A comparison between within-border and cross-border M&As
and the effects on shareholder wealth
-Evidence from the Euronext countries-
August 2008
University of Groningen Faculty of Economics and Business MSc Business Administration: Finance Profile: Corporate Financial Management
Author: Klaas-Jan Thijs Bolhuis Aquamarijnstraat 833 9743 PX Groningen 06-12874638 Student ID: 1322168
Abstract
This study examines the shareholder wealth effects of within-border and cross-border mergers and acquisitions on bidder and target shareholders during 1997-2007. The sample consists of bidders located in one of the four Euronext countries and targets originate from all over the world. The methodology used is the event study. Target shareholders earn significantly higher abnormal returns in cross-border M&As compared to within-border M&As. No significant difference is found for bidder shareholders. Industrial diversification does not result in a significant difference between bidder and target returns. The method of payment does not lead to a significant difference in within-border and cross-border bidder returns. For the targets there is no significant difference in method of payment in within-border M&As, but in cross-border M&As there is a significant difference. A significant size effect is found in the bidder sample, for the target sample there is no such size effect found. Finally, investor protection does not result in a significant difference between bidder and target returns.
Keywords: mergers and acquisitions; within-border and cross-border M&As; event study;
industrial diversification; method of payment; size; investor protection.
TABLE OF CONTENTS 1. INTRODUCTION:... 4 2. EMPIRICAL EVIDENCE ... 6 3. THEORETICAL FRAMEWORK ... 10 3.1 Geographic diversification: ... 11 3.3 Control variables: ... 18 3.3.1 Method of payment: ... 18 3.3.2 Size:... 20 3.3.3 Investor protection: ... 23
4. DATA AND METHODOLOGY... 25
4.1 Data... 25
4.1.2. Summary Statistics:... 27
4.2 Methodology... 30
4.2.1 Structure of an event study... 30
4.2.2 Variables influencing the abnormal return... 33
4.2.3 T-test and robustness test ... 35
5. RESULTS... 37
5.1 Announcement day CARs for all bidders and targets ... 37
1. Introduction:
The World market becomes more and more integrated the last decades. Product and capital markets are more integrated and new markets emerge, as a result globalization becomes an important strategic issue for companies (Moeller and Schlingeman, 2005). Through this globalization companies not only invest in their home country, but also invest in foreign companies. The majority of M&As are concentrated in the U.S. and U.K., but since the 1990s Europe enters the M&As market.
Several economic forces influence the cross-border acquisitions in Europe. First of all, the integration of several European countries in the European Union (EU). Secondly, the establishment of the European Monetary Union (EMU) and the introduction of the euro in 1999. The third economic force is the privatization of state enterprises in many European countries, these companies become a target for domestic and foreign companies as well. Another possibility is that these companies do not want to become a target themselves and pursue aggressive growth strategies both home and abroad. There are several reasons why a company undertakes a merger or acquisition, for example: improving profitability, market access, increasing market share etc. But each merger or acquisition should create value for the bidding shareholders, otherwise it is better for the company to not undertake the merger or acquisition.
An important factor that influences the returns to shareholders is the method of payment, Bruner (2002) finds evidence that target and bidder shareholders gain more in within-border M&As if the acquisition is paid with cash than with shares. In cross-border M&As the target is frequently unwilling to accept foreign equity, which forces the acquirer to pay with cash (Gaughan, 2002). Also size is a factor that might be able to influence the announcement return to shareholders. According to Moeller et al. (2004) target shareholders show higher announcement returns if the acquirer is a large shareholder. For bidder shareholders it is the other way around. There are several studies that focus on investor protection, for example La Porta et al. (2000) and Moeller and Schlingemann (2004). La Porta et al. (2000) find evidence that efficient cross-border M&As will take place when an acquirer from a high investor protection (common law) acquirers a target from a low investor protection country (civil law).
The main focus in this study is whether there is a difference between bidder and target returns in within-border and cross-border mergers and acquisitions. Furthermore, this paper also analyzes the influences of industrial diversification, method of payment, size, and investor protection on the announcement returns for bidders and targets as well.
My sample consists of bidders originated in one of the four Euronext countries, which are Belgium, France, the Netherlands and Portugal, targets originate from all over the world. This study differs from other studies in the way that I study several countries that are integrated in a regulated market. Previous papers have not studied the Euronext countries before, so I am the first one who focuses on the Euronext countries. The M&As take place during 1997-2007, this results in a sample of 365 deals, subdivided in 197 bidders and 168 targets. The bidder (target) sample consists of 60 (53) within-border M&As and 137 (115) cross-border M&As. The event study methodology of Brown and Warner (1985) and MacKinlay (1997) is followed to study the short-term announcement effects.
country and the target in a common law country do not differ significantly from bidder returns in cross-border M&As where the bidder is located in a civil law country and target is not located in a common law country. The paper is structured as follows. Section 2 provides empirical evidence. Section 3 discusses the relevant literature and. Section 4 describes the data and methodology used. The fifth section presents and analyzes the results and section 6 ends with the conclusions and recommendations for further research.
2. Empirical evidence
Many empirical and theoretical studies focus on the announcement effect of mergers and acquisitions. Unfortunately, the cross-border M&A literature is not as large as the within-border M&A literature and relatively few studies compare within-within-border M&As with cross-border M&As. Previous studies are mostly focused on the U.S., but the empirical and theoretical literature on cross-border M&As in Europe is increasing.
Bruner (2001) concludes after summarizing 41 studies that in the aggregate, abnormal (or market-adjusted) returns to buyer shareholders from M&A activity are essentially zero. A reasonable conclusion is that buyers essentially break-even. Bruner (2001) also summarizes 21 studies which focus on returns of target companies. He concludes that target company shareholders enjoy returns that are significantly positive; they receive a premium. Bruner (2001) his evidence is only applicable to within-border M&As. The next question is: do targets also gain significantly in cross-border M&As and how do bidders perform? The previous sections show that cross-border M&As are systematically different from within-border M&As.
targets relative to those that acquire within-border targets experience significantly lower announcement stock returns of approximately one percent and significantly lower changes in operating performance. In other words, investors expect less value creation from the company’s decision to engage in a cross-border relative to a within-border acquisition even after controlling for other factors expected to affect bidder returns, but the abnormal returns earned are still positive. Bodnar (1997) finds with a multivariate test that U.S. companies with international operations have an average company value that is 2,2 percent higher than comparable companies that operate domestically. Freund et al. (2007) show for a sample of 197 U.S. companies who acquired a foreign company during the period 1985-1998 realize positive announcement returns for the bidder.
Table 1: Summary of empirical studies focusing on announcement effects for bidders and target shareholders in within and cross-border M&As
Study Country Period Sample Event
window Bidder return within-border Target return within- border Bidder return cross-border Target return cross-border Bodnar (1997)
U.S. bidder 1987-1993 2712 within-border & 1197 cross-border acquisitions
[-1,1] 2,04% 6,14%
Bruner (2001)
A survey of 21 within-border target return studies and 41 within-border bidder return studies. Bidder shareholders break-even while target shareholders earn a premium.
Campa & Hernando (2004)
European Union bidder & target
1998-2000 182 within-border & 80 cross-border mergers [-1,1] 0,61% 3,86% 0,05% 4,08% Cheng & Chan (1995) Foreign bidder & U.S. target
1985 – 1990 70 cross-border takeovers acquiring U.S. targets [-1,1] 21,80% Conn, Cosh, Guest and Hughes (2005) UK bidder and foreign target 1984-1998) 3204 within-border & 1140 cross-border acquisitions [-1,1] 0,68% 0,33% Danbolt (2004) Freund (2007) Foreign bidders and UK targets
Study Country Period Sample Event window Bidder return within-border Target return within- border Bidder return cross-border Target return cross-border Goergen & Renneboog (2004) Harris & Ravenscraft (1991) European bidder and target Foreign bidder and U.S. target
1993 – 2000 1970 – 1987 86 (85) within-border & 56 (49) cross-border bidders (targets) 1114 within-border and 159 cross-border acquisitions [-1,0] [-20,20] -0,45% 10,22% 26,33% 2,38% 11,25 39,77% Moeller and Schlingemann (2005)
U.S. bidder & foreign target
1985 - 1995 4047 within-border & 383 cross-border acquisitions
3. Theoretical framework
First of all why do mergers and acquisitions exist in the first place? The purpose of a merger is to expand the operations of the company and increase their long-term profitability, two companies are combined to achieve certain strategic issues. Usually mergers occur in a friendly setting (occurring by mutual approval) where the target company helps the acquiring company to ensure the deal will be beneficial to both parties. An acquisition on the other hand might also be a hostile takeover by purchasing the majority of outstanding shares of the target company without approval of the target company. Around a merger or acquisition announcement investors change their expectations about the future prospects. If investors expect the combined/ new company will perform better than the stand-alone company, share prices increase and the other way around if investors expect that the combined/ new company will not perform better.
According to Sudarsanam (2003) there are four perspectives why a company should undertake a merger or acquisition. The first one is the economic perspective where the main focus is to gain competitive advantage over their competitors through cost reduction or increased market power. The second perspective is the strategic perspective. Companies undertake M&As in order to develop a sustainable competitive advantage through acquiring resources and capabilities unique to a firm. The third perspective is the finance theory. According to this theory a merger or acquisition is the result of a conflict of interest among various financial claimholders of the company. A company is owned by shareholders, but is run by managers. This is commonly known as the agency model: shareholders their interest is on shareholder wealth maximization whereas managers may act in their own interest. As a result managers may undertake mergers and acquisitions which are not maximizing shareholder wealth. The fourth and last perspective is known as the managerial perspective. Roll (1986) has put forward the view that bidding managers may suffer from ‘hubris’ which motivates them to overestimate the value they can extract from acquisitions and consequently pay excessive premiums (Sudarsanam et. all., 1996). Even when a bid is value additive to their shareholders, the target management may resist the bid and mount a variety of defensive strategies to frustrate it.
a dynamic learning process and the last stream as a value creating strategy (Shimizu et al., 2004). In this study mergers and acquisitions are seen as a value creating strategy. A first question that needs to be answered is whether mergers and acquisitions do create value for bidder and/ or target shareholders. A second question is whether cross-border deals do create value for bidder and/ or target shareholders. The next subsections introduce the hypotheses and effects that can be relevant for answering these questions.
3.1 Geographic diversification:
management is not performing well and performance will improve by replacing the management, target management will be replaced. One of the most important reasons to invest in a foreign company is market access. In order to avoid trade barriers cross-border mergers and acquisitions may be motivated by a need to operate locally (Danbolt, 2004). In the late eighties and early nineties acquisitions and especially cross-border acquisitions of European countries rise to new heights. One explanation why non-Europe companies invest heavily in Europe is the passing of the Single European act in 1995 before the introduction of the single European market in 1992 (Vaconcellos and Kish, 2004). Finally, investors are willing to pay a premium for geographically well diversified portfolios, because companies can diversify internationally at a lower cost than can individuals. This premium will increase the value of the geographically diversified companies relative to that of domestic companies (Bodnar et al., 1997).
So there are several ways to create firm value by diversifying geographically. If the characteristics mentioned above are unique to a geographically diversified company and cannot be otherwise acquired by investors, than should the value of a geographically diversified company be higher than a pure domestic company to reflect these benefits. This suggests that geographically diversified companies are more valuable than pure domestic companies.
Besides the value creating possibilities, a cross-border merger or acquisition can also reduce company value. Shareholders like to see that shareholder wealth is maximized, but managers sometimes take another direction. If managers act in their own interest this may result in agency costs which can reduce shareholder wealth. Another possibility is that there are culture and tradition barriers. The process after the merger or acquisition is difficult, time consuming and expensive. Shareholders know these potential problems and returns decrease. If a market is higher integrated, the market for corporate control will be more competitive. More competition means that it is less likely that bidders earn synergistic gains, so the returns will be lower (Moeller and Schlingeman, 2005). Market access can also lead to negative abnormal returns: it may be expected that companies who do not have a foothold in another country and see entering this market as a value creating opportunity, are willing to pay a higher premium than companies who are already active in that market. This results in negative abnormal returns (Danbolt, 2004).
For within-border and cross-border bidders the following hypothesis is tested:
I expect that cross-border bidder returns differ from within-border bidder returns, because previous studies find mixed results, several studies indicate that geographically diversified companies are more valuable than pure domestic companies, where other studies find that cross-border M&As reduce company value.
After discussing the bidders I continue with the targets. If capital markets and the market for corporate control are not segmented internationally, one will not expect the level of abnormal returns to target company shareholders to be systematically different in domestic and cross-border acquisitions (Harris and Ravenscraft, 1991). However, Kang (1993) argues that the theory of foreign direct investments posits imperfections that give multinational companies a competitive advantage over local companies in the host country and cross-border acquisitions are likely to create more wealth than within-border acquisitions. Since targets tend to reap more of the benefits of the acquisitions, the theory suggests that the wealth gains to targets of foreign companies are larger than those to targets in within-border acquisitions. Danbolt (2004) finds that bidding companies who do not have a foothold in another country and see entering this market as a value creating opportunity, are willing to pay a higher premium than companies who are already active in that market. This results in positive abnormal returns for target shareholders. As with within-border M&As, cross-border M&As may not only be driven by shareholder wealth maximization objectives, but may also be a result of an agency conflict, with bidding company management aiming to maximize their own utility (Danbolt, 2004). Roll (1986) argues that bidding companies tend to overestimate the value of economic benefits of the merger in his hubris hypothesis. The target company bid premium may thus be the result of a valuation error. Cross-border companies are more difficult to value than within-border companies, due to differences in accounting standards or exchange rate fluctuations on company value. The degree of overpayment may be larger in cross-border than in within-border mergers and acquisitions (Danbolt, 2004).
For within-border and cross-border targets the following hypothesis is tested:
H2: Cross-border target returns differ significantly from within-border target returns
country. Another point is that the cross-border market becomes more competitive than the within-border market and higher premiums are paid for cross-border M&As.
.3.2 Industrial diversification:
Industrial diversification is expansion into product markets new to a firm. The evidence on the performance implications of industrial diversification is inconclusive (Hoskisson & Hitt, 1990). According to early research, industrial diversification offers several benefits, which are related to size and economies of scale/ scope and the associated pooling of risks. In addition, early industrial diversification actions frequently focus on highly related product markets (Tallman & Li, 1996). This indicates that the opportunities to extract synergies are marginal. Research suggests that companies with more narrow scope (dominant business) should be higher performers if they are able to capture potential synergies between their businesses (Geringer et al., 1989). Another benefit of industrial diversification across businesses comes from the cross-guarantee with respect to debt financing (Bodnar et al., 1997). Companies that are industrially diversified have more stable cash flows and thus have more opportunities to obtain external financing deals. This leads to an increase in leverage and greater use of tax shields that can be added to shareholder value.
Another view on industrial diversification is the focus on costs. A first cost is agency costs: industrial diversification potentially benefits corporate managers trough increased power and prestige, through compensation arrangements, or through personal risk reduction (Denis et al., 2002). A second cost is inefficient cross-subsidization of less profitable business units. Less profitable divisions being subsidized by, and at the expense of more profitable divisions. A third cost is the impact on the internal control mechanism. As companies increase their level of geographical diversification, it takes a greater amount of integration for top managers to understand the information that each subsidiary confronts in their diverse markets (Chang and Wang, 2007). If these companies are also industrially diversified, the information asymmetry problem can increase in magnitude to the extent that it becomes too costly for managers to have a proper understanding of the different business-units.
discount. Industrial diversified companies trade at a discount because their cash flows are lower or discounted at a higher rate. Doukas and Kan (2004) find that acquirers of unrelated targets experience greater excess cash flow declines and valuation discounts than acquirers involved in related acquisitions. Doukas and Kan (2004) describe a positive relationship between the cash flow declines and excess value losses following the acquisition.
For within-border M&As with or without a diversifying bidder I test the following hypothesis:
H3: Within-border bidder returns where the deal is diversifying differ significantly from
within-border bidder returns where the deal is non-diversifying
that announcement-period returns and changes in operating performance are lower for companies that increase their global, industrial, or both forms of diversification. Chang and Wang (2007) find that related product diversification positively influences the performance of multinational firms, unrelated product diversification negatively moderates the international diversification-performance relationship. Denis et al. (2002) and Fauver et al. (2004) both find that geographically and industrially diversified companies result in average valuation discounts. Campa and Kedia (2002) and Villalonga (2004a) find that diversification on average does not destroy value. These two studies are controlled for sample selection bias, which was one of the problems using the imputed value method.
I test the following hypothesis for cross-border M&As with or without a diversifying bidder:
H4: Cross-border bidder returns where the deal is diversifying differ significantly from
cross-border bidder returns where the deal is non-diversifying
Based on the findings mentioned above I expect that cross-border diversifying mergers and acquisitions differ from non-diversifying cross-border mergers and acquisitions, since most studies find a diversification discount:
Another interesting point is whether there exists a difference between within-border diversifying deals and cross-border diversifying deals:
H5: Cross-border bidder returns where the deal is diversifying differ significantly from
cross-border bidder returns where the deal is non-diversifying
A cross-border diversifying deal has to deal with the costs of coordinating corporate policies and the difficulties in monitoring managerial decision making in globally diversified firms (Denis et al., 2002). These costs are likely to be bigger for cross-border diversifying deals. Another cost that reduces bidder returns is agency costs (Roll, 1986). So I expect that cross-border bidder returns where the deal is diversifying differ from cross-cross-border bidder returns where the deal is non-diversifying
H6: Within-border target returns where the deal is diversifying differ significantly from
within-border target returns where the deal is non-diversifying
Early research indicates that industrial diversification offers several benefits to bidders, which are related to size and economies of scale/ scope and the associated pooling of risks. Bidding companies are willing to pay a higher premium for unrelated companies compared to related companies to realize the benefits of industrial diversification. This premium results in higher target returns if the bidder is an unrelated company Therefore I expect that within-border diversifying M&As differ from within-border non-diversifying M&As
For cross-border acquisitions I also expect that diversifying M&As differ from non-diversifying M&As:
H7: Cross-border target returns where the deal is diversifying differ significantly from
cross-border target returns where the deal is non-diversifying
Since bidding companies that do not have a foothold in another country and see entering this market as a value creating opportunity, are willing to pay a higher premium than companies who are already active in that market. I expect that this premium in combination with the industrial diversification premium results in a difference between cross-border and within-border returns for targets if the bidder is active in an unrelated industry:
Just like the bidders I compare cross-border target returns with within-border target returns in case of a diversifying merger or acquisition:
H8: Cross-border target returns where the deal is diversifying differ significantly from
cross-border target returns where the deal is non-diversifying
3.3 Control variables:
The two previous sections indicate that there is a difference between cross-border and within-border M&As and between related and unrelated industrial diversification. In most studies authors also distinguish company and deal characteristics that may explain why some companies earn positive returns where others earn zero or negative returns. In this section I discuss the following company and deal characteristics: method of payment, size and investor protection.
3.3.1 Method of payment:
Bouwman et al.(2003) all find that target shareholders gain more if the merger or acquisition is paid with cash than with shares.
There is also a tax argument: if the method of payment is cash, target shareholders are immediately liable to pay their taxes. Taxes are deferred if the method of payment is shares. According to Huang and Walkling (1987) the tax argument expects that M&As paid with cash result in higher returns than M&As paid with shares to compensate target shareholders for the immediate payment of taxes.
For bidding shareholders in within-border M&As I test the following hypothesis concerning M&As paid with cash or shares:
H9: Within-border bidder returns where the method of payment is cash differ
significantly from within-border bidder returns where method of payment is shares
This hypothesis can be explained with the signaling hypothesis; bidder shareholders see a merger or acquisition paid with shares as a signal that the equity is overvalued. This signal influences the bidder returns in a negative way. Bidder shareholders see a merger or acquisition paid with cash as a positive signal and influences bidder returns in a positive way. Therefore I expect that bidder returns in within-border M&As paid with cash differ from within-border M&As paid with shares.
Cross-border M&As are more difficult to value accurately because of imperfect information. According to Hansen (1987) and Moeller and Schlingemann (2005), bidders finance with shares if the asymmetric information about targets is high. In cross-border M&As the target is frequently unwilling to accept foreign equity, which forces the bidder to pay with cash (Gaughan, 2002). The positive signal from paying with cash may therefore be diminished or non-existent for cross-border transactions.
In case of cross-border M&As paid with cash or shares I test the following hypothesis concerning bidders:
H11: Cross-border bidder returns where the method of payment is cash do not differ
significantly from cross-border bidder returns where method of payment is shares
or non-existent for cross-border transactions, because targets are frequently unwilling to accept foreign equity and force the bidder to pay with cash (Gaughan, 2002).
Now I continue with the targets and start with within-border M&As paid with cash or shares:
H10: Within-border target returns where the method of payment is cash differ significantly
from within-border target returns where method of payment is shares
For targets I also expect that within-border M&As paid with cash differ from within-border M&As paid with shares. The signaling hypothesis and the tax argument both suggest that target shareholders earn higher returns if the merger or acquisition is paid with cash instead of shares.
In case of cross-border M&As paid with cash or shares I test the following hypothesis:
H12: Cross-border target returns where the method of payment is cash do not differ
significantly from cross-border target returns where method of payment is shares
For targets I expect that cross-border M&As paid with cash do not differ from cross-border M&As paid with shares. This expectation is explained in the same way as it is explained for the bidders: the positive signal from paying with cash is diminished or non-existent for cross-border transactions.
3.3.2 Size:
instead of creating value for the company, they will undertake value destroying transactions which increases their own wealth.
Moeller et al. (2004) discuss the effect of company size on the returns of bidding shareholders. They suggest the existence of a size effect in acquisition announcement returns. The announcement return for bidding shareholders is higher for small bidders compared to large bidders. This indicates that bidder returns are lower if the acquirer is a large company. Moeller et al. (2004) show that small companies are more likely to pay for acquisitions with cash than with equity. According to the signaling hypothesis mentioned in the previous chapter, M&As paid with cash result in higher returns than M&As paid with shares. Another reason which can explain the size effect is that managers of large companies may suffer from hubris, so they overpay. In particular, managers of small companies have more company ownership than large companies, which are more widely-held. Managers of large companies may be more prone to hubris, perhaps because they are more important socially, have succeeded in growing the firm, or simply face fewer obstacles in making mergers or acquisitions because their company has more resources (Moeller et al., 2004). According to Travlos (1987) companies with poor returns generally pay with equity and Myers and Majluf (1984) show that companies that issue equity signal that the market overvalues their assets in place (the equity signaling hypothesis). Large companies are more likely to be overvalued, because their equity is highly valued. Jensen (1986) argues that empire-building managements would rather make M&As than increase payouts to shareholder. In general the incentives of managers in small companies are better aligned with those of shareholders than is the case in large companies (Moeller et al., 2004).
For bidder shareholders in a within-border merger or acquisition with or without a large bidder I test the following hypothesis:
H13: Within-border bidder returns with a large bidder differ significantly from within-border
bidder returns without a large bidder
The literature indicates that large companies are more complex to manage than smaller companies. Managers of these large companies may suffer from hubris and are more interested in their own personal wealth than in creating value for the company, in such a situation they generally overpay for mergers and acquisitions. So I expect that large bidders differ from non-large bidders in within-border M&As
H14: Cross-border bidder returns with a large bidder differ significantly from cross-border
bidder returns without a large bidder
Large international companies are even more complex than pure domestic companies. If companies expand internationally it takes a greater amount of integration for top managers to understand the information that each subsidiary confronts in their market. When these companies are diversified in product markets as well, the problem of information asymmetry can be greatly magnified to the extent that it becomes too costly for executives to have an adequate understanding of various subunits. Therefore I also expect that large bidders differ from non-large bidders in cross-border M&As
Another question that needs to be answered is if cross-border bidder returns with a large bidder differ from within-border bidder returns:
H15: Cross-border bidder returns with a large bidder do not differ significantly from
within-border bidder returns with a large bidder
Within-border and cross-border large companies are both difficult to manage and in both cases it is possible that the manager suffers from hubris and overpays for the merger or acquisition. Therefore I do not expect that there is a difference between cross-border bidder M&As with large bidder and within-border M&As with a large bidder.
Having discussed the bidders I continue with that targets and I start with within-border M&As with or without a large bidder:
H16: Within-border target returns with a large bidder differ significantly from within-border
target returns without a large bidder
For targets in cross-border M&As with or without a large bidder I test the following hypothesis:
H17: Cross-border target returns with a large bidder differ significantly from cross-border
target returns without a large bidder
In cross-border M&As the situation is not different for the targets compared to within-border M&As, bidders still have to deal with managers suffering from hubris, while the incentives of smaller bidders are better aligned with the shareholders. Therefore I expect that cross-border target returns with a large bidder differ from cross-border target returns without a large bidder.
Finally I formulate a hypothesis concerning the difference between cross-border target returns with a large bidder and within-border target returns with a large bidder:
H18: Cross-border target returns with a large bidder differ significantly from within-border
target returns with a large bidder
For target shareholders I expect that cross-border M&As with a large bidder differ from within-border M&As with a large bidder. In both cases I expect that targets with a large bidder earn a premium over targets without a large bidder. But bidding companies who do not have a foothold in another country and see entering this market as a value creating opportunity, are willing to pay a higher premium than companies who are already active in that market. Within-border targets do not receive such a premium and therefore I expect that there is a difference.
3.3.3 Investor protection:
openly traded on the stock markets than in civil law countries. Poor shareholder protection countries also develop substitutes to protect their shareholders (La Porta et al., 1997). Several substitutes are concentrated ownership, legal reserve requirements or mandatory dividends. Furthermore, good accounting standards and shareholder protection measures are associated with a lower concentration of ownership, indicating that concentration is indeed a response to poor investor protection. La Porta et al. (2002) find that that companies located in countries with better investor protection have higher Tobin’s Q than do companies located in countries with inferior protection.
Investor protection is highest in English common law countries, followed by the Scandinavian, Germanic and French civil law countries. A higher Tobin’s Q is associated with more growth opportunities. La Porta et al. (2000) find evidence that efficient cross-border M&As will take place when a bidder from a high investor protection (common law) acquirers a target from a low investor protection country (civil law). Moeller and Schlingemann (2002) argue that acquisition performance may be lower in more restrictive institutional environments, because of greater asymmetric information. In a country with low shareholder protection, there are large benefits of private control and the market for corporate control does not operate freely (Rossi and Volpin, 2004).
The following hypothesis is tested concerning bidder returns in M&As with the bidder located in a civil law country and the target located in a common or a non-common law country:
H19: Bidder returns in cross-border M&As where the bidder is located in a civil law country
and the target in a common law country differ significantly from bidder returns in cross-border M&As where the bidder is located in a civil law country and target is not located in a common law country
I expect that bidder returns in cross-border M&As where the bidder is located in a civil law country and the target in a common law country differ from cross-border M&As where the bidder is located in a civil law country and target is not located in a common law country. Since shareholders in common law countries are better protected, civil law bidders have to pay a premium for this higher investor protection. Shareholders in non-common law countries are less well protected and there is no need to pay such a premium as bidders do for companies located in a common law country.
H20: Target returns in cross-border M&As where the bidder is located in a civil law country
and the target in a common law country differ significantly from target returns in cross-border M&As where the bidder is located in a civil law country and target is not located in a common law country
For targets I also expect that there is a difference in returns. Target shareholders located in a common law country are better protected than shareholder located in a non-common law country. Bidders pay a premium for targets located in a common law country compared to targets located in a non-common law country. I expect that this premiums result in a difference in returns for targets located in a common-law or targets located in a non-common law country.
4. Data and Methodology
These two sections discuss the data and methodology used. In section 3.1 the requirements for the dataset are given followed by some descriptive statistics of the sample. In section 3.2 the event study methodology is discussed.
4.1 Data
The database of Zephyr is used to come up with a sample of mergers and acquisitions. This study collects all possible information on within-border and cross-border mergers and acquisitions that are completed in the 1997-2007 period. The first step is to find all M&As that are completed in the period January 1997 till December 2007.
focuses on the Euronext countries. The NYSE Euronext offers a diverse array of financial products and services for issuers, investors and financial institutions in cash equities, options and derivatives, ETFs, bonds, market data, and commercial technology solutions (source: Euronext). The Euronext is the Eurozone’s largest cash equities market. The Euronext seeks to provide the highest levels of quality, customer choice and innovation. In principle you can expect that my results will not differ that much from previous studies concerning Europe, but it is possible that there are some deviations. At first the bidders are integrated in worlds leading marketplace and all within-border M&As occur in the same market. Bidder returns in within-border diversifying M&As are expected to result in significantly lower bidder returns than within-border non-diversifying M&As, but what if the integration process is easier since all bidders are active in the same market? Secondly, my sample consists of civil law bidders only, other studies also include common law bidders, and therefore it may be possible that the Euronext countries show different results compared to other studies, because of the strong market integration. It is not sure that these deviations occur, but it is a reason to study the Euronext countries.
I require that both the bidder and target are listed on a stock exchange. The acquired stake has to be minimal 50% with a maximum of 100%. The deal value has to be known and has to be equal or greater than one million euro’s. Finally I require that the method of payment is all cash or all shares. This results in a sample of 559 deals. Further I filter out deals where the bidder carried out multiple acquisitions within a 12-month period. In case of multiple acquisition announcements over a short period of time, it is impossible to distinguish the true effect of any of those announcements, so these deals are excluded. If a stock has more than 10% missing returns in the estimation period, or any missing return in the five day event period, the stock is eliminated from the sample. Finally I end up with 365 deals.
corresponding MSCI index. These MSCI indexes are also extracted from Datastream. Zephyr provides the country where the bidder and target are located, which is used to find out if a deal is within-border or cross-border. The industry Classification Benchmark of Zephyr is employed to classify a deal as diversifying or not. To control for size effects, the market capitalization of each company is extracted from the Datastream database. This study will not focus on the size of the target only on the size of the bidder. The reason is that I only focus on public bidders and targets, because data of private companies is hard to collect.
4.1.2. Summary Statistics:
and taken over by a company located in a common law country. While 43% of the targets are located in common law country are taken over by a civil law country.
Table 2: Sample composition of the bidders; distinguished between within-border and cross-border deals, diversification, method of payment, size and investor protection.
Total sample Diversifying Paid with cash Paid with shares Large acquirer Investor protection
Within-border bidders 60 15 43 17 7 -
Cross-border bidders 137 39 116 21 43 59
Total 197 54 159 38 50 59
Table 3: Sample composition of the targets; distinguished between within-border and cross-border deals, diversification, method of payment, size and investor protection.
Total sample Diversifying Paid with cash Paid with shares Large acquirer Investor protection
Within-border targets 53 13 32 21 7 0
Cross-border targets 115 29 92 23 23 73
Total 168 42 124 44 30 73
Table 4 and 5 divide the sample in deals per year for the bidders and the targets respectively. First of all, the average deal value of the bidder in 2000 and 2004 are relatively high compared to the other years. An explanation is that in the year 2000 the tendency of the market is high in the Euronext countries. As a result of that are share prices on the stock exchanges high. Rau and Vermaelen (1998) indicate that managers of companies with low book-to-market ratios (high market valuations) are more likely to overestimate their own abilities to manage an acquisition; these managers are more likely to be infected by hubris. When market valuations are high, managers are more likely to suffer from hubris and overpay for acquisitions. For 2004 the story is completely different, the average deal value is influenced by one acquisition with an extremely high deal value. Without this acquisition the average deal value is 375 million euro. For the target sample, the average deal values of 1998 and 2002 are high compared to the other years. Both average deal values are influenced by one large deal value. Without these high deal values the averages are both around the 600 million Euros.
not that high since market valuations are low. In the target sample the average deal value is only low for the years 2003 and 2004 (if both outliers are removed).
Fourthly, a relatively large part (32% with an average of 21%) of the acquisitions in 2000 is paid with shares. The stock exchanges are at their highest point in 2000, this means that share prices are high. So for bidders it is profitable to finance the acquisition with the overvalued equity.
Table 4: Summary statistics of the bidder and target sample divided by year
Total N Average deal value (mln EUR) Cross-border Diversifying Paid with cash Paid with shares Large acquirer Investor protection 1998 7 1796,43 5 3 4 3 2 2 1999 11 1629,95 9 3 9 2 3 3 2000 28 2793,60 23 10 19 9 7 11 2001 18 858,51 11 7 14 4 5 6 2002 31 988,83 22 6 26 5 8 7 2003 13 909,06 9 6 10 3 3 3 2004 17 3565,48 11 4 15 2 4 6 2005 25 437,32 17 3 21 4 6 7 2006 26 1512,18 18 8 23 3 7 8 2007 21 1350,70 12 4 18 3 5 6 Bidders 197 1584,20 137 54 159 38 50 59 1998 5 2398,60 3 1 2 3 1 1 1999 9 2513,04 5 0 6 3 1 3 2000 22 1506,54 17 9 16 6 5 10 2001 20 975,19 13 5 15 5 4 7 2002 19 1325,70 12 2 13 6 4 8 2003 20 385,10 14 7 15 5 3 7 2004 18 3556,34 12 5 16 2 3 8 2005 12 1132,62 8 2 9 3 2 6 2006 22 1179,40 16 5 17 5 4 10 2007 21 1357,76 15 6 15 6 3 13 Targets 168 1633,03 115 42 124 44 30 73
To better understand the location of the bidders and targets, figure 1 presents the partition sample of M&A deals by country1. The bidders originate from one of the Euronext countries, which are Belgium, France, the Netherlands, and Portugal. 60% of the bidder sample is located in France and 27% in the Netherlands, relatively few bidders are located in Belgium and Portugal, 11% and 3% respectively. The target sample originates from all over the world, with 24% of the targets located in the U.S., followed by France (21%), the UK (13%) and the Netherlands (11%). The low fraction of UK targets is a little bit surprising, Goergen and Renneboog (2004) show that most UK M&As occur in the UK itself. In their sample 63% of the within-border M&As are in the UK, while only 27,5% of M&As have a
1
target located in the UK. In Campa and Hernando (2004) their sample only 14% of the targets are located in the UK. They compare their sample with the total M&A population, proxied by the SDC M&A database and conclude that UK deals seem to be underrepresented in their sample. Since both studies only focus on Europe and this study also includes targets outside Europe, it is not necessary to worry about the low fraction of UK targets.
Figure 1: Sample composition by country
4.2 Methodology
The methodology I use in this study is the event study, which is the standard among researchers for this topic. The event study is built on the efficient market hypothesis. Systematically nonzero abnormal security returns which persist after a particular type of event are inconsistent with hypothesis that security prices adjust quickly to fully reflect new information (Brown and Warner, 1980). In addition, to the extent that the event is unanticipated, the magnitude of abnormal performance at the time the event actually occurs is a measure of the impact of that type event on the wealth of the company their shareholders. If there is any abnormal performance, this is consistent with the market efficiency hypothesis. Investors change their expectations about the future prospects of the company when the company announces a merger or acquisition. This will lead to security prices that diverge from their normal return, if the market reacts to the unexpected release of value related information. This deviation is the effect of the merger of acquisition. By using the event study methodology the methodology of Brown and Warner (1985) and MacKinlay (1997) is followed.
4.2.1 Structure of an event study
Figure 2: Structure of an event study (MacKinlay, 1997)
The event window:
The first step in the event study is to define the announcement date, which is day 0. Day 0 represents the first trading day when new acquisition information reaches the market. It is important to define day 0 accurately, because stock market reactions can be observed only to unexpected news. If this date is set after the effective information release, the market will already accommodate the shock and it will not be possible to observe the true value of the abnormal return. In this study day 0 is the announcement date provided by the Zephyr database.
After defining the announcement date, it is necessary to define the period over which the security prices of the companies involved in the sample will be examined: the event window. It is common to take an event window which is larger than the announcement date. In principal, an event window of multiple days is taken, with at least the announcement date and the day before and after the announcement. This captures the price effects of announcements which occur after the stock market closes on the announcement day (MacKinlay, 1997). The periods prior to and after the event may also be of interest. It is customary to use an event window of 3 or 5 days including the announcement day. For bidders and targets the event window is [-2, 2].
The estimation window:
Normal performance models:
According to MacKinlay (1997) there are two models to calculate the normal return of a given security: statistical and economic models. In this study the statistical model is used, because it follows from statistical assumptions concerning the behaviour of asset returns and does not depend on any economic arguments (MacKinlay, 1997). The two leading statistical models are the constant mean return and the market model. The constant mean return model is a simpler model than the market model, but according to Brown and Warner (1980, 1985) the constant mean return often yields similar results as the market model. The market model relates the return of a security to the return of a market portfolio. The advantage of the market model over the constant mean return model is that the portion of the return that is related to variation in the market returns reduces the variation of the abnormal return (MacKinlay, 1997). With this advantage there is an increased ability to find any announcement effects, so the normal return model is chosen.
The market model:
The market model is a statistical model which relates the return of any given security to the return of the market portfolio. For any security i the market model is:
it mt i i it R R =
α
+β
+ε
and t =−252,...,−2 (1) ) 0 ( it = Eε
2 ) var( i itσ
εε
=where Rit and Rmt are the period-t returns on security i and the market portfolio.
ε
it is thezero mean disturbance term.
α
i,β
i and2
i
ε
σ
are the parameters of the market model. TheMSCI Europe index is used as the market portfolio for the bidders. For the targets I use the following MSCI indexes: Europe, North-Americ, Pacific and emerging markets. These indexes correspond to the different areas the targets are located in.
mt i i it it R R AR = −
α
ˆ −β
ˆ (2)The abnormal returns must be aggregated in order to draw overall inferences for the event of interest (MacKinlay, 1997). The abnormal return of each day in the event window is aggregated to calculate the cumulative abnormal return (CAR). The CAR of company i in the sample is:
∑
= = 2 2 1 1 ) , ( τ τ τ ττ
τ
i i AR CAR (3)where
τ
1 represents the first day of the event window andτ
2 corresponds to the last day of the event window. Finally the CARs are formed security by security and then aggregated through time: ) , ( 1 ) , ( 1 2 1 2 1 τ τ τ τ∑
= = N i i CAR N CAR (4)4.2.2 Variables influencing the abnormal return
Several variables are discussed in the literature which possibly influences the abnormal returns. These variables are industrial diversification, method of payment, size and investor protection. This section discusses how these variables are measured. The correlation matrixes are provided in appendix 2 and 3 to check for multicollinearity. An implicit assumption that is made when using OLS is that the explanatory variables are not highly correlated with one another (Brooks 2002). If the explanatory variables are highly correlated with each other there is multicollinearity. If multicollinearity occurs the variable will be excluded from the OLS analysis, but this not the case.
Industrial diversification: a deal is diversifying if the first two numbers of the Industry
Method of payment: consists of cash and shares payments. Both payment methods form a
control variable. A 1 is assigned to the control variable cash if a deal is paid with cash and 0 otherwise. For the control variable shares a 1 is assigned to a deal paid with shares and 0 otherwise.
Size: is calculated with the market capitalization. Those acquiring companies with a market
capitalization above the 25th percentile of bidding companies in the sample in the year the merger or acquisition is announced are defined as large companies. And visa versa for non-large companies. If the bidder is a non-large company a 1 is assigned to the deal and a 0 for small bidders.
Investor protection: a company is classified as a common or civil law country. A 1 is
assigned to those bidders that are located in a civil law country and the target originates from a common law country and 0 otherwise. For within-border deals the variable investor protection is left out, since investor protection has no influence on within-border deals.
Testing the control variables:
The hypotheses used in this study are tested in two different ways. The first method focuses on each variable individually and tests whether the means of the subsamples differ significantly from each other. The other method is the Ordinary Least Squares regression. The CARs of bidding and target companies are regressed on the different independent variables in order to analyze the influence of these independent variables. The OLS model is one that is linear in mean and variance and requires the dependent and independent variables to be normally distributed. The OLS regression model assumes that the variance of the errors is constant, also known as homoskedasticity. If the variance of the error terms is not constant, this is called heteroskedasticity. The White test is used to test for heteroskedasticity. If the results of the White test are insignificant it is correct to use the values derived from the OLS regression. An ARCH model is used if the hypothesis of homoskedasticity is rejected. The regression model used in this study is:
ε β β β β β α + + + + + +
= oductDiversification Cash Shares Size Investor otection
4.2.3 T-test and robustness test
A t-test is used to show that the observed abnormal returns are significantly different from zero. The null hypothesis states that the merger or acquisition announcement has no impact on the distribution of the security returns. If the null hypothesis is rejected, I will conclude that the merger or acquisition announcement does carry information content and the merger or acquisition either creates or destroys company value. The formal specification of the t-test is:
0 )) , ( var( ) , ( : 2 1 2 1 2 1 =
τ
τ
τ
τ
CAR CAR CAR (5)Besides that test, I also tests whether the means of the subsamples differ significantly from each other. To compare the means of the subsamples, I use a tailed t-test. The two-tailed t-test statistic is:
0 ) )) , , ( var( )) , , ( var( ( ) , , ( ) , , ( : 2 1 2 1 2 1 2 1 2 1 = + − i i i i i i n CAR n CAR CAR CAR CAR
κ
τ
τ
κ
τ
τ
κ
τ
τ
κ
τ
τ
(6)excess returns are skewed to the right. So I choose to perform the Corrado rank test if the data in my sample is not normally distributed. The Jarque-Bera (JB) test is used to test for non-normality. Corrado (1989) describes the rank test for a one-day event window. The event window in this study is larger than one day; Cowan (1992) extends the rank test to different event windows by assuming that the daily return ranks within the window are independent. Implementing the Corrado rank test involves first transforming each security’s abnormal return into their respective ranks.
) ( it it rank AR K = t =−252,...,+2 k s N i i D K N d Z σ 2 1 1 1 0 + − =
∑
=The standard deviation σk is calculated using the entire 255-day sample period.
∑
∑
+ = − = = + − = 2 252 2 1 )) 2 1 ( 1 ( 1 t t s N i it s k D K N D σwhere d is the number of days in the event window, Ds the number of days in the sample,
5. Results
This section discusses the results of the event study. At first, section 4.1 presents information about all bidders and targets in the sample. The main question in this section is, do bidders and targets create value with a merger or acquisition. The following sections focus on the different subsamples. Section 4.2 provides information on the question if geographical diversified companies differ from non-geographical diversified companies concerning bidder and target returns. In section 4.3 the focus is on industrial diversification. Section 4.4 discusses the method of payment. Section 4.5 addresses the question if M&As made by large bidders differ from M&As made by non-large bidders regarding bidder and target returns. Section 4.6 discusses the last subsample; investor protection. A regression analysis is performed in section 4.7 in order to analyze the impact of the control variables.
5.1 Announcement day CARs for all bidders and targets
The descriptive statistics of the CAR for all bidders and targets in the sample are shown in appendix 4. For the bidder and the target sample the average cumulative abnormal returns are positive; 1,3% for the bidders and 8,1% for the targets. Goergen and Renneboog (2004) find a similar average CAR for the bidders (1,2%), but their average CAR for the targets is higher (13%). In the bidder sample result 54% of the M&As in a positive CAR, for the target sample this percentage is 67%. Campa and Hernando (2004) find similar results, 50% of the bidders show a positive CAR and 60% of the targets. The probabilities of the Jarque-Bera test for the bidders and targets are almost equal to zero, which implies that the sample is not normally distributed. Therefore it is better to use the Corrado rank test for the bidder and target sample instead of the t-test. Section 3.2.3 explains that the Corrado rank test is correctly specified no matter how skewed the cross-sectional distributions of excess returns are.
Table 5: CARs of all bidders and targets for the event days and their corresponding t-test and Corrado rank values
Bidders Targets
CAR t-test Corrado rank test CAR t-test Corrado rank test
-2 -0,001 -0,210 -0,547 0,006 0,445 2,276**
-1 -0,001 -0,246 -0,447 0,015 1,028 2,330**
0 0,008 1,707* 2,592*** 0,075 5,267*** 4,820*** 1 0,013 2,657*** 1,622 0,083 5,802*** 2,828** 2 0,013 2,646*** 1,358 0,081 5,680*** 5,018***
Table 5 presents the CARs and the corresponding test values for all bidders and targets. The Corrado rank test finds a significant announcement day effect, this indicates that bidders earn a positive CAR on the announcement day. The CAR of the other days in the event window does not differ significantly from zero, for these event days there is no value creation nor value destruction for the bidders. Targets earn positive significant CARs in the complete event window. In other words a merger or acquisition creates value for target shareholders. Campa and Hernando (2004) find a positive but insignificant CAR for the bidders and a positive and significant CAR for the targets. Goergen and Renneboog (2004) find a positive and significant CAR for bidders and targets as well. The following subsections discuss the differences between the different subsamples.
5.2 Geographical diversification
This section focuses on the geographical diversification of the bidder and the effects on bidder and target returns. The question addressed here, do cross-border mergers and acquisitions differ from within-border mergers and acquisitions concerning bidder and target return. The results are presented in table 6 and 7. At first, the bidder returns in table 6 are discussed. Appendix 5 provides the descriptive statistics for the bidder sample. Only the within-border sample is normally distributed, so only in this case it is correct to use the t-test. For the all bidders and cross-border sample it is better to use the Corrado rank test, since both samples are not normally distributed. For the sample all bidders, the CARs are not statically different from zero following the Corrado rank test. Within-border and cross-border M&As both result in positive abnormal returns. Although within-border deals are not significantly different from zero and the evidence for cross-border deals is weak. Goergen and Renneboog (2004) find similar results, although they find highly significant cross-border returns instead of weakly significant cross-border returns. Moeller and Slingemann (2005) also find that cross-border M&As result in higher CARs than within-border M&As. Further I find that cross-border deals result in higher abnormal returns than within-border deal, but this result is not significant. Campa and Hernando (2004) neither find a significant difference, only they find that within-border bidders earn higher CARs than cross-border bidders. Table 6 provides enough evidence to reject the hypothesis that cross-border mergers and acquisitions result in significantly different bidder returns than within-border mergers and acquisitions.
three samples are not normally distributed, so the Corrado rank test is used in this discussion. All the CARs are positive and statistically significant different from zero. Cross-border targets earn higher returns than within-border targets. Goergen and Renneboog (2004) find that the announcement effect for within-border and cross-border targets amounts to 10,2% and 11,3% respectively. Campa and Hernando (2004) find just like Goergen and Renneboog (2004) positive CARs for the targets, although their CARs are lower. Targets earn higher CARs in cross-border M&As than in within-border M&As. My results show that cross-border target returns differ significantly from within-border target returns. Harris and Ravenscraft (1991) find that target CARs are significantly higher in cross-border M&As than in within-border M&As. Danbolt (2004) also finds a cross-within-border effect, only her event window is [0,1] in months. The long post-event window makes it hard to compare her results with my study. My results support the hypothesis that cross-border target returns differ significantly from within-border target returns and therefore I do not reject this hypothesis.
Table 6: CARs of bidders and the corresponding t-test to test for differences
Average CAR t-test Corrado rank test Two-Tailed t-test
All 0,013 2,639*** 1,358
Within-border 0,009 1,099 -0,246 -0,446
Cross-border 0,014 2,421** 1,791*
Statistical significance at the 1%, 5%, and 10% level is denoted with ***,**,*
Table 7: CARs of targets and the corresponding t-test to test for differences
Average CAR t-test Corrado rank test Two-Tailed t-test
All 0,081 5,663*** 5,018***
Within-border 0,022 1,980* 2,415** -2,854***
Cross-border 0,108 5,468*** 4,939***
Statistical significance at the 1%, 5%, and 10% level is denoted with ***,**,*
5.3 Industrial diversification
CARs of all samples are positive, but the within-border diversifying sample is the only one that differs significantly from zero (see table 8). Although the results show that bidder returns in within-border diversifying M&As are higher than non-diversifying M&As, this difference is not significant. In section 2.2 the theory concerning industrial diversification is explained, based on this theory I expect that bidder returns in within-border diversifying M&As differ significantly from bidder returns in within-border non-diversifying M&As. The results do not provide evidence for this hypothesis, therefore I reject this hypothesis. Denis et al. (2002) do not support this finding; they find an industrial diversification discount for companies engaging in within-border M&As. Further I find that cross-border non-diversifying deals generate higher CARs than cross-border diversifying deals, just like the within-border bidder sample this difference is not significant. In other words the hypothesis that bidder returns in cross-border non-diversifying M&As differ significantly from cross-border diversifying M&As is rejected. This is consistent with the findings of Denis et al. (2002), they conclude that bidder returns in cross-border diversifying M&As are higher than cross-border non-diversifying M&As, although their finding is not significant. Subsequently I find that the CARs for within-border diversifying M&As are higher than the CARs for cross-border diversifying M&As, but this difference is not significant. The results do not coincide with my expectations, therefore I reject the hypothesis that bidder returns in cross-border diversifying M&As differ significantly from within-border diversifying M&As. Moeller and Schlingemann (2005) find similar results; they find that cross-border diversifying M&As result in lower returns than within-border M&As, but they do not test if the difference is significant.
