The impact of tax treaties on cross-border M&A flows in

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The impact of tax treaties on cross-border M&A flows in

Chinese industries

Cishuang Zhu s2442124

University of Groningen Faculty of Economics and Business

Research Paper for MSc IFM

1/9/2015 Tel: 0626153788

Email: zhucishuang@gmail.com

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Acknowledgement

It is a big challenge for me to write a master thesis and it is my first time writing a formal thesis in English. I have met a lot of difficulties. However, I also enjoyed the hard process since it gives me the opportunity to improve my skills. I cherish the whole process a lot and it is very valuable for my future career.

In finishing my master thesis, I would like to first thank my supervisor Professor Westerman. He instructed me a lot on my topic and research methods through the whole process. Also, I appreciate a lot that he always encourages me which makes me feel confident in writing my thesis. In addition, I would like to t hank my friends and family for their spirit support. At last, I have to thank Univer sity of Groningen, which gives me a fantastic academic experience abroad.

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List of abbreviations

BIT Bilateral Investment Treaty DTT Double Taxation Treaty FDI Foreign Direct Investment

IIT International Investment Treaties M&A Mergers & Acquisitions

UNCTAD United Nations Conference on Trade and Development WTO World Trade Organization

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ABSTRACT

This paper examines whether the number of tax treaties will increase the volume of cross-border M&A deals in Chinese industries. This paper uses industry-level data of China to make a panel database to conduct regressions. Most of the

statistical results show an insignificant relationship between tax treaties and M&A deal volume. Then a series of interviews are conducted to better investigate the relationship between the two factors. The interviews show that the tax treaty will have a positive impact of M&A decisions in companies together with several other determinants such as profitability and governance modes.

Key words: cross-border M&A, China, industry-level, bilateral investment treaty, double taxation treaty

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1. Introduction

Recently, PwC, the world’s second largest professional services network, published the newest M&A review of China. In the review, it said, “In China, mergers and acquisitions (M&A) deal values reached a record high in 2013 by 28% to US$260 billion, with 43 deals greater than US$1 billion compared to 30 deals in 2012. Deal numbers recovered strongly in the second half of 2013 from multi-year lows in the first six months, increasing by more than 40% in the second half. During this period, nearly all categories of M&A showed a sustained growth” (PwC China, 2014).

Since China just had its open-door policy since 1978, it is very worth investigating why there are increasing amounts of merger and acquisitions in this country. For the determinants and causes of M&A deals, of course there are many possible factors such as GDP level, stock market capitalizations, real goods trade flow, average corporate tax, exchange rates, tax treaties, et cetera (Giovanni, 2003). In this thesis, I would be interested in whether tax treaty can be related to the cross-border M&A deals in China. In the following, I will explain why I am going to test the relationship between M&A deals and tax treaties.

In 2009, Deloitte published a report called “The emergence of China: new frontiers in outbound M&A” (Deloitte China, 2009). In the report, it pointed out that the Chinese outbound M&A activity has increased significantly in recent years. Joining the World Trade Organization (WTO), China began its cross-border M&A process after 2001. Between 2003 and 2009, Chinese companies have undertaken 437 outbound acquisitions which represent a total worth of US$ 116.8 billion. For inbound M&A, they also made a figure on Chinese inbound M&A deals from 2002 to 2008 (see below). From this figure, we can see that there is a surge during the stated years, from 239 to 944 deals. Therefore, it is obvious that both outbound and

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inbound M&A deals experienced an increase since China joined WTO. That is one of the reasons why I am interested in investigating Chinese cross-border merger and acquisitions.

Figure1: Deal value of Chinese inbound M&A from 2002 to 2008 Source: Mergermarket

M&A is a special form of FDI. Within FDI, there are four methods: by incorporating a wholly owned subsidiary or company anywhere, by acquiring shares in an associated enterprise, through a merger or an acquisition of an unrelated enterprise and by participating in an equity joint venture with another investor or enterprise. M&A is the third method of FDI. We can see from the following two figures to see the position of Chinese FDI flows in the world. From

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the most recent data we have an overview of the FDI all over the world. It is noticed that in the 20 countries that have the highest volume of FDI flows, most are developed countries but China, as a developing country, stands Number 2 in FDI inflows value and Number 3 in FDI outflows value just behind the United States and Japan. Accordingly there is much research on the determinants of FDI flows in China.

Figure 2: FDI inflows top 20 host economies Source: UNCTAD, World Investment Report 2014

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Figure 3: FDI inflows top 20 host economies Source: UNCTAD, World Investment Report 2014

The relationship between tax treaties and FDI flows has long been a hot topic since there are many relevant studies before. For example, Blonigen and Davies (2002) investigate in the impact of bilateral tax treaties on OECD countries from 1982 to 1992. Lejour (2014) conducts a study on the impact of bilateral and multilateral tax treaties on bilateral FDI stocks. Both of them use a relatively large database in their research. And there are also many other researchers investigating this topic which will be discussed in detail later in the “former research” part. However, there is little research in the area about the relationship between tax treaties and M&A. In this

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paper, I would like to investigate in detail whether and to what extent tax treaties have impact on cross-border M&A deals. I will first collect general data on Chinese industries and then do regression to see the impact of both bilateral investment treaties and double tax treaties on Chinese industries. Since there is not too much theoretical background, I will also emphasize on interviews with firm managers in the real world, to get more practical ideas and outcomes on this topic. The paper will continue as follows: Section 2 provides basic information of merger and acquisition both in China and in the world. Section 3 discusses international tax treaties and it provides possible effects of both BIT and DTT. Section 4 provides a basic overview of previous research since not many studies in this area are conducted before. Section 5 discusses the research methodology and it gives the reasons why the model and some variables are chosen for the analysis. Section 6 has the statistical results and the interview processes with firm managers. The last section includes conclusion of my study and has suggestions for future research.

2. Mergers and Acquisitions

2.1 M&A terminology

Merger and acquisitions are “fusions” of two or more companies to attain certain strategic goals (Nouwen, 2011). Generally, M&A refers to a wide range of M&A structures. They include “capital participations, business tie-ups, divestures and other forms of restructuring” (Schaik, 2008). In this section, I will provide a simple overview of the main M&A types.

An M&A activity can be divided into two activity types: diversification or expansion and restructuring. The first type – diversification or expansion can be

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classified as follows: mergers, acquisitions, contractual agreements or capital tie-ups. A merger process can be seen as an involvement of management, board of directors, shareholders and creditors. Creditors are playing an important role in merger processes since they can provide the firms with loans or bonds when the companies are in financial difficulties. The debt can create a tax shield for interest while the tax shield will make the amount of debt go up again. “The higher level of debt, on the other hand, also raises the probability of financial distress and consequently bankruptcy costs” (Franks and Myers, 1996). Referring to acquisitions, there are two forms which are stock acquisition and asset acquisition.

In a stock acquisition, the acquiring firm has to purchase more than 50% of the acquired firm’s shares in order to get majority ownership. In an asset acquisition, the buyer will purchase the target company’s assets instead of shares. Contractual relationships and capital tie-ups are referring to activities which do not include transfer of managerial and ownership rights. This detailed sub-type is not in the range of the current topic.

The second type – restructuring activities include selling a firm’s business units or part of its assets. A new entity will be created in the transaction through a sell-off, split-off and equity carve-out (Schaik, 2008). The sell-off refers to selling a firm’s business of assets, partly or fully. It can be realized through a spin-off, where a separate new legal entity is established, or through a split-up, where the original company will be substituted by new set-up entities. With a split-off, a subsidiary will become a freestanding entity individually and its shares are swapped for the parent company’s own shares. Referring to an equity carve-out, in that circumstance, a business unit of a firm is sold through an initial public offering (IPO). Then the business unit will set up a new entity and sell its shares to outsiders.

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2.2 M&A activity in the World

Looking back at the M&A history all over the world, there are 6 waves starting from 1890. The length and starting date of each wave is not very specific, but taking the 6 waves as a whole, the wave often ends with a big war or begins with a financial crisis or economic recession. Because of the different development process between countries, the first and the second wave only occurred in the United States. After that, the waves spread to more countries including UK, the continental Europe and also Asia started performing well in later waves.

The specific 6 waves occurred in the 1880-90s, 1920s, 1960s, 1980s, 1990s and 2000s separately. Each wave has its own emphasis and characters. There is also a possible wave coming to us soon. The following figure is a simple conclusion of the circumstances of the first 5 waves stated above. It comes from Keohane, a Financial Times analyst in April, 2014.¹

1 http://ftalphaville.ft.com/2014/04/15/1829112/a-brief-history-of-ma/?Authorised=false

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Figure 4: The first 5 M&A waves in history Source: Financial Times April 5^th, 2014

Wave 1: 1893-1904

The first wave starts in the specific oil, mining and steel industry. Following an economic expansion, the industry consolidation brought the horizontal mergers and the emergence of monopolies. Although the Sherman Antitrust Act² in 1890 tried to limit monopolies and cartels, it did not succeed to have much impact. During that period, mergers “permit a capitalization of prospective monopoly profits and a distribution to portions of the capitalized profit (Stigler, 1950)”. The first wave ends due to new laws such as the Sherman Antitrust Act and also because of the stock market crash in 1905.

Wave 2: 1910s-1929

The second M&A wave began in the 1910s, following after the First World War.

The focus industry has changed into iron, food, papers and printing industry. Unlike the first wave which is characterized by monopolies, the second one creates a new

2 Sherman Antitrust Act: purpose was to restrict the combination of entities that could limit competition unlawful.

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category which is oligopolies. The result of the wave is that the market was not dominated by only one large organization any more, but by two or more corporations. Also, small and medium sized companies began being active in the on the M&A market. Again, the second M&A wave ends due to a market crash which occurred in 1929. After that, the “Great Depression” began and it affected the world-wide economy depression.

Wave 3: 1955-1975

The third M&A wave finally begins after nearly 30 years with more restrictions which intended to prevent the anticompetitive M&A market. Different from the former two, a new conception “diversification” emerged. Equity became the main source of financing instead of cash. Conglomerates occur in this new M&A period and it is defined as “large corporations that consists of numerous businesses not necessarily related” (Nouwen, 2011, p4). Diversification can be a tool to effectively decrease cash flow unsustainability by reducing special risks in industries. The diversification process also changed the market structure in that it enlarged distance between top managers and divisional managers. The ending of the third wave is caused by a significant oil crisis in 1970s.

Wave 4: 1984-1989

The fourth wave was quite unusual compared to former ones. First, it is characterized by “bust-up” takeovers where “large parts of the target were divested after acquiring” (Schliefer and Vishny, 1991). Second, a new concept “leveraged buy-out (LBO)” was created which means that a firm would use huge amounts of debt outside to acquire a company. The fourth wave benefited in that market inefficiencies were eliminated partly. Morck, Schleifer and Vishny (1990) argued that “a bid on a target firm, which is competing in the same industry, has a positive relationship with stock market return for the shareholders of the bidding firm.” Due

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to a stock market crash, the fourth M&A wave slowed down after 1989.

Wave 5: 1993-2000

In the 1990s, there was a huge prospect in both economy and financial markets.

During this period, the merger and acquisition activity also increased a lot in Europe, where the amount is also equal to the United States. The number of cross-border M&A activities went up to a large extent. The economic growth was a key driver in the fifth wave while many organizations and corporations would like to join the economy globalization. Some significant mergers happened at that time such as Citibank and Travelers, and Exxon and Mobil. Another important factor driving the fifth merger wave is informational innovations which changed a lot not only in financial markets but also in many other aspects of the society and economy.

Once again, the wave went to the end due to the recession of the economy especially because of the internet bubble which caused the stock market crash all over the world.

Wave 6: 2003-2008

The sixth merger wave emerged in 2003. Since the fifth merger wave ended in 2000, it was only three years after the internet bubble. Alexandridis, Mavrovitis and Travlos (2011) find that “During the sixth merger wave, acquires’ assets were less highly valued and the valuation diversity between acquirers and targets was narrower relative to the 1990s wave.” Compared to former waves, the market for governance control was less competitive and thus the premiums paid were lower than in the past to a large extent. The driver of the sixth wave is primarily the availability of abundant liquidity. It came to an end when signs of skepticism about the state of the MBS began to show by investors and corporate managers.

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2.3 M&A activity in China

The history of global enterprise management is in a sense a history of mergers and acquisitions. From the first large scale wave of mergers and acquisitions in end of the 19th century and in the 20th century, the world has gone through six times a massive wave of mergers and acquisitions. The global multinational M&A began in about the 1950s in the third wave of mergers and acquisitions. However, for Chinese enterprises a phenomenon should be noticed which is that domestic M&A and cross-border M&A are basically happening synchronous simultaneously.

Chinese enterprises experiencing domestic M&A and cross-border M&A have a history of nearly 30 years with the establishment of Baoding Textile Mills merger with the City Knitting Equipment Factory of Baoding and The Bank of China Group and China Resources Group jointer acquisition of Hong Kong Homelite Investment co., ltd., both in the year 1984.

Wu (2011) divided the history of Chinese enterprises transnational mergers and acquisitions into three stages: Budding stage (1984-2001), Staggered start stage (2001-2007) and Active growth stage (2007- now). Although in 1984 the Chinese enterprises had the first case of transnational M&A, due to the left over by history like slow transformation of China's market economic system, reform of state-owned enterprise reform and unclear property right problems, cross-border M&A of Chinese enterprises was still in a bud stage until 2001. In 2001, as China becomes the WTO's 143th member, Chinese enterprises began to gradually move towards to the world, actively participating in the overseas operation and cross-border M&A.

Inevitably, the companies also have paid a heavy price for that. In 2007, the outbreak of the subprime mortgage crisis and the subsequent Eurozone economic weakness happened in the United States, bringing Chinese enterprises a good opportunity to fast exaggerate overseas. This stage of Chinese enterprises

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transnational merger and acquisition presented the momentum of rapid growth.

Stage one: Budding stage (1984-2001)

Symbolized by the activity that the Bank of China Group and China Resources Group jointly acquired Hong Kong Homelite Investment co., ltd. in the year of 1984, Chinese enterprises embarked on the journey of cross-border M&A. At this stage, the causes of reform and opening up in China had just started, and the country was gradually changing from a planned economy system to a market economic system. The ‘Going Out’ strategy has timely been put forward and gradually permeated into the enterprise business philosophy. During this stage, the Chinese enterprise presented the characteristics of transnational merger and acquisition like small scale, less limitation, destination and et cetera. As year of 1992-2001 for example, during these 10 years the Chinese enterprises just occupied less than 1% of yearly amount of the world’s transnational M&A.

Stage two: Staggered start stage (2001-2007)

After China's accession to the WTO in 2001, Chinese companies began increasingly closely contacting with the international market while a lot of ‘strong combinations’

cross-border M&A cases appeared. For example, in 2004, Lenovo acquired the PC department of the Big Blue IBM for 1.75 billion dollars ($1.2 billion in cash + 19%

Lenovo shares worth about $500 million) and it became the big news at the moment.

However, there were many cross-border M&A cases in the following period with a great number of Chinese companies taking a failure in this stage. In 2003, TCL acquired Thomson of France's color TV business and Alcatel's mobile unit, trying to build a global scale operation of the consumer electronics conglomerate. However, both M&A activities finally ended in failure. Therefore, at this stage, Chinese enterprises in the accession to the WTO brought both opportunities and challenges to the timing of M&A and started the cross-border M&A in a stagger way with

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happiness and sadness.

Stage three: Active growth stage (2007- now)

In 2007, the outbreak of the subprime mortgage crisis occurred in the United States and the subsequent Eurozone economic weakness has happened. They brought a good opportunity of cross-border mergers and acquisitions to Chinese organizations.

On one hand, foreign firms are undervalued and on the verge of bankruptcy and the shareholders have a strong appetite to sell, which deregulated the restrictions on Chinese enterprises' M&A. On the other hand, behind Chinese rapid economic growth, there is a growing surge in demand of the sources of energy, mature technology and wide markets. All of these factors led to the Chinese enterprises’

ushering in the rapid growth stage of cross-border M&A since 2007.

After 2007, the cross-border M&A deals continue to boom up. Detailed M&A deals will be introduced together with specific company case studies in the analysis part.

Here I only use a figure to give an overview of Chinese M&A deals in most recent years. It is from the PwC M&A review of 2013 recently.

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Figure 5: Chinese M&A deal value by main category from 2008 to 2013 Source: Thomson Reuters, China Venture and PwC analysis

3. International Investment Treaty

According to Sachs and Sauvant (2009), there are two main types of an International Investment Treaty (IIT), the bilateral investment treaty (BIT) and the double taxation treaty (DTT). This chapter will basically introduce the two main types of IIT and their effects studied by former researchers.

3.1 Bilateral Investment Treaty

A BIT is an agreement between two sovereign regions. Originally, most BITs were made between developed and developing countries while developed countries were the main source of developing countries’ FDI. In the beginning, the BITs were designed to eliminate risks in investing in developing countries since usually the business environment is not that healthy in developing regions. BITs were intended

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to deal with problems in that some developing countries sometimes expropriated foreign assets but not compensating for the original owners.

During the past few decades, there was a significant growth in international investment agreements with the surge of FDI flows all over the world. According to Kenneth Vandevelde (1998), there are three eras of BIT development which are Colonial Era, Post-Colonial Era and Global Era. From 1959 to 1989, there were only 386 BITs signed during the 30 years. In the next 15 years afterwards, more than 2,000 BITs entered into force. By the end of 2006, 2573 BITs had been established. (Data available on UNCTAD website: http://www.unctad.org/iia) As stated before, originally most agreements were signed between developed countries and developing countries. But by the end of 2006, there occurred 680 BITs between developing countries. In the most recent BITs report by UNCTAD, the countries with the most BITSs are Germany, China and Switzerland.

Table 1: Top 10 BIT countries in 2013

Based on: UNCTAD World Investment Report

Except for new establishment of BITs, renegotiating existing tax treaties have also been popular while by the end of June in 2008; there were 121 renegotiated treaties

Rank Country BITs

1 Germany 136

2 C h i n a 1 2 8

3 Switzerland 118

4 United Kingdom 104

5 France 102

6 Egypt 100

7 Netherlands 96

8 Belgium/Luxembourg 93

9 Italy 93

10 Korea, Republic of 90

Table 1: Top 10 BIT countries 2013

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(Sachs and Sauvant, 2009). This is because the business circumstances are changing and new demands of investment treaties occurred. The revision of old tax treaties is expected to protect investor’s benefits. Also, sometimes BITs are revised to make up for expired ones.

By far, BITs have already been the most common agreements on the foreign investment market. In the beginning of 1990s, there were already bilateral and regional free trade agreements which are also called FTIAs. They include mainly agreements for the national sake. They can influence FDI flows by liberalizing investment markets such as by opening investment sectors. After 2006, the FTIAs were significantly increased and many were occurring between developing countries.

In addition, there are also many inter-regional investment agreements as well as multilateral ones such as Energy Charter Treaty, the Trade-related Investment Measures Agreement and the General Agreement on Trade in Services (Thomas, 1996). However, their impact on FDI flows is still hard to measure.

3.2 Double Taxation Treaty

Similar to BITs, there has also been a surge in double taxation treaties. They work differently form BITs but to some extent they serve for BITs. The original goal of bilateral investment treaties is to protect investments in another country, and the double taxation treaties are established to deal with issues which are likely to occur while the investments made between host and parent countries. The function of DTTs can be concluded as they can “reduce the administrative complexity of foreign investments and facilitate the flow of goods and services between the treaty

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partners” (Sachs and Sauvant, 2009).

The number of DTTs started going up since four decades ago. In the beginning, DTTs were mostly signed between developed countries, to the contrary that most BITs were primarily signed between developed and developing countries. Only after that the emerging markets became host FDI countries gradually, DTTs began to be signed between developed and developing countries. However, developed countries were still having the largest volume of DTTs, with the top 3 being the United States, the United Kingdom and France. (UNCTAD, 2007)

Blonigen and Davies (2004) investigated the effect of DTTs using inward and outward US FDI data from 1980 to 1999. Using the most comprehensive dataset which includes 88 partner countries, they do not find systematic evidence that DTTs can increase FDI activities in the United States. Sometimes DTTs contain tax-sparing provisions, which mean provisions where a country applies a tax credit against taxes owned on foreign income. Furthermore, the tax credit is equivalent to the tax exemption provided by the foreign country. In that case, the residence countries will get a double tax relief and accordingly the investment incentives by host countries are more effective.

In a word, DTTs can typically reduce taxation of the host country and shift tax revenues from the home country to the host country. When helping developing countries attract more investment opportunities, DTTs may also make the tax revenue of those countries fall. Only in the circumstance when the DTTs can really help to improve the economic growth in one country, the reduced tax revenues can be made up through the DTTs.

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4. Former Research

As is already stated in the introduction part, for the specific relationship between cross-border M&A deals and international investment agreements, few resembling studies were made before. Most related are studies about whether tax treaties will increase FDI flows. There are also many investigations on the determinants of M&As. In this chapter, I will briefly introduce the two kinds of research and get inspiration from them for my own study.

4.1 FDI and International Investment Treaties

Even though there is much expectation on tax treaties leading to more FDIs, some former studies find little evidence about it. Blonigen and Davies (2002) investigate in the impact of bilateral tax treaties (BTT) on OECD countries from 1982 to 1992.

They find that treaty formations do not promote new investments. They prefer to hold the view that tax treaties help reduce tax evasion but do not increase FDI.

Blonigen, Oldenski and Sly (2011) try to identify effects of tax relief and information sharing on FDI activity. They think that lack of information sharing agreements will make tax authorities difficult to control income reports by foreign subsidiaries. After analyzing non-service US multinational companies from 1987 to 2007, the authors find that after a tax treaty is signed, subtle net changes in FDI impact economic activity a lot. Davies, Norbäck and Tekin-Koru (2008) use affiliate level data of Swedish multinationals to investigate effect of tax treaties on multinational companies. They also find little evidence in that BTT can increase FDI. However, they do find that tax treaties can enhance opportunities of a company in that country. They also conclude that tax treaties have impacts on behaviors of MNCs in some areas, but not in others.

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There are also studies showing that tax treaties can increase FDI flows. Lejour (2014) conducts a study on “the impact of bilateral and multilateral tax treaties on bilateral FDI stocks”. He finds that tax treaties significantly increase bilateral FDI.

He also finds some other factors attracting FDI such as low withholding tax rates. It is worth investigating in deep since there are big differences between different studies.

The third emphasis of relevant studies is tax treaty shopping through a third country.

Previous studies find that many multinationals divert FDI through countries which have favorable withholding tax rates, especially the Netherlands, which is the largest conduit country in the world. Weyzig finds from his study that “FDI diversion is higher if the home and host country both have a tax treaty with the Netherlands, and lower if there exists a direct treaty between the home and host country” (Weyzig, 2012).

4.2 Research on cross-border M&As

Both the volume and the value of cross-border M&A has increased significantly in the last few years. However, to some extent, the academic research has not responded in time to the fast development of M&A activity all over the world. In this sub-chapter, I will briefly introduce some typical former studies on cross-border M&A deals.

Werner (2002) identified 12 different topics on M&As theory excluding cross-border M&As. This is because according to most researchers, domestic M&As are quite different from cross-border M&As. Nevertheless, there are still a lot of other vital issues within the cross-border M&As research such as mode of FDI or entry (Brouthers and Brouthers, 2000 and Hennart and Reddy, 1997),

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performance outcomes from acquisitive entry (Nitsch et al., 1996) and shareholders’

wealth creation (Kang 1993; Morck and Yeung, 1992). In addition, more and more attention is focusing on integration processes (Risberg, 2001), post-acquisition performance of a parent company (Very et al., 1997) and knowledge transfer and organizational learning (Vermeulen and Barkema, 2001).

There are a number of studies on cross-border M&As as “a potential mode of entry into a foreign market” (Andersen, 1997; Harzing, 2002; Kogut and Singh, 1998).

For the entry mode, the classification can be equity-based such as greenfield, acquisitions and joint ventrues and non-equity-based such as export and alliances.

According to Hennart and Park (1994), Greenfield ventures provide the highest form of control over both resources and technology but at the same time have the highest costs. For acquiring an existing business, it allows the acquiring company to attain the acquired firm’s resources such as knowledge, technology and human resources. While the former is happening on the local level, cross-border M&As are also happening on international levels (Newurry and Zeira, 1997). For the choice of a cross-border M&A, Newurry and Zeira conclude that it is often affected by the following factors: (a) firm-level factors such as local and multinational experience in M&As, products diversification and multinational strategy; (b) industry-level factors such as advertising intensity, technology intensity and sales force intensity;

(c) country-level factors such as cultural distances between acquiring and target countries, market growth differences between home and host markets and risk avoidance.

Some researchers such as Brouthers and Brouthers (2000) and Hennart and Reddy (1997) found that the industry-level and country-level factors will increase the entry likelihood through an acquisition. These factors mainly include market growth and cultural differences between acquiring and target countries and the risk reluctance

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in the home country. In addition, for the firm-level factors, cross-border and local experience (Barkema and Vermeulen, 1998), investing size (Brouthers and Brouthers, 2000) and product diversity (Wilson, 1980) will all have a positive impact on acquisitions.

Except for the entry mode theories, the cross-border M&As are also studied as a dynamic learning process. According to Angwin (2001), the process is intended to

“provide the acquirer with adequate information about the value and risks associated with the target”. Kissin and Herrera (1990) argue that the cross-border M&As demand that a number of factors should be paid attention by foreign government including local taxes, exchange rates, local accounting regulations, risk avoidance and trade restrictions. In a cross-border M&A process, the evaluation process is so complicated that it will occur at all the levels discussed above. At the firm level, accounting regulation differences will cause difficulty in evaluating the financial assets in the acquired firm as well as the changing exchange rates. This process will require detailed knowledge on the local education, skills and work force situation. At industry- and country-levels, deep understanding of the local social and institutional environment is required. Hall (1992) put the emphasis on that the relevance of the target’s reputation should be recognized as a major factor affecting the acquiring firm’s decision whether to acquire.

In a word, while the cross-border M&As are becoming more and more important when companies do business in multiple regions all over the world, the academic research is relatively little broad. The existing studies give some primary perspectives on the functions and influences of cross-border M&As. In the future, more kinds of topics should be added to the current literature.

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5. Research Methods

5.1 Data description

Since I have to use both yearly data and industry level data, I will use panels to conduct my research. In this paper, there are several sources which I will use to construct panels. The cross-border M&A data comes from a fantastic database which is ZEPHYR. According to its official website, ZEPHYR is said to be the most comprehensive deal information database. It has already won three awards for its M&A intelligence provision including “UK M&A Solutions provider of the year”

(2014), “Business Intelligence Publishers Firm of the year” (2014) and “Business Intelligence Publisher of the Year 2014” (www. bvdinfo.com). Thus it is a very convincing and creditable database. From this database, I can find Chinese cross-border M&A deal information since 2005 and the most recent year in this database is 2014. Accordingly, my panel data will start from the year of 2005.

As to BIT and DTT data, following Sachs and Sauvant’s research in 2009, I extract them from the UNCTAD’s Country Specific Lists for BITs and DTTs on UNCTAD official website. (http://unctad.org/en/Pages/Home.aspx) Sachs and Sauvant (2009, p.7) suggest that “UNCTAD” has the best database of BITs.” In addition, from the UNCTAD website lists of DTTs per country with signing dates can be found. This helps to find the relationship between M&A deals and DTT by year. With the two lists, some changes are needed to be made to get my model work. Since both BITs and DTTs are sorted by year, I create cumulative numbers for both of them in order to see whether the number of tax treaties will impact M&A deals. I have to mention that the list of BITs is updated until 1 June 2013 and the list of DTTs is updated until 1 June 2011. Since my database starts from 2005, I will calculate the cumulative numbers after that year.

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5.2 Model applied

There have been many attempts to investigate the relationship between different types of tax treaties and FDI flows. Accordingly, there are many kinds of models established. Barthel, Busse and Neumayer (2009) analyze whether DTTs will lead to higher FDI stocks by applying different econometric specifications and controlling for standard FDI determinants. They use a large database for dyadic FDI from 1978 to 2004 and take the natural log for FDI stocks, which is their dependent variable. For explanatory variables, since the authors’ interest is in DTT, their independent variable is the binary DTT which is labeled dtt_dummy. And they use some control variables such as total host GDP for controlling market size, host GDP per capita for controlling purchasing power of domestic consumers, inflation rate in a host country serving as a proxy for macroeconomic distortions, the ratio of sum of imports and exports to GDP in host country for controlling trade openness and a binary variable bit_dummy controlling for the existence of the bilateral investment treaty. Their model follows Arellano and Bond’s general method of moments which is often referred to as GMM. And after reading other literature investigating the impact of tax treaties on FDI flows, similar variables and models are used to conduct the study. The control variables are mostly about macroeconomic factors and do not apply much to my study since my focus is on industries within one country whereby the macroeconomic figures are all the same.

Using similar style formula, I will apply different independent and control variables.

Although there are few studies about how M&A is related to tax treaties, I find many on examining the determinants of M&A activities. One typical research is from Arikawa and Miyajima (2007) who examine the driving factors on M&A boom in Japan. They also use industry-level data during their research. They apply several related independent variables. The first one is Tobin’q, serving as proxy to

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control for growth opportunities. The second is return on assets (ROA) which is a proxy for profitability. Arikawa and Miyajima also include the lagged sales growth to capture industry shocks. The fourth one is the one-year change of the base money in money supply to control the effect of capital liquidity. And the last one is the average three-year stock return to control for the validity of the effect of the stock market overvaluation.

From Arikawa and Miyajima’s model, I decide to choose the second one – ROA to be my control variable. Firstly, the study is worth referencing because it is one of the few M&A studies using industry-level data within one particular country which I am also using. Secondly, my initial interest is to find whether there is relationship between M&A deals and tax treaties. Thus there is no need for me to consider too detailed variables for the industries. Thirdly, among all the five related variables above, I think it is most important to control for profitability. For companies and organizations, when deciding to start an M&A activity, they usually consider the profitability of their acquirer or target (as said by one of the interviewees in retail sector). Thus I put ROA as a control variable in my model to control for the industry profitability.

In addition, economic activities will always have impacts on those in the next year.

As a result, I also include a control variable which is the M&A deals in the previous year. Since I am interested in whether tax treaties will have impact on cross-border M&A deals, I will use the volume of M&A deals to be the calculating unit of my dependent variable.

Thus my regression model is then

MA_i,t = a₀ + a₁BIT_t + a₂DTT_t + a₃MA_i,t-1 + a₄ROA_i,t + u_i,t

(1)

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where i denotes the industries and t denotes time. The dependent variable is defined as follows:

 MAi,t: the volume of Chinese cross-border M&A deals in industry i at year t.

The independent variables are defined as follows:

 BIT_t: cumulative numbers of bilateral investment treaties at year t,

 DTT_t: cumulative numbers of double tax treaties at year t,

 MAi,t-1: the volume of Chinese cross-border M&A deals in industry i at year t-1,

 ROAi,t: return on assets rate in industry i at year t.

Other items are:

 a0: a vector of nuisance coefficients (constant),

 ui,t: an error term, which is assumed to be distributed N(0, r² ).

5.3 Interpretive multiple case study approach

As stated before, there has been limited research in the specific relationship between tax treaties and cross-border M&A deals. Thus there is not enough theoretical background to back up my statistical results. According to Iskandar and Salleh (2010), interpretive approaches can “examine, investigate, identify and analyze a phenomenon”. They go beyond simply describing and understanding what is happening. I decide to choose several companies in four industries which have the most volume of cross-border M&A deals, to take them as case studies to back up my research. In detail, I find one company per industry. The company has experience in merger and acquisitions. I contacted the managers within the

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company and had private interviews with them. The questions took the form of

“what”, “how” and “why”. In light of the discussion above, the interviews intend to respond to the following questions:

Q1: What is the most important factor will you consider when you company decide to make an M&A activity?

Q2: Why do you think tax treaties have impact on M&A deals?

Q3: Why do you think tax treaties do not have much impact on M&A deals?

Q4: What determines cross-border M&A deals in your industry in your opinion?

6. Analysis

6.1 Empirical results

Since the most recent available year of the control variable “ROA” is 2013, my panel data starts from 2005 to 2013. I download ROA of all the companies within the industry and then calculate the average number to be my control variable value.

During the data searching, I found that in some industries, the M&A deal volume is really low and do not worth regressing. I made two figures of the overview of cross-border M&A volume in all the 19 major sectors in both the beginning year 2005 and the ending year 2013. Referring to the major sectors, of course there are several classifications of industries such as NACE Rev.2, NAICS 2007, UK SIC and et cetera. I choose the “Major Sectors” classification for two reasons. Firstly, I use two databases. One is ZEPHYR and the other is ORBIS. I have to find the same classification in the two databases in order to accord my variables and the “Major Sectors” is one of the few same classifications. Secondly, an expert in this area told me that “Major Sectors” is a good classification for my research. So I start

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investigating the M&A deal volume in all the 19 sectors. Now we first look at the two following figures.

Figure 6: Number of M&A deals in 19 major sectors in 2013 Based on: data from ZEPHYR

Figure 7: Number of M&A deals in 19 major sectors in 2004 Based on: data from ZEPHYR

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From the two figures above, we can see that although there are some changes year by year, some sectors are really low in the volume of cross-border M&A deals.

They are wood sector, hotels sector, post sector, insurance sector, public sector and education sector. For my research if the volume in the industry is too low, there is no need to investigate it in deep. Thus I decide to delete the 6 sectors and just use other 13 sectors to conduct my regression model. In addition, my data starts from 2005 and I have a variable which is the M&A volume in the previous year, so I have to set the time period from 2006 to 2013. Accordingly, my panel data number is 104 (13 sectors*8 years). For the cumulative BITs and DTTs, their changes from year to year are really small. In order to examine the relationship, the number of cumulative BITs and DTTs is multiplied by five times. Using the ordinary least squares (OLS) method, I get the following results. The first figure is the descriptive statistics of the variables and the second figure is the regression results on the four variables.

Table 2: Statistical description of the variables

Mean Median Maximum Minimum Std.Dev MA 304.7692 169.5000 980.0000 40.0000 287.7570 MAt-1 304.2308 172.0000 980.0000 40.0000 283.0171 BIT 568.7500 580.0000 595.0000 510.0000 28.2821 DTT 645.0000 652.5000 665.0000 615.0000 21.1674 ROA 4.3009 3.9827 10.5808 0.7769 2.0904

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Table 3:Outcomes of the panel least squares

As shown in Table 2, large gaps are between the minimum and maximum in M&A volume variable and ROA variable. In detail, the average number of cross-border M&A deals in China is about 300, with the minimum volume is 40 and the maximum volume is 980. In addition, the standard deviation is more than 280 which is really high. Referring to the ROA variable, the circumstance is the same.

Thus we can see the uneven development between the different sectors. For BITs and DTTs, there are not high distances between the minimum and maximum numbers. The average of numbers of BIT and DTT are 568 and 645 respectively, with standard deviations of only 28 and 21. It is concluded that there is not many changes in the number of both BITs and DTTs from year to year.

Table 2 provides the ordinary least squares results of the regression model. The R-squared is 0.9686 which is nearly 1 so that we can to some extent hold the view that the independent variables and control variables are closely related to the dependent variable and are reasonable to explain the dependent. Looking at the coefficients, the M&A volume in the previous year variable is 0.9993. It means the variable is highly positively related to the dependent variable. The coefficient of BIT variable is minus 0.6812. It means the number of BITs has a negative

Coefficient Std. Error t-Statistic Prob.

MAt-1 0.9993 0.0183 54.6919 0.0000

BIT -0.6812 0.4884 -1.3947 0.1662

DTT 0.1654 0.6531 0.2533 0.8006

ROA 1.6272 2.4860 0.6545 0.5143

Adjusted R-squared: 0.9673 Method: Panel Least squares Observations included: 104

R-squared: 0.9686

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relationship with the M&A volume. It is the only variable which has a negative relationship with dependent variable among the four independent variables.

Referring to DTT and ROA, both of their coefficients are positive and are far from 1 (0.1654 and 1.6272 respectively). We may conclude that both the two variables are positively related with M&A volume. However, the strength of relationship is quite low.

Now let us look at the most important results: probability. Since the probability of MA_t-10.0000 while others are far more than 0.05³, it is very obvious that the MA_t-1 variable is very significant while other variables are insignificant. But it is noticed that the probability of BIT is 0.1662, much lower than that of DTT and ROA which are 0.8006 and 0.5143 respectively. From this result, we can say about 84 percent of BITs can explain the volume of M&As. Thus although BIT is not significant, it has stronger capacity to explain the dependent variable than DTT and ROA. Finally we get the conclusion from above that the volume of M&A is affected by that in the previous year and has little to do with neither DTTs nor ROAs. For BITs, it can explain about 84 percent of M&A volume which is not very low. However, the result above is not what we exactly expected. Thus some additional regressions are conducted.

In some FDI related studies, lagged dependent variables are included. For example, Barthel, Busse and Neumayer (2009) argue that the dtt_dummy variable in their paper cannot be directly compared to the one from the static model since it only represents the short-term effect. They suggest taking long-run effects into consideration. M&A is also a kind of dynamic activity. Thus, I use lagged variables for M&A deal volumes following former authors. In detail, I use 2-year lag for dependent variable MA, independent variable MA_t-1and ROA, in order to examine

3 In the paper, the author uses a significance level of 95%.

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whether BITs and DTTs two years ago have an impact on current M&A deal volumes.

Table 4:Outcomes of the panel least squares with lagged variables

As shown in Table 4, there are not many changes from the results in Table 3. The symbols of all the four coefficients stay the same. The probability of MA_t-1 remains 0.0000. Slight changes occur in the other three variables. For example, the probability of BIT increases from 0.1662 to 0.3826 which means the relationship between BIT and M&A deal volumes becomes less strong. Both DTT and ROA still have an insignificant relationship with dependent variable.

At last, I try another way to regress my model. Following an expert’s suggestion, I put BIT and DTT together by simply calculating the total of their volumes, to see whether there are different statistic outcomes.

MAt-1 0.9738 0.0199 49.0401 0.0000 BIT -0.4322 0.4921 -0.8783 0.3826 DTT 0.2890 0.6839 0.4226 0.6738 ROA 2.7044 3.0255 0.8939 0.3743 Method: Panel Least squares

Observations included: 78

R-squared: 0.9710

Adjusted R-squared: 0.9694

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Table 5:Outcomes of the panel least squares with BIT and DTT summed into one variable

From Table 5, it is obvious that the sum of BIT and DTT is strongly significant, with a probability of 0.0029. It is quite different from all the previous statistical results. Both R-squared and adjusted R-squared have a value near 1 which means the independent variables have a good capacity to the dependent one. From this table, we can see both MA_t-1and the sum of BIT and DTT are statistically significant. There is evidence showing that the numbers of BIT and DTT have an impact on cross-border M&A deal volume. But there is one thing to mention. The symbols of coefficients of BIT and DTT separately before are opposite. There is a possibility that their effects are offset in the regression. Another problem is that the coefficient of BIT plus DTT as a whole is negative. This may suggest that the numbers of BIT and DTT have a negative effect on Chinese cross-border M&As, which is not what we expected.

Combining the regression results above, the statistics do not help much on explaining how tax treaties affect the cross-border M&A deals since there is only one significant result. With these questions, I begin my interviews with managers in companies to see the real relationship between tax treaty and M&A deals.

MAt-1 0.9988 0.0182 54.8215 0.0000 BIT+DTT -0.3212 0.1054 -3.0483 0.0029

ROA 1.4278 2.4667 0.5789 0.5640

Method: Panel Least squares Observations included: 104

R-squared: 0.9684

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6.2 Interview processes and results

From the two figures in the empirical results part, we can see some sectors are really performing well or put it in another way, really have high volume in cross-border M&A deals. They are chemicals sector, machinery sector, retail sector, banks sector and other service sector. First I found some typical companies within the five sectors and emailed them. In addition to machinery industry, I got some replies from companies in four other sectors. And fortunately I succeeded in making appointment with two managers in chemistry and retail sectors and two employees in banks and other service sectors.

6.2.1 Company A, retail sector

The first company which responded to my asking for interview is China Dalian Wanda Group Corporation Limited (Wanda Group in the following). The organization is a Chinese conglomerate firm which is active in a series of sectors such as real estate, hotels, tourism and entertainment. I include it as the typical company in retail sector in my study is because the manager who I interviewed is the top manager of a large department in Wanda’s entertainment division. Founded in 1988, Wanda Group was beginning with residential real estate but later it went into retail sector including cinemas, karaoke centers and big department stores.

For M&A activities within Wanda Group, in May 2012, the group acquired AMC Theatres which is a United States based cinema operator. The value of the deal was about USD $2.6 billion and it went through successfully in September 2012. Also, in 2013, Wanda Group acquired the British yacht builder Sunseeker International with a value of US $500 million. Referring to the two successful acquisitions, I made an interview of the top manager (called Manager Z in the following) about

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whether tax treaties have impacted and which factors were driving the two M&As.

According to Manager Z, tax treaties must have impacts on cross-border M&As.

After viewing my statistical results which shows an insignificant relationship between tax treaties and cross-border M&A volume, he first advised that I make the number of tax treaties from 5 times to 10 times since the difference between the number of tax treaties year by year is really small. Following his suggestion, I made the following new regressions.

Table 6

Outcomes of the panel least squares

However, the statistical results show that there is still only a strong significant relationship between cross-border M&A deals volume and that in the previous year, not significant results between the dependent variable and tax treaties numbers.

Manager Z said that it might because when the company is affected by a tax treaty when doing cross-border M&As, it is not the number of tax treaties, but whether the target country has a tax treaty with the home country matters. For Wanda Group, the target country in the two big M&As are the United States and the United Kingdom.

Both countries have tax treaties with China since long ago. The United States had double taxation treaties with China in 1982 in Transport and in 1984 in Income and

MAt-1 0.9993 0.0183 54.6919 0.0000

BIT -0.3406 0.2442 -1.3947 0.1662

DTT 0.0827 0.3265 0.2533 0.8006

ROA 1.6272 2.4860 0.6545 0.5143

R-squared: 0.9686

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Capital separately. The United Kingdom had bilateral investment tax treaties with China in 1986. Manager Z said that the tax treaties are already very mature and they can make sure that the company will benefit from the tax policies.

Referring to other factors determining cross-border M&As in the retail industry, Manager Z gave the following opinions. First, price is always the most important factor affecting companies’ decision on cross-border merger and acquisition. Only when the price offer given by the target’s company is attractive, the acquiring company will consider the deal based on other related factors. Manager Z holds the view that the price does not only prevail in the retail industry, but in nearly all the industry sectors. Secondly, Manager Z said that the legal protection of investor in the target country is also a very important factor when his company considers cross-border M&As. If the investor protection in the target country is low, the target company’s shareholders are more likely to prefer cash rather than equity. Under this circumstance, it will influence the acquiring company’s M&A decision since cash and equity mean very differently to a company.

6.2.2 Company B, chemistry sector

The second company is in the chemicals sector. It is called WuXi Genome Center.

In 2011, the Genome Center is established by integrating with WuXi AppTec’s full-range of discovery and development services for the biopharma industry.

(WuXi AppTec’s official website:

http://wgc.wuxiapptec.com/detail_people.php?id=3) The original company was located in America and thus to some extent, the company itself is an outcome of a successful cross-border M&A activity. That is also why I choose this typical company in the sector. Fortunately introduced by a friend who is working in the company as a drug analyst, I succeeded in having an interview with a manager

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(Manager S) working in the marketing department.

After reading my former statistical results, Manager S said similarly to Manager Z of Wanda Group that as a whole, tax treaties will definitely benefit cross-border M&As but it may not be reflected through the relationship between the number of tax treaties and the M&A volume. He gave the reason that for one tax treaty, the effect of it is not the occurrence of the tax treaty itself, but that the tax treaty will benefit related M&A deals in all the following years. He said it may partly explain why my results show insignificant outcome of both BITs and DTTs. Originated from an American company, the situation is a little similar to Wanda Group since the tax treaty between the home and host country was already signed many years ago. According to Manager S, whether there is a beneficial tax treaty between the target and acquiring company is one of the factors affecting the decision on cross-border M&A activities.

For other factors influencing M&As, Manager S holds the view that except for the price, the company is also likely to solve its own governance problem through an M&A activity. Within the WuXi Genome Center, the integration is serving partly for changing the governance mode within the company. An M&A activity can solve a company’s agency problem as well as improve the governance regime in the target firm, although sometimes the only purpose is to deal with the acquiring company’s own governance issue. Thus, Manager S concluded that in some particular cases such as when a company would like to change its own governance, the tax treaty may not be a factor which the acquiring company would consider. But in other cases, tax treaties do matter. In one word, for companies, there are various kinds of purposes related to an M&A activity. The emphasis influencing factors are accordingly changing with these purposes.

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6.2.3 Company C, banking sector

In the following two cases, I did not succeed in contacting with top managers in the two companies. Instead, I briefly conducted interview with two of the ordinary employees. Working in different departments from managers, they can give different ideas and it adds value to the interview as a whole.

The bank which I chose is a commercial bank where headquarter is located in Zhejiang Province, China. The bank experienced an M&A activity with a small company based in the United States. The employee (Ms Y) whom I interviewed said that from her own perspective, the international taxation issues are very vital during an M&A activity. If the tax treaty has definite advantages for the taxation, it will be beneficial for all the companies which are going to do business with that country, and thus increases the volume of cross-border M&As. For other factors which might affect merger and acquisitions, she replied that the profitability is the most important, especially for banks in the kind of which she is in, which is not owned by a government and has to compete with a lot of other commercial banks.

6.2.4 Company D, other services sector

The company I chose for other service sector is a company focusing on personal care. It is not a big company but it was a merger with a Korean personal care firm.

The employee (Mr. M) told me that the primary driver for the merger is about technology. In personal care area, Korean companies have long been performing well and selling their technology to firms in other countries. In order to reduce the transferring costs and to better adopt new technology, the case company decided to merger with the Korea firm. Thus, technology is the most important driving factor for the specific case.

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Besides, after reading my regression results, Mr. Ma suggested that I do regression for each variable separately to see whether there are further meaningful results.

Following his suggestion, I made the following regressions.

Table 7 Regression results only using MAt-1 independent variable

Table 8 Regression results only using BIT independent variable

Table 9 Regression results only using DTT independent variable Coefficient Std. Error t-Statistic Prob.

MAt-1 0.9989 0.0187 53.2929 0.0000

R-squared: 0.9653

BIT -0.2823 1.0070 -0.2803 0.7798

R-squared: 0.9686

DTT -0.5728 1.3448 -0.4259 0.6711

R-squared: 0.9686

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Table 10 Regression results only using ROA independent variable

From the four new tables, we can see although there are slight changes in the probabilities, overall, the statistical results remain the same as in the empirical results part. Taking all the regression tables, I conclude that the number of tax treaties (both BITs and DTTs) do not obviously have a statistical relationship with the volume of cross-border M&As.

7. Conclusion and Suggestion

This study examines the relationship between the number of international tax treaties and the volume of cross-border merger and acquisitions. In contrast to the expectation that the tax treaties numbers would increase cross-border M&A deals, the study finds no significant relationship between the tax treaties and cross-border M&As in statistics. But according to the interviews held, most managers agree that the tax treaties will definitely have a positive effect on their decision on merger and acquisitions. Thus, combining the empirical results and the opinions given by professional managers, it is concluded that the number of tax treaties do not have an obvious impact on cross-border M&As. However, whether the two countries where the target company is in and where the acquiring company is in have signed bilateral investment treaties or double taxation treaties, does matter in the decision of an M&A activity.

ROA 18.3060 13.5092 1.3551 0.1784

R-squared: 0.9686

The impact of tax treaties on cross-border M&A flows in