The impact of state ownership on post M&A financial performance of Chinese acquiring companies

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The impact of state ownership on post M&A financial performance of

Chinese acquiring companies

University of Groningen - MSc International Business and Management

Faculty of Economics and Business

Student name: Iliyan Doychinov

Student number: S2514362

Master Thesis Supervisor: Dr. M.H.F. (Maurice) Ridder de van der Schueren Co-assessor: Paulo J. Marques Morado

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Abstract

Studies provided that mergers and acquisition activities have an impact on the acquirer’s firm value but there is little information on the nature of the impact in Chinese market. Recently, the M&A in China has substantially increased with more state-owned firms acquiring cross-border and national companies. This paper attempts to identify the various reasons behind the recent M&A activities of Chinese companies (including state-owned organizations) and examine the impact on their post-acquisition financial performance and profitability. The study uses ROA approach on a sample of 708 national and cross-border acquisitions. It is found that state-owned acquirers experienced a positive performance and profitability following merged compared to other counterparts. The t-tests provided that Chinese acquirers reported a drop in performance for 2 years after the acquisition deal. The study uses accounting based approach rather than the common market measurements to arrive at the results and findings

Key words: M&A, cross-border acquisitions, national acquisitions, state-ownership, ROA,

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1. Introduction

China is regarded as one of the largest developing markets in the world where government plays a conclusive role which makes it a desirable test center to experiment the impact of state ownership on the policy and performance of companies (Batjargal et al. 2013). The concept of Mergers and Acquisitions (‘M&A’) has attracted the attention of researchers and authors in both developed and developing countries. Recently, it can be observed the volume and size of merger and acquisition activities increased substantially which highlight the importance of the activity as a mean to gain resources and organizational growth (Bowen, 2014). The ever growing M&A activities in different markets raise the question on the feasibility of such activities on the financial performance of the parties involved. Researchers and authors examine whether M&A is profitable for the organizations and results are inconclusive and controversial.

One of the factors contributing to the growth of M&A activities is the increase in takeover activities by Chinese companies in both local and international markets, exhibiting a 142 percent jump in 2015. Chinese household appliance maker ‘Haier acquiring General Electric’ and ‘China National Chemical Corporation acquired KraussMaffei’ and are some of the takeovers carried out due to increasing competition in the local markets (Bai et al, 2006). Bremmer (2010) mentioned that Chinese takeover activities indicate that over a span of 5 years (2010 to 2014), cross-border and location acquisitions by Chinese companies have increased significantly, reaching 878 deals. Though, the M&A activities are undertaken to enhance foothold in lucrative and competitive markets such as US and Europe; it is necessary to study the impact of these activities on the acquirer’s firm value. Various analysis such as event study analysisis performed examining the impact of state ownership on the change in profitability, much of these studies used ‘market measurements’. This paper attempts to the study the topic using Returns on Assets (‘ROA’) approach where the data for M&A deals in different industries of China is gathered and evaluated to examine its impact on financial performance of the acquiring firm (Berkman, Cole and Fu, 2010).

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5 | P a g e mentioned that in 2010, 80 percent of the companies in China were state-owned and most of the national takeovers are led by government controlled firms. Szamosszegi and Kyle (2011) cited that most of the takeovers by government are focused at expanding aggressively across markets while others are focused at profits, increasing efficiency, asset base and to achieve synergy. Keeping in view, the strategic value of China in financial markets, shareholders and investors could be interested in the profitability of takeover activities of state-owned acquirers. This information can help them in making better and informed investment decisions. Number of research papers explained the role of government on the M&A activities (Bai et al, 2006; Berkman, Cole and Fu, 2010; Bekaert, Campbell and Lundblad, 2005); there is little or no information on the impact of government ownership on the financial performance of M&A activities. Therefore, the second objective of this paper is to examine the impact of government ownership on the financial performance post-acquisition.

1.1. Research aim:

The main aim of this study is to examine the impact of M&A activities on the financial performance Chinese acquiring companies. The researcher further aims at studying the impact on profitability and performance post-merger.

1.2. Research question:

Research questions are formulated keeping in view the introduction and problem analysis. The following questions help to investigate whether there is a significant variation between the ROA of studied Chinese firms before and after merging and acquiring;

 Is there a significant difference between the ROA of Chinese M&A firms in the pre and

post-acquisition period?

 What is the percentage of state ownership on ROA of Chinese acquiring firms?

1.3. Significance of the study:

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6 | P a g e number of deals, target countries, industries and businesses, reasons for M&A and performance post-acquisition. Descriptive analysis is used by the researcher to explain the characteristics of the number of M&A deals. Second, the study uses accounting-based approach to evaluate the profitability of the acquiring firms. Finally, the paper concludes on the role of government ownership on the financial performance of the acquirer, post-acquisition.

After setting the overview of this paper, the researcher examines the theoretical and empirical evidences available related to the research topic. The focus is to find out the results on financial performance before and after the acquisition on both non-government and government-owned companies. The section discusses the acquisition activities undertaken, the scope and details of the deals, who were the parties involved? And what was the performance of the acquirer after the closing of the deal? Based on hypothesis, the research methodology is designed. The analysis is done based on the methodology chosen and they are presented in the result section. Finally, the conclusion sheds light on the overall outcome of the paper and recommendations to the investors and other stakeholders.

2. Literature Review

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7 | P a g e 2.1. Pre and Post M&A Corporate Performance:

The Campbell and Lundblad (2005) study demonstrates that performance measures selected for research have a great impact on the outcomes of the experiment. Some performance measures showed dynamic impact on the company’s performance before and after the M&A but other performance measures such as use of ‘debt-to-equity ratio’ showed low to no impact pre and post M&A. Researchers (such as Bai et al, 2006; Berkman, Cole and Fu, 2010) conducted study on this subject by using short term measures of stock market. Badreldin and Kalhoefer (2009) and Aggarwal abd Samwick (2003) stated that stock response after M&A declaration is considered as an important instrument in most studies to evaluate the performance of firms prior and post M&A, however contradicting results are obtained from different studies that incorporated this measure and thus it shows that a firm performance may boost or diminish after the announcement of M&A. Campa and Hernando (2006) further pointed out that such studies do not provide conclusive results on the positive or negative long term effects of M&A. The ‘Tobin-Q’is another method (Houstan

et al, 2001) that could be utilized as a substitute to evaluate the further future outcomes of M&A.

The Chinese stock markets are usually much regularized than others as special authorization is needed for buying and selling in the regional stock exchanges; permission for the stocks that cannot be bought or sold and the influence of the government on pricing the shares in the stock exchange (Abbas et al., 2014).Looking at the strong influence of the government on the stock market, (Dewenter and Malatesta, 2001) suggest that the performance of acquirer’s financial position after the mergers and acquisitions seems to be independent of the investor’s prospect as well as market variations (Knapp et al, 2005). Thus, considering these factors the study has adopted ‘Return on

Assets (ROA)’, a financial measure of company performance that is widely utilized in several

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8 | P a g e Several studies are conducted to analyze the firm performance after regional M&A’s. Akinbuli and Kelilume (2013) conducted a research to evaluate the performance of Nigerian firms post acquisition by considering the ROA of the firms ranging from year 2010-2012 coupled with a survey for gathering information. The results indicated a severe decline in both performance and productivity after acquisitions during the period. Bhabra and Huang (2013) conducted a similar research on 136 M&A Companies of Chinese stock market and concluded identical results for the year 1997 till 2007. Another study was conducted by Bertrand and Betschinger (2012) on six hundred Russian M&A’s that happened during the year 1999 till 2008 and included acquisition of two thousand companies. The study was performed by evaluating the ROA and the result suggested that more than sixty percent of the firms M&A’s result in failure.

Alger (2015) cited the results of a study conducted in Philippine banking sector and evaluated the firms’ ROA post M&A activity during 2006-2010. The study results were similar to the results of other researchers and stated that there is diminishing trend in the firms ROA. Abbas et al (2014) also conducted similar study in Pakistan by considering the fiscal information of ten banks in Pakistan ranging from year 2006 till 2011. However, unlike prior researches the result suggested that there was no impact on the fiscal performance of company’s post or pre acquisition.

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9 | P a g e There are several studies that demonstrate different reasons of declining firm performance post M&A. According to Mishra and Chandra (2010) a larger number of studies suggest that M&A destroys firm output because of expenses incurred due to elevating agency cost of acquiring and merging firms. Furthermore, Sinha and Kaushik (2010) pointed out that M&A can fail due to managers interests as managers in M&A may focus on self-interest rather than contributing towards organization goals. Such managers contribute in organization failure by declining firm performance through inefficient resource allocation within the company. The M&A process is complex thus managers may conduct fraudulent activity easily during the process resulting in declining firm performance (Ong, Teo and Teh, 2011).

Another reason of post M&A failure was pointed by Muhammad (2010) in his article. The author suggested that lack of transparency in information flow from target company to acquired company can delay work as well as result in task failures furthermore it can reduce the quality of performance thus directly leading to M&A failure. Mishra and Chanra (2010) and Lin and Boh (2012) further included that information exchange failures can increase operating costs and thus resulting in declining returns. Trivedi (2013) and Kemal (2011) also found from their research that horizontal acquisition tend to be more successful than vertical acquisition since vertical acquisition is more vulnerable to wasteful resource allocation, manager self- interest and inefficient information flow.

2.2. Government Ownership:

According to Cornett et al (2006) non-intervention and privatization of the Chinese market is a continuing process. However, the impact of the Chinese government remains momentous on the market. The government owned firms of China are the controlling firms of the Chinese open market thus the market of China is often termed as the government enterprise market. The current study will thus also evaluate the impact of Chinese state on the studied firm M&A performance.

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10 | P a g e state-owned companies. According to Liu and Wang (2013) and Bai, Jiangyong and Zhigang (2006), a number of state-owned companies lack the necessary managerial capabilities and skills required for a successful M&A which not only damages the implementation of cross-border M&A but also damages the performance of the company after the acquisition deal.

Discussing the ‘principle-principle conflict’, Berkman and Cole (2010) explained that the political decisions and motivation can create discrepancy of interest among the government, major and minor shareholders and institutions. While decision on top-managers to regular business operations, the considerations of the state are likely to conflict with the ‘profit maximizing objective’ of the shareholders. Szamosszegi and Kyle (2011) provided an example of divergence of interest between government and investors stating that Chinese Communist Party (‘CCP’) has a strong foothold in China and aims to create stability in the economy rather than increasing profits.

This is contrasting to the objective of shareholders and investors who want to invest in companies with the objective to enhance profits. Other recent studies including (Sinha and Kaushik, 2010; Bertrand and Betschinger, 2012; Campa and Hernando, 2006) also highlighted the negative role of the government ownership on the financial performance of the companies. Hoskinsson et al, (2000) mentioned in this regard that government’s objective of a welfare state may result in reducing unemployment and increasing development; in order to meet ends, government can influence the decisions related to pricing, placement and production.

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11 | P a g e can be said that steps by government such as reducing interest rates, tax rebates, providing liquidity to state-owned companies and assistance in foreign exchange improves bottom-line results.

2.3. Trends in Chinese M&A:

The data from 2004 to 2016 on the cross-border and national M&A activities undertaken in China reflects a significant growth in the acquisition activities, mainly cross-border M&A, since 2002. Same information can be viewed in the descriptive statistics estimated in the result section of this report. It offer valuable information and can be used by future resources as a point of reference on the characteristics of the data. The descriptive analysis is estimated using the financial data1_for

the period between 2004 and 2016.

2.3.1. History of M&A activities in China

The globalization activities undertaken by Chinese companies are much slower than expected. The 2004 statistical dataas mentioned byFeinberg and Gupta (2004)suggests that the size and volume of Chinese cross-border M&A activities were relatively small compare to other emerging economies such as India and South Africa. Initiatives including ‘Go Global Policy’ adopted in 1999 and the admission in the ‘World Trade Organization’ in 2001, contributed towards the growth of M&A deal by Chinese organizations (Chang, Chung and Mahmood, 2006). The figure 1 below provides the data on the volume of acquisition deals by Chinese corporation between 2004 and 2016. It can be observed that till 2011, the growth has been stable however in between 2011 and 2014, there is a jump in the number of acquisition deals carried out by Chinese firms which eventually decline in the following years. The overall pattern shows an increasing trend in the cross-border M&A deal which according to Chen, Li and Shapiro (2014) this is only the beginning of a ‘long-term trend’.

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Figure 1: Cross-border acquisitions by Chinese companies 2004-2016 (source: Chatterjee and Benerjee, 2016)

In addition to overseas acquisition, considerable growth has been observed in ‘inbound’ acquisitions, as shown in figure 2 below. Figure 2 shows that acquisitions reach the highest in 2011 to 17 deals however it wasn’t a trend and so the number of deal declined in 2012. There were number of factors as mentioned by Chatterjee and Benerjee (2013) and Khwaja and Mian (2005) that affected the Chinese economy including [1] rising cost of wages, [2] increase in capital outflow, [3] increase in inflation, [4] increase in bad debts and [5] delay in regulatory approval system. Researchers suggested that these could be the reason behind drop in M&A activities in China. In 2016, the no. of National and cross-borders acquisitions dropped in China due to sluggish economic growth. 10 6 3 9 11 11 7 17 11 13 17 15 14 0 2 4 6 8 10 12 14 16 18

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Figure 2: Inbound acquisitions by Chinese companies 2004-2016 (source: Chatterjee and Benerjee, 2016)

2.3.2. Targets in M&A activities by Chinese firms

This section looks at the target countries and sectors/industries that Chinese firms most enter and acquire to increase productivity, performance and firm value. Notably, in 2000, Chinese companies started acquiring firms in all the directions and geographic regions. The objective of the M&A was solely to increase the size of the firm however between 2004 and 2016 the focus of the companies narrow down to 32 countries (Choi, Park and Hong, 2012). Much of the narrow-down approach is a result of ‘Go Global Policy’ and the attempts made by the government to increase privatization and liberalization. The table 1 below provides the list of top ten countries2_{which are main targets}

of the Chinese firms. (He et al, 2013) mentioned that the list do not contain any under-developed country, even developing countries, are not the targets for Chinese corporate for M&A activities.

2_{Out of 32 countries} 79 68 72 94 146 218 310 178 94 129 154 _{129 113} 0 50 100 150 200 250 300 350

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Table 1:Top ten target countries of Chinese acquirers between 2004 and 2016 (source: Chatterjee and Benerjee, 2016)

Jefferson et al, (2011) documented that most of the M&A deals (both local and cross-border) in between 2004-2016 were targeted in manufacturing industry. Statistics show that the percentage change in the number of overseas acquisition deals from 2004 to 2016 in manufacturing industry was 36 percent whereas the percentage change was 49 percent in the case of national M&A activities. Much of the deals were aimed at realizing the benefits of M&A in developing the manufacturing sector of China. The second industry was ‘Finance’ followed by Real Estate and Insurance’. Khanna and Palepu (2001) mentioned that the percentage change in the number of national acquisitions in the financial sector were 21 percent whereasit was 13 percent for cross-border deals. The acquisition deals in financial industry by Chinese firms follow rapid increase in market capitalization by Chinese banks. Contrastingly, small amount of acquisition deals were undertaken in ‘Mining’ industry as shown in Figure 3 below. Chatterjee and Benerjee (2016) mentioned that Chinese companies invest heavily in sectors that contribute in natural resources and raw materials.

Country Number of acquisitions

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Figure 4: Target industries in national and cross-border acquisition deals (source: Khanna, 2016)

The figure 5 shows the target industries/sectors by private companies and state-owned companies indicating that manufacturing industry is dominant and attractive for both type of ownerships (state-owned deals 38% while private deals 40%); on the other hand, financial sector receive equal almost attention from both, state-owned 13% and private companies 12%, as mentioned by Khanna (2016). 5% 10% 10% 2% 0% 5% 36% 13% 2% 1% 5% 4% 5% 2% 1% 8% 49% 21% 1% 0% Wholesale Trade Transportation, Communications, Electric, Gas… Services Retail Trade Public Administration Mining Manufacturing Finance, Insurance and Real Estate Construction Agriculture, Forestry and Fishing

Acquisitions by Industry- (Cross Border/ National)

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Figure 4: Target industries by state-owned and private companies (source: Khanna, 2016)

2.3.3. Government ownership post M&A

In 90s, privatization of national organizations was regulated because of the severe debt crisis that affected the marketplace resulting in bankrupting number of private and state-owned companies. The crisis raised concerns over state banking system suggesting the change in the relationship between the state and its enterprises (Khanna, 2009). In 1995, the State Council of Chine introduced a policy under which large companies owned by the government were retained while small partnerships were released. Subsequently, municipalities and provincial government stepped in to increase the rate of privatization and to operate as part of the new private companies (Khawaj and Mian, 2005). The policy implementation drastically reduced the number of state-owned companies from 1.2 million to merely 468,000 in 2001. Mishra and Chandra (2010) estimated that in 2001, 80 percent of the shareholding in Chinese listed companies were either municipalities or the provincial government. Further studies indicate that by 2005 the percentage fell down to 65.9 percent while the remaining was held by private investors.

4% 8% 10% 2% 0% 3% 40% 12% 2% 1% 6% 15% 6% 2% 0% 9% 38% 13% 2% 1% Wholesale Trade Transportation, Communications, Electric, Gas… Services Retail Trade Public Administration Mining Manufacturing Finance, Insurance and Real Estate Construction Agriculture, Forestry and Fishing

Acquisition by Industry (State/ Non State Owned)

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17 | P a g e Figure 5 (below) shows the share of state-owned companies in the merger and acquisitions deals between 2004 and 2016. The figure shows that following the privatization policy, the role of government as a major shareholder dropped slowly reaching the lowest in 2012. The figure shows that in 2004, most of the acquisitions in both national and cross-border level were initiated by the government despite the fact that the total deals in 2004 were only 89 (including both national and

overseas M&A).

Figure 5: Government controlled acquisition in between 2004-2016 (source: Khanna, 2016)

The figure 5 also illustrates that the difference in the national and cross-border acquisitions where government is the controlling shareholder. It is evident that the government is more incline towards cross-border acquisitions than the national deals. The spike in the figure points out the increase in government-controlled acquisitions across China. Khanna and Palepu (2001) suggest that this could be driven by political considerations for increasing resources, technology and skills.

Ong, Teo and Teh (2011) documented that size and volume of both national and overseas merger and acquisitions deals in which the government acts as a controlling shareholders. The size of the deal is measured by the total assets acquired after the successful completion of the acquisition. The author divided the data (total of national and overseas deals) into four categories i.e. size is >€1

billion, size is >€0.75 billion, size is >€0.50 billion and size is >€0.25 billion. It can be observed

that government ownership in the acquisition deal increase with the increase in the size of the deal. The graph shows that when the size of the deal is size is >€1 billion then the government ownership is 45 percent which is 3 times more than the ownership if the size is >€0.75 billion andsize is

-

cross border

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>€0.50 billion. It can be concluded that government is more attracted in acquiring companies that

have higher total assets than others.

Figure 6: All acquisition deals where government is the major shareholder (data is divided in four total assets categories) (source: Khanna, 2016)

Rani, Yadav and Jain (2013) looked at the role of government shareholder in acquisition deals in different industries for instance the author mentioned that if government owns 66 percent of the acquisition in ‘Real Estate’ then this means that remaining is owned by private investors. It was mentioned above that manufacturing industry underwent a number of acquisitions and takeovers between 2004 and 2016 where most of the national and cross-border acquisitions happened within manufacturing industry. The same is reflected in the figure 7 below as well which shows that 40 percent of the acquisition share is with the government in deals within manufacturing industry. The figure further illustrates that 39% of the Transport, Communication, Electric and Gas deals have government as the major shareholder whereas only 19 percent of the acquisition in ‘Mining’ industry is owned by government. The figure shows that compare to other industries, Retail trade and Finance also received enormous investment from the government as they became the major shareholders in acquisition deals related to these industries (Trivedi, 2013).

0% 10% 20% 30% 40% 50% Firms > € 1 billion total assets Firms > € 0.75 billion total assets

Firms > € 0.50 billion total assets

Firms > € 0.25 billion total assets

Government ownership (in four

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Figure 7: Percentage of deals in which government is the major shareholder (source: Gu and Reed, 2016)

The above analysis pointed out that despite the fact that the role of government as a major shareholder in acquisition deals is reducing after the privatization and liberalization policy; the role of government and state-ownership remains substantial due to the overall influence of government on the market and business decisions (Gu and Reed, 2013). This clearly outlines the influential position of the government in M&A process as well as on the performance of the companies post acquisitions. Therefore, the study on the role of government is of great importance to all the stakeholders of M&A activities.

2.3.4. Performance of parties involved post M&A

Sinha and Kaushik (2010) provided that in terms of size, government-owned acquiring firms are bigger compare to private companies. The financial information offered shows that that state-owned companies have a relatively higher ROA of 8.09 percent compare to 6.86 percent of private companies. Though it has been discussed above that better financial performance of state-owned companies is due to the fact that state-owned companies receive rebates and favors from the government. It also shows that state-owned companies acquire large companies (estimated by total assets) than private companies which is not surprising as they have more liquidity and financial support from the government. It is further observed that state-owned companies target companies

40% 39% 28% 24% 19% 12% 12% 10% 8% 1% 0% 5% 10% 15% 20% 25% 30% 35% 40% 45% Manufacturing Transportation, Communications, Electric, Gas and…

Retail Trade Finance, Insurance and Real Estate Mining Wholesale Trade Agriculture Construction Services Public Administration

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20 | P a g e with lesser ROA which in line with the objective to reduce unemployment. While, private companies look at profitability than the size of the target companies. The second chapter is based on the methodology chosen to design the research strategy, collect data, analyze and present data in order to answer the research questions set out in this chapter.

2.4. Research Hypothesis:

The research hypothesis for this study is as follows;

H0: There is no impact of government ownership on the financial performance of Chinese

acquiring company

H1: There is an impact of government ownership on the financial performance of Chinese

acquiring company

2.5. Conceptual framework:

The conceptual framework for this study is as follow:

3. Data methodology

3.1. Sources of data and sample size:

In order to study the impact of different types of ownership (private and state-owned) on the financial performance of the acquirer’s company after the M&A activities, the data is collected on all the national and overseas acquisition by listed Chinese companies for the period of 2004 to 2016.The information on the number of M&A deals, target industries/sectors, and the value of the deal is obtained from the China Stock Market and Accounting Research Database (‘CSMAR’).

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21 | P a g e Based on the information, the financial information including ROA, leverage ratio and total assets is extracted which is needed to perform the bivariate tests. The population comprises of 2778 M&A deals that were reported in between 2004and 2016. However, to obtain a representation and reasonable sample size, the data was analyzed on the following criteria;

a. The data comprises of financial information two years before and two years after the M&A activity.

b. Since the data required for the analysis should be two years before therefore the statistical analysis could be performed on data between 2006-2014 (2004, 2005, 2015and 2016) data

is not included because of the previous restriction of the number of years of financial data required)

c. Due to extremely small amount of merger deals that took place during the study period therefore merger deals are ignored

d. Deals in financial sector are not taken into consideration. Due to the fact that financial companies have different nature of assets and liabilities, deals which include banks. insurance companies and financial institutions are excluded from the data

e. A deal is classified as an ‘acquisition’ if the takeover in the target is more than 10 percent therefore only such deals are taken into the sample size

f. Financial data of the acquiring company along with the profit and company information must be available at CSMAR database.

Applying the above criteria on the population reduces the size of 668 companies which construct the sample for this study. The sample data is further divided into the following subsamples:

Type of Acquisition Number of Deals

Subsample state-owned 177

Subsample non state-owned 511

Subsample national 658

Subsample cross-border 30

Main sample 688

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22 | P a g e 3.2. Research Methodology:

3.2.1. Dependent Variable:

ROA is an accounting-based measure which is used as a substitute for financial presentation of companies. Studies demonstrated that ROA can be implemented to measure the financial returns intended for a long-term analysis. The ratio is estimated by divided the net income with total assets and indicates the profits generated by the company by effectively utilizing the available resources. For the analysis, two different ROA are used: ROAbefore and ROAafter. The ROA of the acquirer

before the acquisition deal is represented as ROAbefore (used as a control variable) while the ROA

after the acquisition deal was successful closed is indicated as ROAafter. The ratio asserts that the

higher the ROA, the more efficiently management is using its asset base to generate profits. ROAafter is the average of the ROA two years after the acquisition.

The descriptive statistics of the ROAafter is estimated and presented in the table 4 below. It can be

observed that during the global financial crisis of 2008, the average ROAafter4.76 percent which is

lower when compared with the entire period of 2008-2014 of 5.22 percent. It can be seen that the ratio recovers and reaches the highest in 2009 to 7.93 percent. The lowest ROA is observed in 2013 which is 3.63 percent followed by 4.29 percent in 2012. The statistics further provided that 25th

percentile of ROA improves much faster than the 75th_{percentile indicating that underperforming}

companies recovered at a much faster rate than over-performing companies. It can be summarized that ROAafter do not exhibit a clear pattern over the years.

Year Mean Min Q1 Median Q3 Max Std

2008 4.76 -22.09 2.07 4.51 10.11 23.99 7.88 2009 7.93 -7.17 4.63 7.06 11.65 20.83 5.48 2010 5.86 -40.13 2.27 4.96 9.33 41.08 7.60 2011 5.46 -19.07 2.29 4.46 7.69 25.78 5.95 2012 4.29 -10.32 1.42 3.35 6.30 20.62 4.92 2013 3.63 -23.59 1.36 3.72 6.38 16.78 5.60 2014 6.49 -1.78 2.50 5.50 9.64 21.51 4.84 2008-2014 5.22 -40.13 2.03 4.47 7.99 41.08 6.09

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23 | P a g e 3.2.2. Independent Variable:

The independent variable in this study is the percentage of government ownership the companies that acquire target firms from different industries. (Gmelich, 2011) estimated state-owned as the percentage of government and related entities share in the total equity of the company. Due to limited data available on the ownership structure of Chinese companies within different industries, a dummy variable is created indicating whether state has a major stake in the acquiring company or not. The dummy variable indicates one if government is a major holder and 0, if otherwise. Major stakeholder in this study is the stockholder who owns more than half of the equity in the company or it’s the major shareholder estimated by the percentage of shares held.

3.2.3. Control Variable:

In order to reduce the impact of number of fact that can altogether influence the corporate’s performance creating a forged association between the multivariate analysis, this study attempts to perform analysis by controlling a certain set of factors.

a) Leverage ratio of acquiring firm:

Another important ratio is the leverage ratio which is estimated as total liabilities divided by total assets (also known as debt ratio). The ratio indicates the proportion of assets that are financed by liabilities (including debt). It offer critical information related to the capital structure3

b) Size of the firm of acquiring firm:

Feilto-Ruitz and Menundex-Requejo (2012) mentioned that organizations that have large amount of assets benefit from the concept of economies of scale and have better access to financing options which eventually enhances the performance and profit margins. Tian (2001) reported a positive relationship between size of the firm and its bottom line results. This report uses natural log of total assets as Berger and Ofek (2002) mentioned that log values have less variation than normal values.

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24 | P a g e c) Firm age of the acquiring firm:

Dewenter and Malatesta (2001) explained that firms go through a business life cycle and current state in the cycle defines the age of the firm. (Chen et al, 2014) calculated the firm age by taking the difference between the year of inception and current year. In China, generally aged firms have more government ownership therefore it is necessary to control this variable.

d) Diversification effect:

Diversification refers to the scenario where the acquiring firm takes over an unrelated business segment of the target company; for instance, an electronic company taking over a restaurant business is regarded as diversified acquisitions. Whereas, undiversified is when the acquisition is carried out in the related line. According to Tian (2001), if the first two digits of SIC of both the target firm and the acquiring firm differs then it is a diversified acquisition. Using the same method, it can be observed that the sample data for this study comprises of 350 diversified deals while the remaining are undiversified deals. Dummy variable is created for diversified indicating 1 is diversified and 0, of otherwise.

e) ROAbefore:

The ROAbefore is the return on assets estimated before the acquisition. It is same way how ROAafter

is estimated. It is added to the regression model in order to enhance the goodness of fit and to achieve a better R and adjusted R2_.

Variables Mean Min Q1 Median Q3 Max Std

Leverage ratio 0.46 0.02 0.33 0.48 0.62 1.26 0.19

SIZE (ln) 17.63 14.28 16.66 17.39 18.41 22.49 1.35

Age 10.78 0.88 7.92 10.56 14.08 35.20 4.17

ROA before 6.41 -48.52 2.90 5.56 9.52 53.57 8.69

Table 5: descriptive statistics of all control variables

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25 | P a g e shows that 75 percent of the acquiring companies have size less than €1 billion. On average the ROAbeforeis higher than ROAafter as ROAbefore is 6.41 whereas after the acquisition the average ROA

is 4.76. Thus, the introductory analysis shows that financial performance of acquiring company declines as a result of the acquisition. On average, the acquiring companies have a leverage ratio of 0.46 indicating that less than half of the assets are finance by debt.

3.2.4. Multicollinearity:

Multicollinearity is tested by estimating the Pearson correlation between all the variables. The table 6 below shows the correlation between the variables and it can be seen that the highest correlation is between the dummy variable of government ownership and size of the firm. This indicates that state-owned companies have a relatively higher size than private companies. The analysis shows that diversification is positively association with ROAafter as well as government

ownership which provides indication on the relationship between these two variables. Since the matrix doesn’t provide any strong correlation coefficient between any variable, there seems to be a problem of multicollinearity.

Variables ROA after Leverage Size Age

Dummy -State Ownership

Dummy -

Diversification ROA before

ROA after 1 Leverage -0.1232 1 Size 0 0.05 1 Age -0.07 0.14 -0.02 1 Dummy -State Ownership 0.18 0.04 0.26 -0.12 1 Dummy – Diversification 0.04 0.04 -0.05 0.08 -0.02 1 ROA before 0.21 -0.22 -0.02 -0.1 -0.01 -0.05 1

Table 6: Pearson’s correlation matrix for all the variables

3.2.5. Bivariate analysis:

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26 | P a g e samples. The results are provided in the following chapter on ‘results and findings’. In addition to this, regression analysis is also performed where ROA will regressed using ‘Ordinary Least Square

Method’ against the dummy variable of government ownership and other control variables. The

estimated regression model for national acquisitions is as follows:

ROA after = α0 + β1Dgovernment ownership + β2Ageit + β3SIZEit + β4LEVit + β5Ddiversification

+β5ROAbeforeit + ε…… Eq i

Whereas, the regression model for cross-border acquisition is as follows:

(M2) ROA after = α0 + β1Dgovernment ownership + β2Ageit + β3SIZEit + β4LEVit +β5Ddiversification

+β5ROAafter it + ε………..Eq ii

In the above equation, ROA after as discussed before represent the two years average of two years

ROA after the deal is completed and ROA before is the ROA two years prior to the deal. Age is the

difference between the date of inception and current year and size is the natural log of total assets. Lev refers to the debt ratio of the acquiring companies; D government ownership is the dummy variable

for government ownership and D diversification is the dummy variable for diversification.

4. Results and Findings:

The extracted data including the independent, dependent and control variables of study was analyzed using SPSS and results obtained are shown and discussed below;

4.1. Univariate analysis of ROA pre and post-acquisition

Under this section, the report attempts to estimate the difference between the performance measure, ROA before and after the acquisition. This is done to answer the first research question and the test used to evaluate that whether the sample means are same is ‘T-test’. The test will provide that whether the ROA is different in the two periods or same. The difference between the ROA prior and post the acquisition is estimated using the following formula;

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27 | P a g e In the above equation, ROA after is the return after the acquisition occurred whereas ROA before is the return that was encountered before acquisition occurred. The ROA difference is the variance among both returns.

The hypothesis to be tested in this section is as follows:

H0: there is no difference between the two periods (mean of the population is same)

H1: there is a difference between the two periods (mean of the population is not same)

Each set of difference is considered as one sample and therefore the hypothesis seeks to tests for

the overall population mean. Existing literature do not provide exhaustive results on the influence of acquisitions on the acquiring company’s performance which is presented in the alternative hypothesis i.e. mean of the population is either more than or less than zero. The test is first performed using the data for national and overseas acquisition. The table below shows the results for the T-tests:

F Sig. t df

Sig.

(2-tailed) Mean Difference Std. Error Difference

Subsample national Equal variances assumed 88.763 .000 3.33 658 .000 -1.31 10.18

Equal variances not assumed 5.67 30 .000 1.31 23.08

Subsample crossborder

Equal variances assumed 40.257 .003 1.87 658 .000 10.18 5.2

The above table shows that there is high dependency between ROA and national as well as cross border acquisition since the significance at two tail is lower than 0.01.

Table 7: T-test for ROA (using subsample data for national and overseas acquisitions) (using SPSS)

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28 | P a g e The results further provides that the difference is negative which means that the ROAbefore is higher

than the ROAafter regardless of whether the acquisition deal is national or overseas.

The same T-test is computed using the subsample for state-owned and private companies (the

results are presented in table 8 below). The test result shows that for private companies there is a

significant negative difference between the two periods. This implies that for firm with private ownership, the ROA reduced by 1.87 percent in two periods following the acquisition deal. On the other hand, the results provide insignificant positive difference in performance of state-owned companies, pre and post the acquisitions. Thus, the results do not provide any findings on the impact of ownership structure on the financial performance after the takeover.

F Sig. t df

Sig.

(2-tailed) Mean Difference Std. Error Difference Subsample

state-owned

Equal variances assumed 78.763 .000 3.33 187 .000 0.11 10.18

Subsample non-state-owned

Equal variances assumed 30.257 .003 1.87 187 .000 -1.84 5.2

Equal variances not assumed 4.25 521 .000 -1.84 11.72

Table 8: T-test for ROA (using subsample data for state-owned and private companies)

4.2. Multivariate analysis of ROA and state ownership

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29 | P a g e The results are difference for cross-border acquisition model as the findings indicate insignificant association between government ownership and ROA despite the fact that coefficient was positive for national deals. In addition to this, both regression models provide significant results between ROAafter and diversification as the p-value is more than the alpha value of 0.05. Similarly, for

controlled variable, size, the result shows insignificant coefficient. In contrary to this, leverage depicted a negative association with ROA at significance level of 0.01 which implies that acquiring companies that have high debt-to-asset ratio, tends to report low ROA. Finally, the ROAbefore has

positive association with ROAafter which indicates that companies having better performance

before the acquisition continue the same nature after the acquisition deal as well.

Independent variables National (M1) Cross-border (M2) Intercept 7.5152* 0.7832 Dummy government ownership 1.892* 1.188 Leverage -0.8008** 3.212 Size -0.1408 -0.0528 Age -0.0616 -0.0792 ROA after 0.1672* 0.4488* Dummy diversification effect -0.1408** 1.6632** N 658 30 Adj. R2 _0.21 _0.16

Table 8: Multivariate analysis between ROA and other variables (using Eviews)

5. Discussion

The results and findings can be summarized as follows:

First, the descriptive analysis, the researcher attempt to evaluate the characteristics of the M&A

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30 | P a g e Chinese companies targeted companies in all geographic regions until recently when the approach is narrowed down to developed countries. This is in line with King et al. (2004) that state that privatization and liberalization by the government is a step to enhance economic and social development through acquiring resources, technology and skills in both local and international markets.

Reference to the target industry, the analysis provided that most of the deals (national and cross-border) were targeted in manufacturing sector. It was found that nearly 50 percent of the acquisition and takeovers are done in manufacturing sector followed by transport industry but very less deals are completed in mining sector which is undoubtedly surprising. Considering the sharp growth in demand for natural resources coupled with the limited number of acquisition and takeovers in mining industry supports the statement of Hemerling et al (2006) that much of the data is not available. However, manufacturing and transport sector acquisitions are explainable since manufacturing requires access to resources that cannot be produced and yet essential such as packaging for a candy selling company. On the other hand, transport companies acquires due to the cost associated with acquiring license and vehicles.

The descriptive analysis further outlined that the ownership of Chinese government has dropped down tremendously in the recent years following the crisis that hit the nation in 90s. The dropped significantly affected the acquisition activities of state-owned companies in both national and cross-border markets. The results are in line with Gmelich (2011) which pointed out a decreasing trend in the acquisition activities of the Chinese government. The descriptive analysis provides critical analysis of the ROA, M&A activities in China and ownership structure thus it can be used for future exploratory studies.

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31 | P a g e deal is done. Notably, Du and Boateng (2015) used a much longer time period before and after the acquisition however their results are on accordance with this study. The decline in financial performance of these acquiring firms is often due to cultural differences and other barriers that restrict both parties from uniting completely and making most of the acquisition.

Reference to national deals, the decrease in performance after the deal is completed is in line with number of studies (Walter and Howie, 2003; Gmelich, 2011; Aivazian et al., 2001). Most of the studies, along with this study, reported that performance in most of the cases dropped after the M&A indicating that the deal didn’t aim at increasing the profits but other motives such as increasing efficiencies, asset base and coverage which are beyond the scope of this paper.

In the bivariate analysis section, the author first estimated the t-test to compare the ROA before and after the acquisition of state-owned companies. The t-test provided that the means of the sample are same i.e. there is no difference in the financial performance of state-owned companies before and after the takeover. This is in contrast to summary statistics that shows that state-owned companies generally experience a drop in profit margins following the acquisition and takeover activity. The descriptive further highlighted that government ownership factor contribute in enhancing the performance after the margin which is in line with the results of Tian (2001) which cited that government has other considerations than profit which influences the performance of the company after the deal. Thus, it is found that percentage of government ownership in Chinese acquiring companies influence the performance after the acquisition as depicted by ROA.

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32 | P a g e state-owned companies. The insignificant coefficient in case of overseas takeovers can be either because the number of deals is relatively small or the data extracted is bias. There is not much theoretical analysis available on the impact of state-ownership on the financial performance in case of overseas acquisitions. Therefore, it is recommended that future studies can narrow down the scope of analysis and study the impact of percentage of government ownership in Chinese acquiring companies on the success of M&A with respect to a particular industry. This study indicated that M&A deals are high in mining industry therefore future researchers can focus on the impact of government ownership in Chinese acquiring companies on M&A within mining industry.

The report also performed analysis by controlling different variables. For instance, when the diversification variable is controlled then the results provide significant association between ROA and diversification. The findings are line to the existing theories which assert that acquiring companies experience drop in performance if the acquisition is done in an unrelated line of business. The results of the current study propose that ‘agency problem’ do not influence the performance of the acquirer after the takeover. Though a lot of studies are conducted on the issue of agency problem, no study elaborated the effect of agency problem on national and international acquisition hence it is further recommended that future authors can conduct work on this topic.

Finally, when the control variable, leverage ratio, was controlled then the results depict that when leverage increases, ROA of acquiring companies’ decreases. The findings suggest that companies who go for long term loans to finance acquisitions and takeovers experience diminishing profit margins after the deal is completed. The results are in line with Edamura et al. (2014) and Doukas and Kan (2008). Though size and age do not have significant impact on performance but it has been observed that companies who are financial better before the acquisition are likely to perform in the same way after the acquisition.

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33 | P a g e

6. Conclusion and Limitations

This current study examines the characteristics of Chinese companies in an event of M&A while primarily focuses on the post-M&A financial performance in the light of state-ownership. The study offers that both local and international acquisitions in China are dramatically increasing with takeovers by companies including Haier, ChemChina and others in different industries and geographic regions. Despite the fact that after the introduction of ‘Go Global Policy’ and privatization in 90s, the stake of government in Chinese companies is reducing; but, even in recent times, large companies are still owned and operated by government itself. Further, Chinese government also controls much of the activities and transaction in stock market which exhibit the dominant influence of the government on corporate activities.

In contrast to previous studies that are focuses on short term market measures such as event analysis, this report uses accounting-based approach where ROA is used as a proxy for financial performance while dummy variable is created for state-ownership in Chinese listed companies. Reference to which companies comes under the umbrella of state-ownership, this report reflected on whether the company is controlled by the state or not (government as a controlling

shareholder). This implies that even in companies where government hold 35 percent of the

ownership, the firm is state-owned if it is controlled and monitored by the government. This indicates that the report used approximation for identifying state-owned companies however in future researchers can use financial information related to ownership structure to find out whether the company is government-owned or not. Precise ownership stake in the acquiring firms can give more precise results related to the influence if this stake on corporate performance.

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34 | P a g e of the resources for insignificant association hence it is recommended that future researchers can perform study on the same topic but using a more extensive data stretched over number of years.

The report finds that after the acquisition and takeover, the financial performance of companies decline, regardless of the target industry/sector/country. In both national and overseas M&A, acquiring companies report a drop in financial performance after the deal is successfully completed. This conclusion could be of interest to the investors and shareholders who can look out for other options for investing rather than investing in companies that are going for M&A.

In relation to local acquisitions, the study found that state-owned companies record a higher ROA than other counterparts. The findings outline the benefit of government as a major shareholder for the acquiring company. On the other hand, for cross-border acquisitions, the study fails to provide significant association which could be due to less number of cross-border deals or limited data reported in CSMAR database. Hence, it is recommended for future studies to study the impact on cross-border acquisition using a much extensive data than this report’s.

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35 | P a g e

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Appendix

Paired t-test ROA after< ROA before

National 49%

Cross-border 44%

State-owned 42%

Non state-owned 51%

Table I - Percentage of acquirers that have lower ROA in the period after the acquisition (2006 and 2014) Table I - Percentage of acquirers that have lower ROA in the period after the acquisition

(2006 and 2014)

The table I above shows the percentages of companies from the sample data that have lower ROA after the takeover and It can be observed that state-owned companies have the least percentage compare to private companies.

Figure IROA of state-owned companies before and after the acquisition from 2006 and 2014

Figure I above shows that on average basis ROA for state-owned companies didn’t reduce much. In case cases, the ROA reported after the acquisitions were higher than the previous one.

1,00% 8,00% 6,00% 7,00% 12,00% 9,50% 12,00% 9,00%_8,50% 5,00% 12,00% 9,00%10,00%_8,50% 5,00% 13,00% 11,00% 7,50% 0,00% 2,00% 4,00% 6,00% 8,00% 10,00% 12,00% 14,00% 2006 2007 2008 2009 2010 2011 2012 2013 2014

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40 | P a g e

Figure II ROA of private companies before and after the acquisition from 2006 and 2014

Figure II above shows that on average basis private companies experience a drop in ROA after the acquisition

Year Mean Min Q1 Median Q3 Max Std

2008 4.8136 -22.088 1.936 4.5672 10.1288 23.9888 7.964 2009 8.3864 -7.172 4.6288 7.4976 12.1968 20.8296 5.3592 2010 5.7904 -40.128 2.2704 4.928 8.8968 41.0784 7.8144 2011 5.3944 -19.0696 2.4288 4.444 7.6384 25.7752 5.94 2012 4.312 -10.3224 1.408 3.3616 6.3008 20.6184 4.9368 2013 3.476 -23.5928 1.3464 3.6784 6.204 16.7816 5.808 2014 6.5472 -1.7776 2.4728 5.5792 9.7328 21.5072 4.8664 2008-2014 5.2184 -40.128 2.0944 4.4352 7.9904 41.0784 6.1688

Table II – Statistics for national acquisitions (2008 and 2014)

The table II above shows the ROA of national acquisitions in 2008 is much lower than the ROA of the overall period.

5,50% 9,00%8,50% 7,50% 14,00% 10,00%11,00% 14,00% 10,00% 5,00% 11,00% 9,00% 5,00%6,00% 2,00% 6,00% 9,00% 8,00% 0,00% 2,00% 4,00% 6,00% 8,00% 10,00% 12,00% 14,00% 16,00%

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41 | P a g e

Year Mean Min Q1 Median Q3 Max Std

2006 2.7896 2.7896 2.7896 2.7896 2.7896 2.7896 0 2007 4.3824 -4.1976 2.8072 5.8872 7.4712 10.34 5.5088 2008 6.7936 0.9592 3.7928 7.6736 9.548 12.452 4.1184 2009 7.6208 0.9328 2.6752 6.9608 10.0936 18.5152 6.512 2010 1.7776 1.7776 1.7776 1.7776 1.7776 1.7776 0 2011 4.8048 0.9944 1.6896 5.0688 6.9696 12.4872 3.3704 2012 3.2824 3.2824 3.2824 3.2824 3.2824 3.2824 0 2006-2012 5.4032 -4.1976 1.7776 5.2536 8.2016 18.5152 4.5144

Table III – Statistics for overseas acquisitions (2008 and 2014)

The table III above shows the ROA of overseas acquisitions in 2008 is much lower than the ROA of the overall period.

Definitions of the variables

Variable Definitions

Dependent Variable

ROA after A proxy of corporate accounting profitability. It is calculated as the net profit/loss before taxes over total assets two years following

the deal.

Independent

variable

D government ownership A dummy variable of state ownership. If the government is the

controlling shareholder of the acquiring firm it takes one,

otherwise zero.

Controlling variables

Age Firm age. It is calculated by taking the difference between the

current year 2015 and the year of incorporation of the firm

LEV Leverage. It is calculated by dividing total liabilities over total

assets.

D diversification A dummy variable of diversification. If the first two digits of the acquirer's SIC differ from the target's SIC the dummy variable takes

one, otherwise zero.

SIZE Corporate size. It is calculated by taking the natural logarithm of

the total assets.

ROA before A proxy of corporate accounting profitability. It is calculated as the net profit/loss before taxes over total assets one year prior the

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The impact of state ownership on post M&A financial performance of Chinese acquiring companies