, corporate governance and ownership structure influence the method of payment decision as agency conflicts are expected to be high in cash rich firms. Therefore, I use a sample of 863 corporate acquisitions of firms from 16 European countries in the time period from 2006 to 2015.
I do not find evidence for the theory of financial flexibility based on acquisition data. Cash rich firms are not significantly more likely to use equity as a method of payment. The method of payment is dependent on acquirer- as well as transaction characteristics. In contrast to firms based in Great Britain and Ireland, continental European firms’ method of payment decision is significantly influenced by the ownership structure of the acquirer. In addition, I find that for the whole of Europe stronger governance has a positive effect on the probability to use cash as a method of payment which can be explained through shareholders pressure to disgorge cash. Overall, my findings underscore the importance of differing institutional environments and governance regimes on corporate investments decisions.
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