The influence of a changing debt market on M&A
payment methods.
Evidence from Euro zone cross-border M&As
by
Bastiaan P.W. Natter
1689134
Supervisor: dr. W. Westerman Assessor: dr. H. GonencUniversity of Groningen
Faculty of Economics and Business
MSc. International Financial Management
December 2013
Eerste Hunzestraat 3A
9715 BH Groningen
06-22234745
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Abstract
The financial market has seen significant changes in recent years. The crisis of 2008 and following regulatory reactions have reduced the availability of capital in the market. Consequently, firms find it harder to lend money from the debt markets, which might have an influence on the choice of payment in M&As. This study continues on the work of Di Giovanni (2005) to identify whether the choice of M&A payment methods have altered. This study employs the method introduced by Zhang (2001), utilizing an independent t-test in combination with a factor analysis and discriminant analysis to measure these effects. The empirical results show no significant evidence for the influence of debt market changes on M&A payment methods but show significant evidence for the influence of the relative size of the target and the acquirers leverage ratio.
Key words:
M&As, payment methods, availability of capital.
1. Introduction
The Merger & Acquisitions (M&A) market has seen significant growth throughout the past decades. Consequently, M&A financing has become a well debated topic in academic literature. A large number of academics have studied the effects, causes, and implications of M&As both locally and internationally. Among these topics are the determinants of the payment methods that influence the financing decisions. Several factors have been identified as key variables in the selection of M&A financing. The acquirers financial condition (Zhang, 2001) (Faccio & Masulis, 2005), the importance of corporate control (Amihud, et al., 1990) (Faccio & Masulis, 2005), and the financial environment (Di Giovanni, 2005) are examples of determinants in the financing decision. However, many factors have shown to be inconsistent among markets, time periods, corporations. Accordingly, there is still a significant need to further explore these determinants. The factors determining the payment methods in M&As are both internal and external to the firm (Massa & Zhang, 2013).
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altered. The amount of new loans fell during the crisis (Ivashina & Scharfstein, 2010), and regulations on the financial markets were invoked. A monetary policy of contraction shrinks the banks’ balance sheets and reduces the supply of bank loans (Massa & Zhang, 2013). Consequently, firms find it harder to lend money from the debt markets, which might have an influence on the choice of payment in M&As. Di Giovanni (2005) argues that financial markets significantly influence M&A activity. Di Giovanni (2005) studies the influences on the amount of M&A transfers and finds a significant effect of the stock market to GDP ratio and a positive but insignificant effect of the credit to GDP ratio. However, as emphasized by Massa & Zhang (2013), a reduction in bank loans might have an influence on M&A payment methods. The changes in the availability of capital are visible in graph 1. This shows the fluctuation and drop in the availability of capital in the Euro zone.
Graph 1
Consequently, this study attempts to deepen the knowledge on the relation between the changes in the credit market and the choice of payment methods utilized in M&As. Since Di Giovanni (2005) finds a positive relation between the number of M&As and the availability of credit, this study will continue on his findings by identifying the effects of this change on the exact payment methods utilized in M&As. The European M&A market has seen significant changes in the past decades. The introduction of the Euro and the European Commission’s interventions have facilitated the progress to create a homogeneous and fertile ground for corporate acquisitions (Bjorvatn, 2004) (Moschieri & Campa, 2013).
This paper will attempt to continue on the research of Zhang (2001), Faccio & Masulis (2005), Massa & Zhang (2013). The objective of this study is to identify the influence of a change in capital availability, i.e. a change in the availability of debt, on the financing structure employed in cross border M&As. To analyze this effect this study will employ a
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method introduced by Zhang (2001). Zhang (2001) employs an independent t-test on the different payment options to compare the mean values of the different payment methods. Zhang (2001) also utilizes a factor analysis to examine the mean differences between the payment methods in the sample, and finally he employs a discriminant analysis to classify the M&As in the sample based on the payment method variables.
Employing these methods, the empirical findings show no significant evidence for the effects of debt market changes on M&A payment methods. Accordingly, this study shows that the amount of debt available to the market does not influence a bidder’s choice between cash, debt, and equity. Di Giovanni (2005) finds a measurable effect of the effects of changes in the availability of capital in the market on the amount of M&As. This paper finds no measurable effect on the payment methods used. As a result, it can be concluded that constraints on the financial market do not harm the M&A market. This study does identify the target size ratio and acquirer post deal leverage ratio as factors that significantly influence the method of payment decision. The empirical findings further show that the categorization of the payment method can be a factor that complicates the measurement of financing options since payment methods generally consist of combinations of methods. Accordingly, the discriminant analysis finds that the groupings of payment options can be improved.
This study contributes to existing literature by continuing on the work of and Zhang (2001), Faccio & Masulis (2005), and Massa & Zhang (2013), providing evidence of the influence of the availability of capital on M&A financing structures and thereby identifying the effects of financial constraints on the M&A market. Furthermore, this study identifies the need for a closer study on the classification of payment methods and opens the academic debate on how correct classifications should be introduced.
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2. Previous literature
The field of corporate mergers & acquisitions (M&As) has received notable attention from academics in recent years. This section of the paper will identify the key literature on the topic and its contributions to the understanding of the aspects involved in M&As. Especially since most of the M&A research is based on U.S. transactions, research in the European market may provide interesting insights. Since the beginning of this century, the M&A activity in Europe has seen remarkable growth in both volume and size. Europe has become an attractive market for foreign investors (Moschieri & Campa, 2013). Many scholars argue that this is the consequence of the European Commission’s intervention to create a homogeneous and fertile ground for corporate acquisitions (Bjorvatn, 2004) (Moschieri & Campa, 2013). The homogeneity peaked after the introduction of the Euro as a paper currency in 2002. As a result, the transaction costs in the European cross-border M&A market decreased and efficiency increased (Moschieri & Campa, 2013). However, the Euro zone still inhabits considerable national differences. Ownership structures, corporate governance rules, corporate laws, securities regulations, and market conditions still differ significantly between countries (Faccio & Masulis, 2005). This allows to academics to study a wide variety of attributes contributing to the M&A process.
There is a considerable debate in academic literature on the classification of the different payment methods considered in M&A financing. Martynova & Renneboog (2009) identify four different payment structures involved in M&As, i.e. cash, debt, debt-and-equity, and equity. Zhang (2001) identifies cash offers, share exchange offers, and combinations of cash and share as the different payment methods. Amihud, et al. (1990) recognize cash acquisitions and equity acquisitions in their study on M&A payment methods and corporate control. The importance of payment methods classification is highlighted by Zhang (2001). Via a discriminant analysis Zhang (2001) concludes that only 61.2% of the original grouped cases are correctly classified. The mixed attributes inhibited by cash and share payments form the main reason for this discrepancy in the study.
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financing, and debt financing is preferred over equity financing (De Jong et al., 2011). Pecking order theory is often contrasted with static tradeoff theory, i.e. a firm moves towards a target debt ratio in its capital structure and basis it financing preference on its position to this target (De Jong et al, 2011). However, Hovakimian et al. (2001) and De Jong et al. (2011) stress that static tradeoff theory is more applicable to repurchase decisions, where pecking order theory is more important in the issue decision. Leary & Roberts (2010) incorporate a wide range of factors included in alternative theories (e.g. the tradeoff theory) into the pecking order model. They find that when the factors from previous structure studies are incorporated, the pecking order theory accurately classifies over 80% of the debt and equity issuances.
Pecking order theory is generally viewed as a solid predictor of financing decisions (Leary & Roberts, 2010). However, several academics disagree with the predictive power of pecking order theory. Fama & French (2005) identify several situations which tend to enforce pecking order theory but identify a “deep wound on the pecking order theory” (Fama & French, 2002) in their observation of large equity issues by small low-leverage growth firms. Frank & Goyal (2003) argue that, by time, firms tend to move away from pecking order theory and equity becomes more important. They further identify that small firms tend to behave in a non-pecking order manner. In their study the international differences in non-pecking order theory, Seifert & Gonenc (2008) find little overall support for pecking order behavior for American, British, and German firms. However, they do find evidence for pecking order behavior in Japanese firms. The academic literature on pecking order behavior shows both evidence in support and criticism. Nevertheless, it is able to reasonably structure the decisions between different financing options. Accordingly, this study assumes pecking order theory as a solid predictor for financing decisions.
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Academic research recognizes three major streams in cross border M&As. Namely, mode of entry in a foreign market, dynamic learning process in a foreign culture, and a value creating strategy (Shimizu, et al., 2004). Acquisitions as an entry mode can be described as acquiring a firm to obtain its resources such as its knowledge base, technology, and human recourses to gain access to the foreign market and have a solid locally know base to expand from (Shimizu, et al., 2004).
The dynamic learning process in M&As focuses on the due diligence, negotiation process, and integration processes. In for example a due diligence process, domestic and cross border M&As differ significantly due to some complex elements. These elements can be the different institutional environments (Feito-Ruiz & Menédez-Requejo, 2011), the corporations, or the different national cultures (Angwin, 2001). Especially the process of the due diligence can significantly influence the assessment of a corporation and give a solid assessment of the risks involved. These factors may influence the financing decision of the acquirer.
The value creation element relates to the acquirer’s shareholders. Several studies have found that cross border M&As provide integrating benefits of internationalization, synergy, and risk diversification and thereby create wealth for both acquirer and target firm shareholder (Morck & Yeung, 1991) (Morck & Yeung, 1992) (Kang, 1993) (Markides & Ittner, 1994) (Shimizu, et al., 2004). The statement of value creation is rather contrary to the empirical evidence found in the market (Shimizu, 2004). Nevertheless, it holds as an argument for corporations to engage in cross border M&As. The differences between national and cross border M&As results in both challenges and opportunities for corporations. Accordingly, the financing decision should incorporate these different aspects and risk to correctly value the target corporation and result in the optimal benefit for the acquirer.
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by Toughran & Vijh (1997). Their study shows that companies who utilize a stock offer earned significant negative excess returns whereas when tender cash offers were utilized there are significant positive excess returns.
As mentioned previously, the second major step in financing sources is debt. Massa & Zhang (2013) argue that when the company’s access to debt declines, the financing structure will be tilted towards equity. Hovakimian, et al. (2001) find that firms tend to move towards a certain optimal debt ratio, although this is more significant with debt and equity repurchases than raising capital. Debt has become an important financing source in large takeovers, Seventy percent of the takeovers with external finding are financed with debt (Martynova & Renneboog, 2009). The last major source of financing is equity financing. Equity payments tend to be utilized when the acquirer’s stock is overvalued (Vermaelen & Xu, 2013). However, equity financing poses several challenges for risk averse managers. Equity financing generally reduces the control the acquirer has over itself due to the outgoing shares. Hence, the original ownership structure is altered which increases the risks for the organization (Faccio & Masulis, 2005). Accordingly, the choice for equity financing is balanced between factors. On the one hand, equity financing is preferred when firms are financially constrained. On the other hand, the need for corporate control, often measured via the degree of management share ownership, increases the preference for non-equity financing options (Faccio & Masulis, 2005). Additionally, equity financing is often viewed as a value reducing payment method in M&As and is therefore less preferred (Martynova & Renneboog, 2009).
The previous parts in this section of the paper have debated the European M&A market, different payment methods, pecking order theory, and difference between domestic and cross-border M&As. The following section will discuss the different literature on the determinants of payment methods and form the hypotheses which are applied in this study. The determinants of payment methods are a heavily discussed topic among academics and conclusive evidence for all topics still remains absent.
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compared to its peak during the top of the credit boom. The amount of new loans fell sharply during the financial crisis (Ivashina & Scharfstein, 2010). This meltdown continued through the crisis due to the banking panic. In the fourth quarter of 2008 the dollar volume of lending was 47% lower than its previous quarter. By applying a nested panel regression framework on 764 major banks, Brei & Schclarek (2013) find that private banks tend to reduce their lending during times of crisis, which reduces the availability of capital in the market. Additionally, the reactions following the crisis have severe supply side implications. After the financial crisis, many regulative institutions invoked regulations that influence a financial institution’s lending capabilities.
In the US, the Dodd-Frank Wall Street Reform and Consumer Protection Act (DFA) is the 2319 page long regulative reaction by the U.S. government to the 2008 financial crisis (Krainer, 2012). European regulators came up with the Basel accords. The Basel accords mainly focus on increasing the capital requirements for financial institutions. Accordingly, financial institutions are required to keep a higher percentage of cash in house to ensure that there is enough liquidity to cover unexpected events. This approach has received severe criticism by academics. Allen, et al. (2012) argue that although there is the possibility of almost no trade-off between the safety and the level of output of the system, there is a profound risk that the supply of credit to the economy will be disrupted by the implementation of the new regulations; moreover the long run rate of growth of the economy will be adversely affected if riskier borrowers such as some small businesses are unable to get adequate access to finance. Massa & Zhang (2013) emphasize that a monetary policy of contraction shrinks the banks’ balance sheets and reduces the supply of bank loans. Consequently firms find it harder to lend money from the debt markets which might have an influence on the choice of payment in M&As.
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pecking order preferences. In accordance with the literature described in the above section, this study employs the following hypothesis concerning the availability of capital:
Hypothesis 1. The availability of capital hypothesis – A change in the availability of debt in the market has an influence on M&A payment methods.
The theory used to analyze the hypothesis is based on the principal of financial deepening discussed by Di Giovanni (2005). “Financial deep markets –whether measured by size or liquidity– provide firms access to capital necessary to undertake investment projects which they might otherwise have to forego”(Di Giovanni, 2005, p. 130). As seen in earlier section of this paper, the amount of debt in the markets has seen large fluctuation in the recent years. Accordingly, this study aims to find whether this fluctuation has effects on the payment methods.
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It is important to address the ownership fraction of an organization in relation to the European market since a widely held corporation is only a common organizational form for large firms in the richest common law countries, such as the United States (La Porta, et al., 1999). Accordingly, most of the corporations in the European market are not widely held. La Porta et al. (1999) find that except in economies with very good shareholder protection, relatively few firms are widely held. Faccio & Lang (2002) partially agree with these findings. In their study of 5,232 corporations in 13 Western European countries, they find that firms are widely held (36.93%) or family controlled (44.29%). They do however note that widely held firms are more important in the UK and Ireland, and family controlled firms in Continental Europe. Complementing this study, Caprio, et al. (2011) find that ownership is negatively correlated with the probability of launching a takeover bid, and family controlled firms are less likely to engage in acquisitions, especially when there is the risk of losing control on the firm by the family. Friend & Lang (1988) however contradict the previously noted findings. Their study of 984 NYSE firms from 1979 to 1983 shows a decrease in firm debt as the level of management investment (shareholding) in the firm increases. This study, however concerns the US market which, as mentioned earlier, differs significantly from the European market. As a result of previous studies, this paper employs the following hypothesis.
Hypothesis 2. The ownership hypothesis – The higher the ownership fraction of the acquirer’s major shareholder, the more reluctant the acquirer is to finance the deal with equity.
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higher levels of tax-deductible R&D expenditures and low current earnings and cash dividends which reduces the firm’s need for additional tax shield. Accordingly, debt financing becomes less attractive. These findings are confirmed by Jung, et al. (1996). Their study also finds that higher market-to-book acquirers are more likely to utilize equity rather than cash or debt as a payment method. Cleary (1999) also employs the market-to-book ratio as a measure for firm growth and finds the ratio to be a significant determinant for financing decisions. In accordance with the previous literature, this study will employ the following hypothesis in relation to the acquirers growth opportunities.
Hypothesis 3. The Growth opportunity hypothesis – Firms with higher growth opportunities are more likely to finance a deal with equity
Several studies on M&A payment methods have acknowledged the importance of firm size or deal size. Faccio & Masulis (2005) measure the relative deal size as the ratio of deal offer size (excluding liabilities) divided by the sum of the deal’s offer size plus the bidder’s pre-offer market capitalization at the year-end prior to the bid. Utilizing this method, they find it to have a significant effect. Grullon et al. (1997) and Zhang (2001) measure the size ratio as the ratio of the book value of total assets of the target to those of the acquirer for the financial year prior to the acquisition. Both studies find that the size of the corporations has a significant influence on the choice of payment methods. According to Zhang (2001), the bigger the size of the target firm, the more likely the acquirer will utilize equity financing as its payment method.
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(2002) find a positive relation between the target size and returns when the target is a private firm or subsidiary. The negative relation between the size and target in public firms might be caused by the stronger negotiation position of the target and its ability to extract more gain from the deal. The difference between private and public targets is explained by the liquidity of the target. Private firms cannot be bought and sold as easily as public targets and are therefore less attractive (Fuller, et al., 2002).
Several studies contradict the previous findings. Martin (1996) measures the targets relative size as “the ratio of the amount paid for the acquisition to the sum of the market value of equity as of 20 trading days just before the announcement date” (Zhang, 2001, p. 8). In his study the sum paid in the acquisition is not significant at a 5% level in any of his regressions. Gosh & Ruland (1998) support the findings of Martin (1996). They find no significant evidence for the influence of size on the payment method utilized in M&As. Their explanation for these findings is based on a differentiation in motivation between the bidder and the target. According to Gosh & Ruland (1998), the target’s shareholders prefer equity financing to maintain a level of influence in the new organization, whereas the bidder’s shareholders prefer cash financing to reduce the risk of losing control over the corporation. This is relatively consistent with the previous findings on the corporate control motivation in payment methods.
This study utilizes the size measure as introduced by Zhang (2001) and therefore employs the following hypothesis in relation to the target’s size:
Hypothesis 4. The size hypothesis – Larger target size decreases the utilization of cash as a payment method.
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The concept of asymmetric information has been a well debated subject among academics. Asymmetric information theory states that there exists asymmetric information between the management and market participants. As a result, different payment methods in M&As may signal different types of valuable information to the market investors (Zhang, 2001). Myers & Majluf (1984) argue that the payment method incorporated by bidders provides signals about the bidder’s asset value. Stock bids tend to be a sign of overvalued assets, whereas cash values are viewed as a sign of under valuation. According to Myers & Majluf (1984) market participants view these payment methods as bad news and good news respectively. These findings are supported by the studies of Hansen (1987) and Travlos (1987). Martin (1996) finds that bidders are more likely to make cash offers when there is more uncertainty about the value of the bidders. These findings are in line with the previously mentioned study of Faccio & Masulis (2005). As uncertainty decreases and information is known, equity offers become more likely to occur than cash offers. Shen (2013) finds that information asymmetry, as the underlying motivator of the pecking order behavior, increases the informational premium in equity and leads firms to prefer issuing debt over equity.
Following the previously mentioned studies, this paper will employ the following hypothesis on information dissemination:
Hypothesis 5. Information Asymmetry hypothesis – Deals with low asymmetric information are more likely to be financed with equity than cash.
To test this hypothesis, this study will utilize the intra industry concept introduced by Faccio & Masulis (2005).
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The Modigliani & Miller (1963) approach to the leverage ratio provides incentives for firms to have a higher debt ratio since this will provide a tax shield. Accordingly, firms will strive towards having an optimal debt ratio, as assumed by static tradeoff theory (De Jong, et al. 2011) (Hovakimian, et al. 2001). The magnitude of M&A deals will adjust this balance and firms will have to decide whether to finance a deal with cash, debt, or equity.
Another viewpoint on the leverage influences in M&A deals is provided by Martynova & Renneboog (2009). Their research has its foundation in the study of Black & Scholes (1973). They argue that equity of a leveraged firm is a call option on the firm’s assets whose value increases with the volatility of future cash flows. Accordingly, management can increase its shareholder wealth by increasing its investment in risky projects. As a result, wealth will be redistributed from bondholders to shareholders. As earnings volatility increases, creditors will anticipate on increasing bankruptcy cost by demanding better debt covenants. Consequently, borrowing cost increase and debt financing will become less attractive for leveraged firms (Martynova & Renneboog, 2009). Cai & Zhang (2011) find a direct correlation between leverage ratio and future investment. Their study identifies that highly leveraged firms have lower investment opportunities and therefore have a lower degree of future investment.
In accordance with previous literature, this study incorporates the financial position of a firm via the firm’s leverage ratio. This leads to the following hypothesis.
Hypothesis 6. The financial position hypothesis – Low leveraged firms are more likely to utilize debt financing than high leveraged firms.
Firms with low leverage ratios have higher financing opportunities due to the lower capital constraints. This is consistent with Martynova & Renneboog (2009).
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Thirdly, Cleary (1999) and Faccio & Masulis (2005) find strong evidence for the effects of growth opportunities on the payment decision. Fourthly, Grullon et al. (1997) and Zhang (2001) argue that the relative size of the target is a determinant for financing preferences. Fifthly, Faccio & Masulis (2005), among others, find significant evidence for the influences of information dissemination. Lastly, Martynova & Renneboog (2009) find evidence for the influences of a bidder’s financial position on the financing choice. The remainder of this paper will attempt to identify whether these factors influence a bidder’s financing position. The following section of this paper will describe the data collected to perform the different stages of the analysis to test the different hypotheses..
3. Data
This study utilizes a data set compiled from several databases. The following section describes the different variables, the selection procedure, and the data sources.
3.1 Sample definition
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3.2 Payment methods
This study partitions the M&A payment methods in three general categories: cash, debt, or equity. This method consist of the underlying payment categories utilized in previous studies. All M&A data is collected from: Zephyr, comprehensive M&A data with integrated detailed
company information (Orbis). Debt and equity may entail a small fraction of internally
generated funds. Furthermore, debt financing may involve the utilization of loan notes. However, following Faccio & Masulis (2005) and Martynova & Renneboog (2009), the payment with loan notes is equivalent to a cash payment. Like Martynova & Renneboog (2009) the remainder of this study will not differentiate between the two and refer to both as cash payments.
3.3 Availability of capital
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3.4. Ownership
Several studies have identified the relationship stock ownership and the M&A payment methods. Stulz (1988) argues that the larger the fraction of managerial ownership held by the acquiring firm is, the less likely it is that the acquisition is financed by utilizing stock exchange (Zhang, 2001). This notion is further supported by Amihud et al. (1990) who find that corporate insiders who value control will prefer financing investments by cash or debt rather than issuing new stock that dilutes their holdings and increases the risk of losing control. Accordingly, the fraction of managerial ownership should have a significant impact on the choice of payment methods in the European M&A market. However, these studies fail to incorporate all nations of this sample for various reasons. Therefore, this study incorporates a different measure. Friend & Lang (1988) find that firms with a large non-managerial shareholder generally have a significantly higher debt ratio than firms with no principal shareholders. These findings suggest that the existence of large non-managerial shareholders might make the interest of managers and public stockholders coincide (Friend & Lang, 1988). Zhang (1998) emphasizes these findings by concluding that the higher the fraction owned by the controlling shareholder, the higher the firm’s leverage ratio, i.e. the higher the fraction of debt in the organization’s capital structure. As a result, this study measures the ownership via the direct ownership of the bidder’s largest shareholder prior to the acquisition.
3.5 Growth opportunities
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3.6 Relative size
The influence of the deal size on M&A payment is under severe discussion. Grullon et al (1997) find that an increase in deal size generally leads to a higher probability of equity financing or a combination rather than cash only offers. However, Martin (1996) does not find any significant relation between relative deal size and M&A payment method. Even though this variable is still open to debate, this study will incorporate the relative size effects. According to Faccio & Masulis (2005) the relative size can be computed as the ratio of deal offer size (excluding assumed liabilities) divided by the sum of the deal’s offer size plus the bidder’s pre-offer market capitalization at the year-end prior to the bid.
3.7 Degree of relatedness
Faccio & Masulis (2005) further identify the relation between the degree of industry relatedness of the acquirer and the acquired company. In their study they find that sellers are more willing to accept a continuing equity position when both organizations are well acquainted with industry risks and prospects. Accordingly, this study will measure the degree of relatedness via a dummy that equals zero when the bidder and target are in the same industry (when the primary 3-digit SIC codes coincide) and one if they are in different industries.
3.8 Bidders financial position
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3.9 Sample Distribution
As mentioned earlier in this section, the final sample for this study consists of 272 Euro zone cross-border M&As. Table 1 shows the country specific distribution of the sample. It can be seen that Germany, France, and the Netherlands are the three countries with the largest number of bidders. Furthermore, it shows that cash financing constitutes for 60.7% of the sample, debt financing for 22.4% of the sample, and equity financing for 16.9% of the sample. These findings are consistent with the pecking order preferences introduced earlier in this study.
Table 1 Country specific distribution
Payment methods
Cash Debt Equity Total
Acquiror country code AT 14 2 2 18 BE 15 5 5 25 CY 2 1 0 3 DE 16 6 9 31 EE 1 2 0 3 ES 17 11 0 28 FI 12 9 7 28 FR 23 6 11 40 GR 4 2 0 6 IE 11 3 0 14 IT 16 5 3 24 LU 6 2 3 11 MT 0 2 1 3 NL 26 5 5 36 PT 1 0 0 1 SI 1 0 0 1 Total 165 61 46 272
AT = Austria, BE = Belgium, CY = Cyprus, DE = Germany, EE = Estonia, ES = Spain, FI = Finland, FR = France, GR = Greece, IE = Ireland, IT = Italy, LU = Luxembourg, MT = Malta, NL = the Netherlands, PT = Portugal, SI = Slovenia
4. Methodology
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accordingly assess which variables influence the different payment choices. Thirdly, to better examine differences in mean values this study will employ a factor analysis. “Factor analysis groups financial variables into categories with common factors. It is expected that a small number of factors can explain most or the large part of the attributes in financial entities. Thus, factor analysis allows a study to concentrate on important factors by reducing a larger number of variables to a smaller number of factors. Moreover, factor analysis reveals the relationship between the variables defined in the study as it classifies variables with similar characteristics into one factor and variables with different features into other orthogonal factors” (Zhang, 2001, p. 16). Lastly, this study will utilize a discriminant analysis to classify the M&A cases by payment methods used in the transactions. “The purpose of discriminant analysis is to make it possible to identify those variables that significantly contribute to the predictive process and thereafter drop the others from the discriminant function” (Zhang, 2001, p. 18). As a result, this study is able to identify significant factors, and allows an assessment of the group composition of the different payment methods. The methods will be employed in the following section.
5. Analysis
Table 2 presents the descriptive statistics for the sample of Euro zone cross-border M&As. It provides insights in the exact mean and standard deviation of each variable. In accordance with the previous sections of this paper, the availability of capital is defined by the variable credit/GDP, the ownership position by the variable share ratio, the growth opportunities by the variable MtB ratio, the target’s size by the size ratio, the information asymmetry by the relatedness variable, and the financial position by the leverage ratio.
Table 2 Descriptive statistics
Methods of Payment
Cash Financing Debt Financing Equity Financing
Mean Standard Deviation
Count Mean Standard Deviation
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Table 2 shows that the lower the credit to GDP ratio the more likely the deal is financed with equity. Accordingly, it seems that a declining availability of capital leads to more equity financing. However, when the ratio is higher, cash financing seems to have a preference above debt financing. This is consistent with pecking order theory that cash is preferred to debt and equity in every situation.
The differences in ownership seem to be relatively small, the means of the ownership ratio differ from 0.31 to 0.39. The higher the ownership percentage of the single largest shareholder, the more likely the deal is financed with cash. It seems that organizations with a large shareholder are more reluctant to finance a deal with equity because this will decrease their control.
The market to book ratio shows that the higher the acquirer’s market to book ratio the more likely the deal is financed by either cash financing or equity financing. Accordingly, it seems that corporations with growth opportunities have attractive shares that can be utilized in financing the deal.
The size ratio shows that the larger the size of the acquired organization, the more likely the deal is financed with debt. Thus cash financing becomes less likely when the payment size increases and debt or equity financing is preferred.
The relatedness dummy shows that firms generally prefer to acquire firms from different industries. The degree of relatedness seems to be relatively equal among the three payment methods.
The leverage ratio shows that firms with a larger post acquisition leverage ratio are typically more interested in utilizing debt financing.
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Table 3 T-test for equality of means
Table 3 shows that the t values for the size ratio and the leverage ratio are significant at a 5% level. That means these variables are well defined for the classification of the payment methods when cash financing and debt financing is used. The t values of the other variables are not significant at a 5% level. Accordingly, these variables have no measurable effect when the choice between cash and debt payments are made.
Independent Samples Test (Cash vs. Debt)
Levene's Test for Equality of Variances
t-test for Equality of Means
F Sig. t df Sig. (2-tailed) Mean Difference Std. Error Difference 95% Confidence Interval of the Difference Lower Upper credit/GDP Equal variances assumed .308 .580 .530 225 .597 3.2550 6.1443 -8.8528 15.3628
share ratio Equal variances assumed .610 .436 .761 177 .448 0.0323 0.0425 -0.0515 0.1162 MtB ratio Equal variances assumed 3.131 .079 .916 177 .361 3.1217 3.4088 -3.6053 9.8488
size ratio Equal variances assumed 11.040 .001 -2.289 156 .023 -0.2784 0.1217 -0.5188 -0.0381 Relatedness Equal variances assumed 2.973 .086 -.784 225 .434 -0.0573 0.0731 -0.2013 0.0867
leverage ratio Equal variances assumed
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Table 4 T-test for equality of means
Table 4 shows that the t values for all variables are insignificant at a 5% level. This suggests that there is no clearly defined classification between cash financing and equity financing. The table does show that, although not significant, the size ratio does seem to have some effect, this is also shown in table 3 where the relation is significant. Furthermore the ownership ratio and leverage ratio seem to have some measurable effect on the variables even though they are insignificant.
Independent Samples Test (Cash vs. Equity)
Levene's Test for Equality of Variances
t-test for Equality of Means
F Sig. t df Sig. (2-tailed) Mean Difference Std. Error Difference 95% Confidence Interval of the Difference Lower Upper credit/GDP Equal variances assumed 1.974 .161 .990 209 .323 6.6617 6.7261 -6.5980 19.9214
share ratio Equal variances assumed .637 .426 1.539 162 .126 0.0728 0.0473 -0.0206 0.1662 MtB ratio Equal variances assumed .289 .592 -.202 166 .840 -0.9443 4.6641 -10.1529 8.2642
size ratio Equal variances assumed 2.074 .152 -1.689 153 .093 -0.1062 0.0629 -0.2304 0.0180 relatedness Equal variances assumed .000 .982 .011 209 .991 0.0009 0.0825 -0.1617 0.1635
leverage ratio Equal variances assumed
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Table 5 T-test for equality of means
Table 5 shows that the t values for all variables are insignificant at a 5% level. This, like in the case of cash and equity financing, suggest that there is no clearly defined classification between debt financing and equity financing. Unlike in table 4, the variables seem to be quite insignificant and no measurable effect can be classified.
The results of this test are relatively consistent with the findings of Zhang (2001) who finds that most variables are significant in comparison with cash financing. Like in the descriptive statistics, size seems to be a determinant factor in the decision to finance a deal when cash financing and debt financing are considered. According to the independent t-test, the leverage ratio seems to have a significant effect when cash financing and debt financing are considered. This is consistent with the hypothesis.
All other variables are inconsistent with their hypothesis since no significant influence of the variables on any of the payment methods can be defined.
Independent Samples Test (Debt vs. Equity)
Levene's Test for Equality of Variances
t-test for Equality of Means
F Sig. t df Sig. (2-tailed) Mean Difference Std. Error Difference 95% Confidence Interval of the Difference Lower Upper credit/GDP Equal variances assumed .609 .437 .458 106 .648 3.4067 7.4395 -11.3429 18.1562
share ratio Equal variances assumed .002 .969 .762 83 .448 0.0405 0.0531 -0.0652 0.1462 MtB ratio Equal variances assumed 3.854 .053 -.930 83 .355 -4.0661 4.3717 -12.7612 4.6291
size ratio Equal variances assumed 2.491 .119 .848 77 .399 0.1723 0.2032 -0.2323 0.5768 relatedness Equal variances assumed 1.333 .251 .612 106 .542 0.0582 0.0952 -0.1305 0.2469
leverage ratio Equal variances assumed
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Factor analysis
The statistics above describe how some of the variables have a statistically different mean values when the different financing options are compared. Accordingly, there is a need to further investigate the determinants of M&As financing on the basis of a factor analysis. The accurately perform the factor analysis, cases with missing variables are deleted list wise. As a result, the final sample in the factor analysis and discriminant analysis consists of 137 M&As.
Table 6 Principal Compnent Analyis
Total Variance Explained
Component
Initial Eigenvalues
Extraction Sums of Squared Loadings
Rotation Sums of Squared Loadings Total % of Variance Cumulative % Total % of Variance Cumulative % Total % of Variance Cumulative % 1 1.678 27.970 27.970 1.678 27.970 27.970 1.667 27.789 27.789 2 1.096 18.260 46.229 1.096 18.260 46.229 1.081 18.022 45.812 3 1.004 16.726 62.955 1.004 16.726 62.955 1.029 17.143 62.955 4 .977 16.286 79.241 5 .899 14.979 94.220 6 .347 5.780 100.000 Extraction Method: Principal Component Analysis.
Table 6 shows the results of the principal component analysis which is conducted on the correlation between the six variables. Three factors are extracted with eigenvalues equal or greater than one. The first component accounts for 28% of the total variance, the second component accounts for 18%, and the third for 17%. In total these factors account for 63% of the total variance. There are other variables in the sample, but they can be viewed as insignificant.
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Table 7 Rotated Component Matrix
Rotated Component Matrixa
Component 1 2 3 credit/GDP -.067 -.048 .708 share ratio -.223 .740 -.018 MtBratop .870 -.133 .054 size ratio .277 .698 .001 relatedness .097 .033 .724 leverage ratio .878 .163 -.019 Extraction Method: Principal Component Analysis. Rotation Method: Varimax with Kaiser
Normalization.
a. Rotation converged in 4 iterations.
Discriminant analysis.
The previously discussed factor analysis shows that there are three factors in this sample which explain 63% of the total variance. In line with Zhang (2001) this study will employ a discriminant analysis to distinguish the cases listed in the sample.
Table 8 Eigenvalues
Eigenvalues
Function Eigenvalue % of Variance Cumulative % Canonical Correlation 1 .166a 88.9 88.9 .377 2 .021a 11.1 100.0 .142 a. First 2 canonical discriminant functions were used in the analysis.
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Table 9 Structure Matrix
Structure Matrix Function 1 2 leverage ratio .679 -.412 share ratio -.413 .402 relatedness -.115 -.080 MtBratop .106 -.729 size ratio .505 .553 credit/GDP .015 .193
Pooled within-groups correlations between discriminating variables and standardized canonical discriminant functions
Variables ordered by absolute size of correlation within function.
Table 10 depicts an indication of the success rate for the predictions of membership of the grouping variable’s categories. This shows that 56.9% of the cases are qualified in the correct group. This is a relatively low success rate. The mixed attributes of different payment methods make it difficult to classify the payments in exact groups.
Table 10 Classification Results
Classification Resultsa Payment method Predicted Group Membership Total 1 2 3
Original Count Cash 58 12 15 85 Debt 9 12 5 26 Equity 11 7 8 26 % Cash 68.2 14.1 17.6 100.0 Debt 34.6 46.2 19.2 100.0 Equity 42.3 26.9 30.8 100.0 a. 56.9% of original grouped cases correctly classified.
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Table 11 Functions at Group Centroids
Functions at Group Centroids
Payment method Function
1 2
Cash -.302 .031
Debt .676 .171
Equity .312 -.272
Unstandardized canonical discriminant functions evaluated at group means
The Fisher’s classification function derived by the discriminant analysis is depicted in table 12. “These coefficients can be used directly for classification – an activity in which either the discriminating variables or the canonical discriminant functions are used to predict the payment method to which a case most likely belongs” (Zhang, 2001).
Table 12 Classification Function Coefficients
Classification Function Coefficients
Payment method
Cash Debt Equity credit/GDP .098 .099 .096 share ratio 7.756 5.732 5.981 MtBratop .009 -.026 .001 size ratio .080 .701 .154 Relatedness 2.282 2.087 2.180 leverage ratio 1.044 3.943 3.078 (Constant) -9.764 -9.861 -9.315 Fisher's linear discriminant functions
From table 12 the following classification functions can be derived for each group.
Ci=-9.764 + 0.098*Credit/GDP + 7.756*share ratio + 0.009*MtB ratio + 0.080*Size ratio
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Dj=-9.861 + 0.099*Credit/GDP + 5.732*share ratio + -0.026*MtB ratio + 0.701*Size ratio
+2.087*Relatedness + 3.943*leverage ratio Where j = 1,…,26
Ek=-9.315 + 0.096*Credit/GDP + 5.981*share ratio + 0.001*MtB ratio + 0.154*Size ratio
+2.180*Relatedness + 3.078*leverage ratio Where k = 1,…,26
Where Ci, Dj, and Ek represent Cash financing, Debt financing, and Equity financing
respectively.
The above equations show a clear difference between Ci and Dj in terms of size ratio, share
ratio, and leverage ratio. The other variables do not differ greatly between the functions. The difference between Dj and Ek is clearly visible for the size ratio and the leverage ratio,
whereas the other variables differ less between the functions. Similarly, there is a difference between Ci and Dj. The differences between debt and equity payments seem less defined as
the differences between cash and debt payments.
The results from the discriminant analysis depict that two of the six variables, namely the size ratio and the leverage ratio are dominant factors. This is consistent with the previous factor analysis with exclusion of the Market to Book ratio. Furthermore, it is in line with the results of the first independent t-test (Cash vs. Debt) which also identifies the Size ratio and Leverage ratio as determinant factors.
6. Conclusion
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The main objective of this study is to identify the relation between changes in the debt market and M&A payment methods. The empirical findings of this study are not consistent with the availability of capital hypothesis. This study finds no significant relation between the credit to GDP ratio and the payment methods utilized in M&As. Di Giovanni (2005) finds a positive, but not significant, relation between this form of financial deepening and the number of M&As. As a result, this study tested whether this form of financial deepening would influence the payment method utilized and finds no correlation between the variables. Accordingly, this study concludes that the availability of capital in the market does not significantly influence the choice of payment methods.
This analysis shows no evidence for several other factors. The empirical analysis finds no significant evidence for the ownership hypothesis, the growth hypothesis, and the information asymmetry hypothesis. All three tests find no measureable effect of the ownership, and the growth variables. The factor analysis does however identify the market-to-book ratio as a dominant factor in the sample. However, since this factor is measurable but insignificant for the other two tests, this study does not acknowledge it as a determining factor in the choice of payment.
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that equity is often utilized as a last option payment method, relatively uninfluenced by the different variables. The main choice is made between cash and debt.
The empirical evidence provides an interesting notion on the classification of the different payment methods. This study identifies three main sources of financing: cash, debt, and equity. However, as mentioned in previous sections of this study, other classifications can be utilized. The discriminant analysis shows that only 56.9% of all the cases are correctly classified. Zhang (2001) employs a different categorization and finds similar results. As a result, the empirical findings of this study show that there is still a lack of knowledge on the correct classification of payment methods. The combination of payment methods utilized by different acquirers complicates this matter significantly.
This paper has several managerial and academic implications. Firstly, it contributes to the existing literature by enriching the knowledge on the effect of financial deepening on M&A payment methods. These findings show that changes in the market do not influence the choice of payment method. Accordingly, this study shows that financial constraints on the debt market as invoked in recent years do not disrupt the M&A market. It is important to note this effect since the European financial sector is posed with harsh regulations as a result of the financial crisis. There is severe academic debate on whether the imposed legislation such as the Basel accords damage the economy. This study shows that the European legislation does not influence the M&A market and therefore does not harm the growth induced by cross-border M&As. Secondly, this study contributes to the existing literature by adding the knowledge of the European M&A market. Most studies focus on the US market. This study emphasizes the dissimilarities between the different markets and broadens the knowledge on the complex differences in the European market.
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