The effects of creditor rights on industrial and geographical diversification: A European analysis

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The effects of creditor rights on industrial

and geographical diversification: A

European analysis

Thesis

Master of Science in Business Administration Specialization Finance

University of Groningen Faculty of Economics and Business

Author: Thomas van der Leij

Student number: S156370

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Abstract

This paper investigates whether firms in countries with strong creditor rights perform more risk reducing activities measured by industrial and geographical diversified acquisitions. Using 352 completed acquisitions in 18 European countries I find that strong creditor rights induce firms to diversify, industrially as well as geographically. Furthermore, I also examine how creditor rights impact the value of these industrial and/or geographical diversifications. Based on the cumulative abnormal return over a 5-day window surrounding the announcement date, I find that creditor rights are

negatively related to the value of the diversification. This negative relationship is not found for domestic focusing acquisitions. Finally, cross-border acquisitions into countries with relatively weak creditor rights is higher valued than those acquisitions into countries with relatively strong creditor rights. The results are important for policymakers to question the effectiveness of creditor rights as it causes value reductions for firms.

JEL-classification G18, G32, G34, G38

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I. Introduction

Strong creditor rights might induce firms to engage in risk-reducing activities such as diversification strategies. When firms choose to diversify, we would expect that these firms have estimated that the benefits of diversification outweigh the costs of

diversification. Otherwise, the diversification results in a value reduction which is harmful for the firm and its stakeholders. Academics, however, investigated that industrial diversification is often related to a value discount. Denis, Denis and Yost (2002) discuss the value effects of industrial diversification compared to focusing firms and found support for the diversification discount for US bidders. For geographical diversification the empirical evidence is more ambiguous but there is, however, a small tendency towards a value discount for geographical diversification. But the debate is not over yet. Most research papers who have found a value discount for industrial and geographical diversification claim that the agency theory and the inefficient resource allocation theory explain why there is a diversification discount. Diversified firms are, according to these academics, complex entities who cannot cope with the manager versus shareholder relationship, i.e. the agency problem, and that these managers also cannot cope with the decisions to allocate the firm’s resources among the

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applied by academics to investigate the value effects of industrial and geographical diversification. To contribute to the industrial and geographical diversification literature, I add the creditor rights index, pioneered by La Porta, de Silanes, Shleifer, and Vishny (1997) and updated by Djankov (2007), as an additional explanation for the

diversification discount.

The aim of this paper is to investigate whether creditor rights induce firms to industrially and/or geographically diversify. Enacting creditor rights causes firms to lower their risk-level to prevent the firm from facing financial distress which is unfavorable when strong creditor rights prevail. Industrial and/or geographical diversification is one of the

possibilities to lower their firm’s risk-level. Research on the effects of creditor rights on corporate diversification decisions is scarce and therefore, I investigate the effects of creditor rights on the diversification decision. This is the first paper discussing the propensity and value effects on industrial and/or geographical diversifications for a sample of European countries.

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firms are more likely to diversify if there are strong creditor rights in their country and at the same time these diversifications are often associated with value reductions. Creditor rights’ objective to temper risk-behavior within firm ultimately results in engaging in value-reducing corporate activities. Therefore, we expect an increased likelihood of industrial and/or geographical diversification when strong creditor rights are prevailing in a country. I use a dataset of 352 acquisitions in 18 European countries in 2005. From these 352 acquisitions, 103 (29%) are industrial diversifications, 133 (38%) are

geographical diversifications and 33 (9%) are industrial as well as geographical

diversifications.1_{. The 103 industrial diversification can be divided into two subgroups,} the domestic industrial diversification with 70 (19,9%) observations and the industrial diversification abroad accounting for 33 (9,4%) of the observations. The 133

geographical diversification can be divided into two subgroups as well, the same-industry geographical diversification with 100 (28,4%) observations and the industrially and geographically diversifications with 33 (9,4%) observations. The divisions are made to control for the multi-segment multi-country firms which are included in both types of diversification. The last group is the domestic focusing acquisitions which consists of 149 (42,3%) of the sample. The results in the paper indeed support the idea of an increased likelihood of industrial and/or geographical diversification when a country has strong creditor rights. Furthermore, I study how these industrial and/or geographical

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abnormal return for firms engaging in industrial and geographical diversification. This is in line with the results of similar papers. As discussed above, diversifications, whether industrial, geographically or both, are related to value discounts due to agency problems and resource misallocations. As we hypothesize that creditor rights induce firms to diversify, we expect to find a negative relationship between creditor rights and firm value for diversification strategies. If the objective of creditor rights is to reduce risk in firm’s investment policies, it succeeds in targeting its objective. The accompanying value reductions which are associated with industrial and geographical diversification,

however, are the dark side of the role of creditor rights. Therefore, it is important for policy makers to investigate the effects of creditor rights on firm’s investment policies to see whether the objectives are maintained. A large body of the literature includes only US bidders and looks at the reasons why the diversification discount appears. My contribution is the addition of the role of creditor rights into the field of the diversification discount.

In addition, I investigate the differences between acquisitions in target countries with relatively low creditor rights and acquisitions in target countries with relatively strong creditor rights compared to the bidder’s firm country. I run multiple regression analysis for geographical diversification in countries with relatively weak creditor rights

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shareholder of bidder firms needs to be compensated for a higher likelihood of expropriation from the managers of the target firms as there is less monitoring from creditors. This result is also supported by Collins, Hagendorf, and Keasey (2008) who find similar results for banking acquisitions in Europe and the US.

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2. Literature review

In this section I present the empirical evidence of previous literature regarding the value effects of diversifications. I start with a timeline in which I discuss the value effects of diversifications empirically found in the last couple of decades. Then I present the empirical evidence regarding geographical diversification. The literature regarding the value effects of geographical diversifications is very limited and mainly started in the 21st century. Third, I present the concept of creditor rights and how it is related to industrial and geographical diversification. I finish this section with an empirical overview of the value effects of firms diversifying into countries with different creditor rights levels.

2.1 Trends in the value of diversifications over time

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contributed to overinvestment in industries with low investment opportunities and cross-subsidization between weak-performing segments and strong-performing segments of the firm which is known as the cross-subsidization hypothesis. This article was written in 1995 when the emphasis was on the costs of diversification. In the 1970s and 1980s, there was still evidence that diversification was a success story. Weston (1970) was one of the first to address that conglomerates benefit from a large internal capital market. Myers (1977) and Stulz (1990) support the benefits of a large internal capital market and conclude that conglomerates indeed invest more in positive net present value projects than specialized firms. Capital markets were less-developed in the 1960s and 1970s compared to the beginning of the 21st_{century and therefore, the} benefits of a larger internal capital market should be of a smaller magnitude nowadays. The idea of a large internal capital market is in the literature known as the internal capital market theory. With well-developed capital markets we would expect a negative relationship with the value of the acquisitions. The articles also address the increased debt capacity of the large diversified firms as a benefit of diversification. These

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Besides the potential benefits of industrial diversification there is one large cost for the multi-segment firm: agency problems2_{. The more segments a firm has the more complex} the operating structure of the firm will be which, in turn, increases the likelihood of inefficient resource allocation, according to Scharfstein (1998) and Rajan, Servaes, and Zingales (2000)3_{. The agency theory and inefficient resource allocation hypothesis are} widely used to address the diversification discount.

Kaplan and Weisbach (1992) investigate divestures completed in the 1980s and,

although, diversifying acquisitions are four times more likely to divested, the authors do not find strong evidence that these diversifications are less successful than their

focusing counterparts. There is, however, a value discount for the diversifying

acquisitions. Although the majority agrees that there exists a diversification discount, there are also authors claiming that there is no diversification discount or they conclude that there is a diversification premium. Villalonga (2004) and Campa and Kedia (2002), address the endogeneity problem which means that the choice to diversify lies within the model. Using econometrically advanced methods they conclude that by controlling for endogeneity, the diversification discount disappears. However, after their

contribution that there is no diversification discount, Ammann, Hoechle, and Schmid (2011) also address the endogenous nature of the corporate diversification decision and concluded that even by controlling for endogeneity there is still a diversification

2_{Other papers who addresses the agency theory hypothesis to investigate the diversification discount are} Anderson, Bates, Bizjak, and Lemmon (1998) and Palia (1999)

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discount. This, in addition to Laeven and Levine (2007) and Schmid and Walter (2009), whose research also support the existence of a diversification discount4_.

Table I. Overview of recent literature regarding the value of industrially and geographically diversified firms.

Study Country Period Theory / Geographical/ Diversification

Acquirer Method Industrial Discount/premium

Kaplan and US 1971-1982 Divestures Industrial Discount

Weisbach (1992)

Lins and EU, US, 1992-1994 Agency theory Industrial Discount Servaes (1999) Japan

Hadlock, Ryngaert, US 1983-1994 Agency theory Industrial Premium and Thomas (2001)

Dennis, Dennis and US 1984-1997 Agency theory Both Industrial discount/

Yost (2002) Geographical discount

Bodnar, Tang, and US 1984-1998 Firm size Geographical Premium Weintrop (2003)

Villalonga (2004) 1978-1997 Endogeneity Industrial None

Dos Santos, Errunza, US 1990-2000 Valuation of Both Industrial discount/

and Miller (2008) target Geographical premium

Kim and Mathur (2008) US 1990-1998 Agency theory Both Industrial discount/

Geographical discount

Francis, Hasan, US 1990s-2000s Financial market Geographical Premium

and Sun (2008) Integration

Amman et al. (2008) US 1985-2005 Endogeneity Industrial Discount Acharya et al. (2009) World 1994-2004 Creditor rights Industrial Discount

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2.2 Geographical diversification

The previous discussion only included the evidence regarding industrial diversification. The literature regarding geographical diversification is more ambiguous and still limited. Geographical diversification is nowadays supported by the idea of opening markets and globalization. Due to the rise of internet, consumers are able to buy products worldwide and developing economies provide the investment opportunities for geographical diversification. On the other hand, this fierce global competition gives rise to the view of less industrial diversification as firms are forced into more focusing strategies, according to Dennis et al. (2002). The authors observe that there is a sharp rise in the number of geographical diversifications in the 1990s. The fraction of geographical diversified firms in their sample grew from 29% at the beginning to 45% at the end. These geographically diversified firms, however, are traded at a discount compared to domestic focusing firms. Geographically diversified firms gain in excess value when reducing their global activities. The value discount for geographically diversified firms is less than for

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excess of $40mln. According to Bodnar et al. (2003), the differences in the outcomes results from this firm size proxy. Francis et al. (2008) support also the idea of a value premium for geographical diversification. The sample includes only US bidders and the value premium is driven by a low cost of capital of the bidder. They also state that this value premium did not exist at the beginning of the 1990s. During that period there was still a value discount for geographical diversification and it changed towards a value premium during the mid-1990s. Dos Santos et al. (2008) not only investigate the value of industrial diversification but also studied geographical diversification for US bidders. Unlike the industrial diversification discount, they find a value premium for geographical diversification. However, when US bidders acquired an unrelated cross-border firm, it results in a value discount.5_{It is not the intention of this paper to discuss what the} benefits and costs are and how they affect value but to give the reader a brief understanding what they are, I list them in the table below.

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Table II Benefits and costs of geographical diversification

Benefits of geographical diversification

1. They can lower their tax ability by shifting operations to countries with the lowest taxes 2. Raise capital in markets with the lowest costs

3. Large geographically diversified firms can usually invest at a lower cost than investors and therefore, shareholders reward these firms with a premium

4. It reduces the overall firm’s risk-level

Costs of geographical diversification

1. Due to complexity these firms have high-cost of coordinating operations (agency theory)

2. Inefficient cross-subsidization of weak performing divisions by strong performing divisions (cross-subsidization theory)

Now I have given a brief overview of the diversification discount for industrially as well as geographically diversified firms, I continue with the role of creditor rights and its effect on the value of corporate acquisitions. This section also includes the propensity effects of creditor rights on the diversification decision.

2.3 Creditor rights

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expenditures and corporate diversification. According to Acharya et al. (2011), strong creditor rights induce firms to engage in diversifying acquisitions. It is previously mentioned, however, that these diversifying acquisitions are harmful for the

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to engage in corporate diversification. Acharya et al. (2011) use probit models to test for the propensity effects of creditor rights on corporate diversification. In their research paper they included 38 countries from 1994-2004 and they find that firms residing in countries with strong creditor rights are more likely to engage in industrial

diversification than in focusing acquisitions. In addition, they also provide evidence that creditor rights have a negative impact on firm value, i.e. there is a diversification

discount. They only tested the value for industrial diversification. The value effects of creditor rights on geographical diversification were not included in their research. The implementation of creditor rights is on the one side a positive contribution to prevent executives and management from taking excessive risk or expropriating firms’ assets but on the other side, which is known as the dark side of creditor rights, it reduces firm value by engaging in diversifying acquisitions. This can be explained by a simple pricing model such as the CAPM where risk and return are positively related due to investors who require a higher return when risk increases. If, for example, a firm engages in an industrial and/or geographical diversification and lowers the firm’s overall risk-level its required rate of return will drop or else it would be a money tree. And there are still no free lunches. The propensity effect of creditor rights on geographical diversification is negative as well, implying that strong creditor rights induce firms to engage in

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2.4 Cross-border acquisitions in countries with different creditor rights levels

John, Freund, Nguyen, and Vasudevan (2010) study the effects of investor protection in target countries on the value of bidders in cross-border acquisitions, both private and public targets, during a 5-day window period surrounding the announcement date. They support the view that relatively strong creditor rights compared to the US are negatively related with firm value for US bidders. Again, the authors only include US bidders. The results apply for private bidders as well as for public bidders. The lower CAR for bidders can be explained by the higher valuations of target firms in countries with stronger creditor rights. Due to better control of the creditors the firm’s operations are under more scrutiny than in case of weak creditor rights which provides less risks for

shareholders and hence, shareholders will agree with less compensation. In a paper by Collins et al. (2008), the same results are found for banking acquisitions in the EU and US. They argue, that the higher abnormal returns for bidders in target countries with relatively low creditor rights is needed because there is a higher likelihood of

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3. Hypotheses

In the previous section, I have already outlined the theoretical background of the independent variable, creditor rights, and the effect on the value of acquisitions. In this section, I outline the hypotheses following from the theoretical background. First of all, strong creditor rights induce managers to engage in risk-reducing opportunities to prevent financial distress. By engaging in diversifications, the bidder is spreading its idiosyncratic risk but at the cost of a lower return. Acharya et al. (2011) examines the propensity effect of creditor rights of acquisitions for countries all over the world using probit models and find that creditor rights are negatively related with same-industry and country acquisitions indicating that there is a lower likelihood of same-industry and same-country acquisitions when the bidder’s country has strong creditor rights. This hypothesis will be tested with industrial diversifications and with

geographical diversifications. The criterion for industrial diversification is a difference at the 2-digit SIC-code. To test the geographical acquisitions, I include cross-border

acquisitions. Hence, our first two hypotheses are that firms residing in countries with strong creditor rights are more likely to engage in diversifying acquisitions,

geographically or industrially.

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Hypotheses Ib: Firms residing in countries with strong creditor rights are more likely to engage in geographical diversification than firms in countries with weak creditor rights.

Although, we expect to see more diversifying acquisitions made by firms in countries with strong creditor rights (hypotheses Ia and Ib), we hypothesize that diversifying acquisitions, whether geographically or industrially, are valued less than domestic focusing acquisitions.

Hypotheses IIa: Creditor rights are negatively related with the value of industrially diversified firms.

Hypotheses IIb: Creditor rights are negatively related with the value of geographically diversified firms.

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creditor rights index. The objective of hypotheses IIa and IIb is a follow-up of hypotheses Ia and Ib to study, if strong creditor rights induce firms to diversify, the value effects of these diversifications. Firms are not prohibited by strong creditor rights to engage in focusing acquisitions. There is only a higher likelihood of engaging in diversifying acquisitions and therefore, investors do not interpret a diversifying acquisition

announcement differently for firms in weak creditor rights countries and strong creditor rights countries. Hence, the literature regarding the diversification discount is still valuable to explain why we expect a negative relationship between creditor rights and firm value. Dennis et al. (2002) find valuation discounts for industrially and

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Stulz (2011), however, find no relationship between creditor rights and the abnormal returns of the acquirer. The majority of the literature find a value reduction for diversified firms, whether they were geographical and/ or industrial. Hence, as we hypothesized earlier, strong creditor rights are more likely to induce diversification and diversification is empirically tested as a value-reducing activity, thus we expect to find a negative link between creditor rights and firm value.

For the last hypotheses, I split up the sample of cross-border acquisitions into two subsamples. The first consists of firms diversifying into countries with relatively weak creditor rights and the second subsample consists of firm diversifying into countries with relatively strong creditor rights. John et al. (2010) argue that firms in countries with relatively strong creditor rights are more likely to raise funds through bank borrowing and as a result, shareholders are better protected by monitoring of these banks. Hence, the firm is higher valued which leads to lower returns for bidder firm’s shareholders. In addition, as earlier mentioned in section 2.4, Collins et al. (2007) show that the higher abnormal returns for bidders in target countries with relatively low creditor rights is needed because there is a higher likelihood of expropriation by insiders in countries with weak investor protection. They also point out, that there is a more competitive bidding environment in target countries with a strong investor protection environment. Due to this fiercer competition, bidders will outbid their opponents with a higher price than in a situation without fierce bidding competition. There is also some evidence that the results are ambiguous. Gande, Schenzler, and Senbet (2009) concludes that

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diversification into a target country with weaker creditor rights. The authors argue that the higher valuation for diversifications into strong creditor rights countries is caused by improved borrowing contracts. As the literature regarding this topic is scarce, I use related topics to formulize my hypothesis. There is a wider range of literature regarding corporate governance and protection measures to study the effect on the value of mergers and acquisitions. One commonly accepted statement is that better corporate governance and protection is related to higher firm value in these countries. Gompers (2003), examines firm value for firms with high shareholder protection using the G-index(index to measure shareholder protection using 24 criteria) and concludes that firms with strong shareholder protection is related to higher firm value which indicates a lower return for bidder firms. Therefore, foreign bidders will gain less because of the higher price they have to pay for the higher valued firm in the country with better corporate governance and protection. Therefore, I hypothesize that bidders will realize higher abnormal returns when they acquire targets in countries with relatively low creditor rights compared to acquisitions in target countries with relatively strong creditor rights. Thus, diversification into countries with relatively weak creditor rights results in a higher value than diversifications into countries with relatively strong creditor rights.

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4. Data and methodology

4.1 Data

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observations. The divisions are made to control for the multi-segment multi-country firms which are included in both types of diversification. The last group is the domestic focusing acquisitions which consists of 149 (42,3%) of the sample. Due to a few outliers, the data is winsorized at the 95% level. Now I move on to the description of the

variables.

Creditor rights

The data for the independent variable creditor rights is provided by Djankov, McLiesh, and Shleifer (2007). The variable creditor rights (CRIGHTS) is an index based on four criteria:

1. whether there are restrictions, such as creditor consent, when a debtor files for reorganization

2. whether secured creditors are able to seize their collateral after the petition for reorganization is approved, that is, whether there is no automatic stay or asset freeze imposed by the court

3. whether secured creditors are paid first out of the proceeds of liquidating a bankrupt firm

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For every criterion available, 1 point will be added, hence, the lowest score is zero (if none of the criteria is observed) and the highest score is 4 (if all criteria are observed). When the index is zero it means that a country has weak creditor rights and the

opposite is true for a creditor rights index score of 4: strong creditor rights. This method is constructed by La Porta et al. (1997). The creditor rights index for each country in my sample is presented in table V.

Dependent variable

In the probit regressions, the dummy variable equals 1 if it is a same-industry acquisition and zero otherwise for the industrial diversification probit regression and the dummy variable equals 1 if it is a same-country acquisition and zero otherwise for the

geographical diversification probit regression. Data for industrial and geographical diversification is available on Zephyr.

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Control variables

To control for other factors influencing the propensity and value effects on acquisitions, I include several country- and firm-level variables. The first control variable is the

shareholder rights index. Data on shareholder protection is provided in an article by Djankov, LaPorta, de Silanes, and Schleifer (2008). The shareholder rights index is also known as the anti-director rights index (ADRI). The ADRI measures the legal protection provided to minority shareholders against the self-dealing behavior of managers. This index consists of several components and for each component observed there will be one point added to the index. The ADRI ranges from a minimum of zero (weak

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Table III Description of the revised anti-director rights index7

This table describes the revised anti-director rights index and its components. The source of the data is the commercial laws of the various countries.

Vote by mail Equals one if the law explicitly mandates or sets as a default rule that: (a) proxy solicitations paid by the company include a proxy form allowing shareholders to vote on the items on the agenda; or (b) a proxy form to vote on the items on the agenda accompanies the notice to the meeting; or (c) shareholders vote by mail on the items on the agenda (i.e., postal ballot); and zero otherwise.

Shares not deposited Equals one if the law does not require or permit companies to require shareholders to deposit with the company or another firm any of their shares prior to a general shareholders meeting.

Cumulative voting Equals one if the law explicitly mandates or sets as a default rule that shareholders owning 10% or less of the capital can cast all their votes for one board of directors or supervisory board candidate (cumulative voting) or if the law explicitly mandates or sets as a default rule a mechanism of proportional representation in the board of directors or supervisory board by which shareholders owning 10% or less of the capital stock can name a proportional number

of directors to the board, and zero otherwise.

Oppressed minority Index of the difficulty faced by (minority) shareholders owning 10% or less of the capital stock in challenging (i.e., by either seeking damages or having the transaction rescinded) resolutions that benefit controlling shareholders and damage the company. Equals one if minority shareholders can challenge a resolution of both the

shareholders and the board (of directors or, if available, of supervisors) if it is unfair, prejudicial, oppressive, or abusive; equals one-half if shareholders are able to challenge either a resolution of the shareholders or of the board (of directors or, if available, of supervisors) if it is unfair, prejudicial, or oppressive; equals zero otherwise.

Pre-emptive rights Equals one when the law or listing rules explicitly mandate or set as a default rule that shareholders hold the first opportunity to buy new issues of stock; equals zero otherwise.

Capital to call a meeting The minimum percentage of share capital [or voting power] that the law mandates or sets as a default rule as entitling a single shareholder to call a shareholders’ meeting (directly or through the court). Equals one when capital to call a meeting is less than or equal to 10% and zero otherwise.

Anti-director rights index Aggregate index of shareholder rights. The index is formed by summing: (1) vote by mail; (2) shares not deposited; (3) cumulative voting; (4) oppressed minority; (5) pre-emptive rights; and (6) capital to call a meeting.

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determinant of creditor rights which was also mentioned in La Porta et al. (1998). Furthermore, they mention that common law countries have stronger creditor rights than French civil law countries. The UK has indeed the maximum score for creditor rights, leaving all civil law countries behind them. Ireland, however, with its common law does not have strong creditor rights. In addition, the only countries that score the maximum in the creditor rights index are common law countries. Another control variable is the Log average real GDP-per-capita of each country to proxy the level of economic development as different levels of development may have different

investment opportunities. The data for GDP-per-capita is available in the database from the European Union. Furthermore, I include the natural logarithm of the market

capitalization of each country: Log Market Cap. This measure is often used in the literature to proxy for the development of capital markets. If capital markets are well-developed there is less necessity for borrowing and hence, creditor rights will be less effective than in countries with less developed capital markets. Log MarketCap is calculated as the average market capitalization of the major stock index in a country during the period 2003-2005. The last country-level control variable is macroeconomic risk, measured as the standard deviation of the quarterly growth in real industrial production for each country in the period 2000-2005 which measures the risk all firms experience when operating in a country. High macroeconomic risk will induce firms to diversify. To mitigate macroeconomic risk, we would expect to find that high

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natural logarithm of the total assets of a firm as a proxy for firm size. According to Moeller et al. (2004), smaller firms gain more from domestic acquisitions than larger firms. There gain is on average 2% larger. Leverage, measured as net debt-to-total assets, is included to control for the capital structure of a firm. Highly leveraged firms are more likely to run into financial distress and to prevent the firm from facing bankruptcy, these firms are more likely to engage in risk-reducing activities such as diversification. EBITDA/sales and ROA are two proxies for operating performance before the announcement date. Hence, we can control for value effects that are caused by weak performance of the bidder.

4.2Methodology

For the first set of tests, I use probit regressions to test for a higher likelihood of industrial and geographical diversifications if acquiring firms are located in countries with strong creditor rights. Acharya et al. (2009) estimate a probit regression for the propensity to industrially diversify using creditor rights as independent variable. I use a dummy variable in the probit regressions which equals 1 if it is a same-industry

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Diversificationc = β0 + β1*CRIGHTS + β2*SRIGHTS + β3*Log(marketcap) + β4*Log(GDP) + β5*LO + β6*MacroRisk + β7*Leverage + β8*LogAssets + β9*EBITDA/Sales + β10*ROA (1)

Variable definitions can be found in table IV.

The equation above is also used for the probit regression where we estimate the propensity effect of creditor rights on geographical diversification (hypothesis Ib).

The equation is similar for both probit regression, but the dependent variable in the first probit regression refers to industrial diversification and in the second probit regression it refers to geographical diversification. The independent variable and all the control variables are the same in both probit models.

According to the theory, we should expect a negative estimated coefficient for the creditor rights index which would indicate that bidders are induced to diversify when located in a country with strong creditor rights. The opposite is true for shareholder rights. Here we expect to find a positive coefficient as shareholders demand the highest return possible for their investment and diversifying acquisitions are often associated with a greater value loss for the shareholders of bidders compared to focusing

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Table IV Variable definitions Dependent variable

Cumulative abnormal return The cumulative abnormal return is calculated over a 5-day window surrounding the announcement date. The local market index’ return is subtracted from the firm’s return (daily). The abnormal returns are then cumulated for the 5-day window period. Source: Datastream

Independent variable

Creditor rights An index aggregating creditor rights, following La Porta et al. (1998). It is the sum of the four indexes that follow. CRIGHTS then ranges between 0 and 4. Source: Djankov et al. (2007)

Control variables

Shareholder rights An index that aggregates shareholder rights. “The index is formed by adding one when: (1) the country allows shareholders to mail their proxy vote to the firm, (2) shareholders are not required to deposit their shares prior to the general shareholders’ meeting, (3) cumulative voting or proportional representation of minorities in the board of directors is allowed, (4) an oppressed minorities mechanism is in place, (5) the minimum percentage of share capital that entitles a shareholder to call for an extraordinary shareholders’ meeting is less than or equal to 10 percent (the sample median), or (6) shareholders have preemptive rights that can be waived only by a shareholders’ vote. The index ranges from zero to six.” Source: Djankov et al. (2008) Legal origin A dummy variable that identifies the legal origin of the Company law

or Commercial Code of each country. The detailed origins are common law and civil law. Source: La Porta et al.(1998)

Macroeconomic risk The standard deviation of the quarterly growth in real industrial production for each country in the period 2000-2005. Source: Eurostat Log Market capitalization The natural logarithm of the stock market capitalizations in U.S. dollars

in 2004. Source: www.nationmaster.com

Log GDP-per-capita The natural logarithm of the average real GDP per capita in euros, 2001-2005. Source: Eurostat

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Table IV (continued)

Leverage Ratio of total debt to total assets in book value. Debt is total liabilities minus equity and minus deferred taxes. Source: Datastream

EBITDA/Sales EBITDA/Sales. Source: Datastream

Log total assets The natural logarithm of the firms book value of assets. Source: Datastream

4.2.1 Value effects of creditor rights on diversification

To test for the value effect of creditor rights, I use OLS (Ordinary Least Squares) multiple regression analysis. The dependent variable is the cumulative abnormal return (CAR) as explained in the data section. The independent variable is creditor rights. The control variables are SRIGHTS, legal origin, LogGDP, macrorisk, LogMarketCap, LogAssets, leverage, EBITDA/Sales and ROA. I use this equation to examine the direct impact of creditor rights on the value of industrial and/or geographical diversification. In my research, the emphasis is on the direct value impact of creditor rights on each group. Therefore, the following equation estimates the value effects of creditor rights and its control variables on diversification, geographically and/or industrially (hypothesis II):

CARc = β0 + β1*CRIGHTS + β2*SRIGHTS + β3*Log(marketcap) + β4*Log(GDP) + β5*LO + β6*MacroRisk + β7*Leverage + β8*LogAssets + β9*EBITDA/Sales + β10*ROA (2)

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I estimate this equation for a series of subsamples to search for different effects among the subsamples. First, I run multiple regressions for three subsamples, the first is the entire cross-border sample (133), and the second is the entire industrial diversification subsample (103). For the second subsample we expect a negative coefficient for CRIGHTS, and for the last subsample we expect a negative coefficient for CRIGHTS as well. To further test the value effects of CRIGHTS, I split up the entire domestic sample into domestic focusing and domestic diversifying subsamples. The entire cross-border sample is split up into cross-border focusing and cross-border diversifying subsamples. With the results of the subsamples, I am able to provide more in-depth conclusions regarding hypothesis II, i.e. to provide specific conclusions regarding the value effects of creditor rights on focusing and diversifying acquisitions.

4.2.2 Value effects of creditor rights on diversifying acquisitions in countries with lower creditor rights

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variable which equals 1 if the firm diversifies into a country with relatively weak creditor rights and zero otherwise. I estimate the following equation to test hypothesis III:

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5. Empirical evidence

5.1 Summary statistics

Descriptive statistics are available in table V below. Panel A in table V presents the 18 selected countries and data for the number of cross-border acquisitions, domestic acquisitions, industrial diversifications, creditor rights, shareholder rights, the level of macroeconomic risk, GDP-per-capita and legal origin. Panel B presents the mean and median value for each variable for all the observations and two sub-samples, the industrial diversifications and the geographical diversifications.

Table V. Descriptive statistics

Panel A presents the 18 European countries included in this research and for which all country-level data was available. I excluded acquisitions made in the financial and government regulated industries (healthcare and education). The first 4 columns display the number of acquisitions for that particular subsample. Column 5 presents the creditor rights index, column 6 the shareholder rights index, column 7 macroeconomic risk (macrorisk), column 8 real GDP-per-capita and column 9 the legal origin.

(1) (2) (3) (4) (5) (6) (7) (8) (9)

CB Dom. CB DIV Dom. DIV CR SR Macrorisk GDP LO

Austria 3 2 2 0 3 2.5 1.7 €27306,58 Civil Belgium 5 2 0 1 2 3 1.8 €26396,35 Civil Denmark 5 2 1 0 3 4 1.6 €34897,7 Civil Finland 10 9 1 1 1 3.5 2.1 €27905,81 Civil France 10 30 3 10 0 3.5 0.0 €25347,32 Civil Germany 15 17 3 3 3 3.5 1.1 €25964,28 Civil Greece 1 1 0 4 1 2 2.2 €14978,79 Civil Hungary 2 2 1 2 1 2 2.0 €7042,89 Civil Ireland 4 0 1 0 1 5 4.6 €33706,69 Common Italy 8 15 2 4 2 2 1.0 €22667,.58 Civil Netherlands 5 5 3 3 3 2.5 1.9 €28769,95 Civil Norway 6 7 2 3 2 3.5 2.8 €45105,55 Civil Poland 0 5 0 2 1 2 2.2 €5411,77 Civil Portugal 1 5 0 0 1 2.5 1.7 €13377,23 Civil Spain 8 4 1 1 2 5 0.8 €18138,25 Civil Sweden 15 17 6 3 1 3.5 0.8 €30462,26 Civil Switzerland 8 4 1 1 1 3 1.9 €39535,00 Civil

United Kingdom 27 92 6 32 4 5 0.7 €28442,64 Common

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Table V continued

Panel B. Mean and median values of the independent and control variables for industrial and geographical diversifications.

All Industrial Cross-border

acquisitions acquisitions acquisitions

(N=352) (N=103) (N=133)

Creditor rights Mean 2.32 2.73 2.23

Median 2.00 3.00 2.00

Shareholder rights Mean 3.79 3.92 3.76

Median 3.50 3.50 3.50

Legal origin Mean 0.33 0.45 0.24

Median 0.00 0.00 0.00

Market capitalization Mean 11.92 11.96 11.84

Median 12.08 12.08 11.92

Real GDP-per-capita Mean 4.42 4.41 4.44

Median 4.45 4.45 4.45

Macrorisk Mean 1.22 1.19 1.36

Median 0.87 0.80 0.97

Total assets Mean 5.69 5.72 6.10

Median 5.61 5.65 5.99 Leverage Mean 0.19 0.25 0.16 Median 0.16 0.18 0.13 EBITDA/Sales Mean 0.07 0.09 0.01 Median 0.13 0.13 0.14 ROA Mean 0.11 0.10 0.12 Median 0.12 0.13 0.13

Panel C. Correlations among variables in regression.

Correlations are based on 352 acquisitions in 2005. Of these 352 acquisitions, there are 103 industrial diversifications, 133 geographical diversifications, and 33 industrial and geographical diversifications.

CAR GDP CR OM SIZE LO LEV RISK CAP ROA SR

CAR 1,00 GDP -0,01 1,00 CR -0,06 0,23 1,00 OM 0,04 -0,03 -0,10 1,00 SIZE -0,16 -0,02 -0,25 0,04 1,00 LO -0,03 0,20 0,78 -0,12 -0,30 1,00 LEV -0,02 -0,01 -0,07 0,02 0,38 -0,12 1,00 RISK -0,15 -0,04 -0,36 0,06 0,18 -0,38 0,01 1,00 CAP 0,07 0,33 0,53 -0,08 -0,24 0,63 -0,05 -0,74 1,00 ROA 0,03 -0,05 -0,12 0,25 0,25 -0,15 0,04 0,12 -0,13 1,00 SR 0,01 0,37 0,63 -0,11 -0,26 0,81 -0,17 -0,44 0,65 -0,13 1,00

Notes: CAR is the cumulative abnormal return, GDP is the log real GDP-per-capita, CR are creditor rights, OM stands for

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Table V continued

Panel D. Variance inflation factors for the independent variables

This table presents the variance inflation factors (VIF). When the uncentered VIF is higher than 5 it might indicate that there are multicollinearity issues in the regressions. All 352 observations are included in the analysis of variance inflation factors.

Uncentered Centered

Variable VIF VIF

Intercept 2122.7 NA Creditor rights 10.1 2.794 Shareholder rights 53.4 3.831 Legal origin 8.4 5.605 MacroRisk 11.2 2.785 Log GDP-per-capita 1491.4 1.502 Total Assets 38.0 1.393 Leverage 1.2 1.238 ROA 1.5 1.153 Log MarketCap 2047.9 4.124 EBITDA/Sales 1.1 1.080

Panel A of table 5 presents an overview of the 18 European countries and its data. In panel B, mean and median values are provided for 3 different groups. As expected, the mean (median), 2.73(3.00) of creditor rights for industrially diversifying firms is higher compared to the mean (median) for the entire sample of 2.32(2.00). Firms engaging in industrial diversification tend to be more often in higher creditor rights countries than in the entire sample of acquisitions. The mean (median) of creditor rights for firms

engaging in border acquisitions is 2.23(2.00). The mean and median for cross-border acquisitions is lower than for the group of industrial diversifications.

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A stronger shareholder rights index is associated with focusing acquisitions as these are seen as more valuable for investors. Hence this is the opposite of what we expect. Next section must show us empirical evidence whether significant results can be drawn from these mean and median values.

Furthermore, as expected, firms engaging in cross-border acquisitions have a higher average (1.36) macroeconomic risk than firms engaging in industrial diversification (1.19) and the entire group of acquisitions (1.22). To spread the market risk, firms spread their operations across countries to reduce their risk. In addition, firms engaging in cross-border acquisitions tend to be larger than the other samples. They might need to explore abroad to meet growth objectives set by the company’s management. In panel C you will find the correlation matrix for all the variables used in the

regressions. To detect multicollinearity problems, I also tested for variance inflation factors which are shown in panel D. This method can be used to see which variances of variables are significantly changed due to multicollinearity. As a rule of thumb, an uncentered VIF of 10 is the critical limit for which variables are diagnosed with

multicollinearity. The variance inflation factors give values in excess of 10 for creditor rights, shareholder rights, macrorisk, log GDP-per-capita, total assets and log

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5.2 The propensity effect of creditor rights on industrial and geographical

diversification

The first test is to find empirical evidence for hypothesis Ia:

Hypotheses Ia : Firms residing in countries with high creditor rights are more likely to engage in industrial diversification than firms in countries with weak creditor rights.

The first test is to study the risk reduction effort of firms by looking at whether firms diversify or not when their countries have strong creditor rights. Using a probit model, where the dummy equals 1 if it is a same-industry acquisitions and zero otherwise I search for propensity effects. We hypothesize that firms in countries with high creditor rights want to reduce their risk by diversifying (at the 2-digit SIC-code) and hence, spreading their risk across multiple industries. Hence, we expect a negative sign for our main variable creditor rights. As hypothesized, the CRIGHTS coefficient is negative and significant at the 1% level when we exclude LEGAL ORIGIN and LOG MARKETCAP due to multicollinearity. SRIGHTS is also highly correlated with CRIGHTS and therefore, we excluded SRIGHTS in model (1) in table VI8_{. Again, the sign of the coefficient is in support} of the hypothesis that strong creditor rights induce industrial diversification as risk-reducing activity. SRIGHT is negative and insignificant in all the models. Although we cannot draw conclusions from insignificant results, we expect, however, to see a

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positive sign for the SRIGHT variable. Shareholders should in theory be interested in focusing acquisitions. These focusing acquisitions are expected to provide more value for the shareholders and therefore, firms residing in high shareholder rights countries should tend to engage in focusing acquisitions rather than diversifying acquisitions. All the control variables do not affect the likelihood of an industrial diversification.

Now the results for hypothesis Ib will be presented.

Hypotheses Ib : Firms residing in countries with high creditor rights are more likely to engage in geographical diversification than firms in countries with weak creditor rights.

Again, CRIGHTS is negative and significant in models (1), (3), and (4) of table IV. In model (2), CRIGHTS is not included. Firms in strong creditor rights countries are more likely to engage in cross-border acquisitions than in domestic acquisitions. Strong creditor rights induce firms to diversify away risk, i.e. idiosyncratic risk. SRIGHTS is negative and

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high levels of leverage induce firms to engage in domestic acquisitions. One plausible explanation for this unforeseen sign is that firms with high levels of leverage cannot cope with the cross-border acquisition and the accompanying efforts which only increase the risk of financial distress for these firms.

Table VI Merger-level analysis: proportion of industrial diversification

The table presents the coefficient estimates from probit regressions. The dependent variable equals 1 if the acquirer and target are in the same industry using a 2-digit SIC code. Acquisitions in the financial and regulated industries (healthcare and education) are excluded from the regression analysis. The independent variable is creditor rights (CRIGHTS). The control variables include SRIGHTS, legal origin, macrorisk, the natural logarithm of GDP-per-capita, the natural logarithm of total assets, leverage, ROA, the natural logarithm of a country’s market capitalization and EBITDA/Sales. Model (1) excludes SRIGHTS, legal origin, and Log MarketCap due to multicollinearity. Model (2) excludes CRIGHTS, legal origin, and Log MarketCap. Model (3) excludes legal origin and Log MarketCap. Model (4) includes the independent variable and all control variables. The sample period is 2005.

Standard errors are in parentheses. ***, **, * indicate significance levels at the 1%, 5%, and 10%, respectively. (1) (2) (3) (4) Variable Intercept -2.164 0.354 -2.818 -2.026 (3.007) (3.219) (3.174) (3.327) Creditor rights -0.251*** -0.261** -0.184*** (0.068) (0.071) (0.089) Shareholder rights -0.103 -0.105 -0.211 (0.092) (0.096) (0.141) Legal origin -0.617 (0.387 MacroRisk -0.077 -0.102 0.012 -0.005 (0.168) (0.161) (0.168) (0.171) Log GDP-per-capita 0.534 -0.036 0.244 0.048 (0.590) (0.581) (0.577) (0.647) Total assets -0.058 -0.411 -0.065 -0.062 (0.007) (0.069) (0.072) (0.070) Leverage -0.200 -0.190 -0.150 -0.165 (0.155) (0.155) (0.158) (0.157) ROA 0.250 0.272 0.223 0.224 (0.385) (0.407) (0.390) (0.405) Log MarketCap 0.217 (0.289) EBITDA/Sales -0.063 -0.050 -0.059 -0.060 (0.040) (0.089) (0.040) (0.089) R-squared 0.05 0.01 0.03 0.05 Observations 352 353 353 353 Industrial div. 103 103 103 103 Non-industrial div. 249 249 249 249

Table VII Merger-level analysis: proportion of geographical diversification

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industries (healthcare and education) are excluded from the regression analysis. The independent variable is creditor rights (CRIGHTS). The control variables include SRIGHTS, legal origin, macrorisk, the natural logarithm of GDP-per-capita, the natural logarithm of total assets, leverage, ROA, the natural logarithm of a country’s market capitalization and EBITDA/Sales. Model (1) excludes SRIGHTS, legal origin and Log MarketCap due to multicollinearity. Model (2) excludes CRIGHTS, legal origin and Log MarketCap. Model (3) excludes legal origin in Log MarketCap. Model (4) includes the independent variable and all control variables. The sample period is 2005.

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5.3 The value effects of creditor rights on industrial and geographical diversification

In this section I discuss the empirical results for hypothesis IIa and hypothesis IIb: Hypotheses IIa: Creditor rights are negatively related with the value of industrially diversified firms.

Hypotheses IIb: Creditor rights are negatively related with the value of geographically diversified firms.

In the table below I present the mean and median cumulative abnormal returns for the entire sample and the multiple subsamples. I test for differences in mean and median using the t-test and Wilcoxon rank test, respectively.

Table VIII. Mean and median values for the 5-day window cumulative abnormal returns. CAR

Mean Median

Total sample 1.31% 0,41%

Industrial diversification 1,09% -0,02%

Domestic acquisitions 1,53% 0,34%

Domestic industrial diversification 1,26% -0,02% Domestic focusing acquisitions 1,65% 0,58% Cross-border acquisitions 0,95% 0,60% Cross-border industrial diversification 0,75% -0,03% Cross-border focusing acquisitions 1,02% 0,69%

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focusing acquisitions vs. each of the other (sub)samples. None of the outcomes are significant at the 10% level.

Table IX presents the results for the effect of creditor rights on the value of industrial diversification. As hypothesized, industrial diversification is negatively related to the value of the acquisitions, measured by the cumulative abnormal return over a 5-day window surrounding the announcement date. In models (2) and (4), CRIGHTS is negative and significant at the 5% level. In model (1), CRIGHTS is insignificant, caused by a high correlation with LOG MARKETCAP and LEGAL ORIGIN. When these two control variables are excluded from the regression due to multicollinearity, CRIGHTS will become

significant10_{. The results are supported by the subsamples in table X and XI, where all} industrial diversifications are split up into two subsamples, i.e. domestic industrial diversification and cross-border industrial diversification. In both subsamples, CRIGHTS is negative and significant at the 5% level, indicating that investors do not believe that industrial diversification is beneficial for the firm’s performance, although strong creditor rights induce firms to industrially diversify. In support of the hypothesis Ia, strong creditor rights induce firms to industrially diversify, and in support of hypothesis IIa the value of these industrial diversifications is negatively related with creditor rights. The results are slightly affected when the variance inflation factors are taken into account11_{. Important, is that creditor rights remains significant in several settings} 10_{I run also OLS multiple regressions with the variables which are excluded in table III and IV. I repeated} models (2), (3), and (4) including legal origin and excluding Log MarketCap. Then I repeated models (1), (2), and (3) including Log MarketCap and excluding legal origin. These regressions were similar to the models in table III and IV and therefore, I did not include these regressions in the paper.

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showing the robust nature of the negative effect of creditor rights on industrial

diversifications as well as geographical diversifications. There is a trade-off with on the one side strong creditor rights which the firm have to incorporate in their corporate decisions or otherwise it is more likely that the firm will have more problems in case of financial distress. On the other side, the firm knows that industrial diversification is harmful for their investors and still continues with the industrial diversification to lower the risk within the firm. Creditor rights have no impact on domestic focusing

acquisitions as expected. CRIGTHS is also negative and significant for the cross-border acquisitions. This result is confirmed by the subsamples border focusing and cross-border industrial acquisitions in tables XIII and XIV. Bidders in strong creditor rights countries are more likely to engage in cross-border acquisitions as pointed out in section 5.3 regarding the propensity effects of creditor rights on geographic diversification, however, investors are not enthusiastic about this tendency indicated by the negative CRIGHTS sign in table XIV below. Hence, managers of bidder firms might know that investors oppose the idea of cross-border acquisitions, but still are more likely to invest abroad if the domestic market is faced by strong creditor rights.

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macroeconomic risk is observed in a country. Investors might believe that high volatility in the real production of a country might disturb the positive effects of the acquisition. The value effects of MACRORISK are highest in case of a domestic focusing acquisition where the coefficient is negative and significant at the 10% level. Logically,

macroeconomic risk affects the entire economy, however, it affects one industry differently than the other. When a firm operates in only one industry and that specific industry is sensitive for the real production of the economy, investors will lower their investment in a focusing firm. MACRORISK is also negative and significant for the cross-border industrial diversifications. It is of less influence for cross-cross-border acquisitions as the macroeconomic risk is spread across countries. Furthermore, total assets, a proxy for firm size, is also negatively related to the value effect of the industrial diversification. Investors might expect that large firms are more likely to overinvest in industrial

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Table IX Value effects of creditor rights on industrial diversification

The table presents the coefficient estimates from OLS. The dependent variable is the cumulative abnormal return over a 5-day window. Model (1) shows the result for all industrial diversifications. Model (2) excludes Log MarketCap due to multicollinearity and SRIGHTS. Model (3) excludes CRIGHTS and includes

SRIGHTS. Model (4) includes both CRIGHTS and SRIGHTS. Acquisitions in the financial and regulated industries (healthcare and education) are excluded from the regression analysis. The independent variable is creditor rights (CRIGHTS). The control variables include SRIGHTS, legal origin, macrorisk, the natural logarithm of GDP-per-capita, the natural logarithm of total assets, leverage, ROA, the natural logarithm of a country’s market capitalization and EBITDA/Sales.

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Table X Value effects of creditor rights on domestic focusing acquisitions

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Table XII Value effects of creditor rights on domestic industrial diversification

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For cross-border industrial diversification, the ROA and LOG GDP-PER-CAPITA are both negative and significant while both variables are insignificant in all the other regressions. Firms with high operating performances are less likely to diversify industrially or

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Table XII Value effects of creditor rights on cross-border diversification

The table presents the coefficient estimates from OLS. The dependent variable is the cumulative abnormal return over a 5-day window. Model (1) shows the result for all industrial diversifications. Model (2) excludes legal origin and Log MarketCap due to multicollinearity and SRIGHTS. Model (3) excludes CRIGHTS and includes SRIGHTS. Model (4) includes both CRIGHTS and SRIGHTS. Acquisitions in the financial and regulated industries (healthcare and education) are excluded from the regression analysis. The independent variable is creditor rights (CRIGHTS). The control variables include SRIGHTS, legal origin, macrorisk, the natural logarithm of GDP-per-capita, the natural logarithm of total assets, leverage, ROA, the natural logarithm of a country’s market capitalization and EBITDA/Sales.

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Table XIII Value effects of creditor rights on cross-border focusing diversification

SRIGHTS. Model (4) includes both CRIGHTS and SRIGHTS. Acquisitions in the financial and regulated industries healthcare and education) are excluded from the regression analysis. The independent variable is creditor rights (CRIGHTS). The control variables include SRIGHTS, legal origin, macrorisk, the natural logarithm of GDP-per-capita, the natural logarithm of total assets, leverage, ROA, the natural logarithm of a country’s market capitalization and EBITDA/Sales.

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Table XIV Value effects of creditor rights on cross-border industrially diversifications

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5.4 Acquisitions in countries with lower creditor rights

In this section I present the empirical evidence for hypothesis III.

Hypothesis III: Diversification into a target country with relatively weak creditor rights is valued higher than diversification into a target country with relatively strong creditor rights.

I have 133 cross-border acquisitions from which 20 are acquisitions made in countries with the same creditor rights level. The remaining sample only consists of acquisitions made by firms in countries with dissimilar creditor rights, whether the target firm’s country has weaker or stronger creditor rights. The first subsample consists of firms residing in countries with higher creditor rights than in the country of the target firm. The second subsample is the other way around, i.e. the firms residing in countries with lower creditor rights than in the country of the target firm. The dummy equals one if the target is residing in a country with lower creditor rights and zero when a firm diversifies into a country with higher creditor rights. The results are provided in table V. In support of the hypotheses, the dummy creditor rights is positive and significant at the 10% level, indicating there is some evidence that cross-border acquisitions in countries with lower creditor rights are valued higher than cross-border acquisitions in countries with higher creditor rights12_{. Gande et al. (2009) find that American firms engaging in}

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Table XV. Value effects of acquisitions in countries with lower creditor rights.

The table presents the estimated coefficients from the OLS regression. The dependent variable is the 5-day window cumulative abnormal return. The independent variable is the dummy creditor rights. The dummy equals one if a firm diversifies into a country with lower creditor rights and zero when a firm diversifies into a country with higher creditor rights. The control variables include SRIGHTS, legal origin, macrorisk, the natural logarithm of GDP-per-capita, the natural logarithm of total assets, leverage, ROA, the natural logarithm of a country’s market capitalization and EBITDA/Sales. Model (1) includes all control variables. Model (2) excludes legal origin and log marketcap due to multicollinearity. In model (3) the dummy equals one if a firm diversifies into a country with lower creditor rights and zero otherwise, hence it also includes acquisitions in countries with the same creditor rights index. Standard errors are in parentheses. ***, **, * indicate significance levels at the 1%, 5%, and 10%, respectively.

Variable (1) (2) (3)

Intercept 0.151 0.141 0.206

(0.159) (0.172) (0.165)

Dummy Creditor rights 0.014* 0.015*** 0.015***

(0.007) (0.007) (0.007) Shareholder rights -0.002 -0.004 -0.003 (0.005) (0.003) (0.003) Legal origin -0.007 (0.014) MacroRisk -0.006 -0.006 -0.007** (0.006) (0.003) (0.003) Log GDP-per-capita -0.025 -0.023 -0.038 (0.033) (0.039) (0.037)

Log Total assets -0.001 -0.001 -0.000

(0.003) (0.003) (0.003) Leverage -0.000 -0.001 -0.006 (0.009) (0.008) (0.009) ROA -0.030 -0.029 -0.025 (0.026) (0.025) (0.024) Log MarketCap 0.000 (0.010) EBITDA/Sales 0.000** 0.000 0.000 (0.001) (0.000) (0.000) R-squared 0.12 0.12 0.15 Observations 113 113 133

acquisitions in countries with stronger creditor rights relative to the USA were higher valued than when they acquired targets in countries with lower creditor rights relative to the USA. This is the opposite of my findings. The authors only look from the

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6. Conclusion

In this study I investigate the effect of creditor rights on industrial and geographical diversification for firms in 18 European countries in 2005. First, I looked at the

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of diversification. This is in line with theory that the costs of diversification outweigh the benefits of diversification as explained by the agency theory, inefficient resource

allocation theory and the market power theory. Furthermore, this paper shows that diversification in target countries with relatively low creditor rights is higher valued than diversification in target countries with relatively strong creditor rights. This is in line with Collins et al. (2009) who find similar results for banking acquisitions in the EU and US. My results are also confirmed by the results of John et al. (2010) who find similar results for US bidders and foreign targets. Gande et al. (2004), however, find the opposite results, i.e. they find that the acquisition in a target country with relatively strong creditor rights is higher valued compared to an acquisitions in a target country with relatively weak creditor rights. Their findings, however, are not in line with theory that shareholders need to be compensated for a higher likelihood of managers’

expropriation of firms’ assets in countries with weak creditor rights.

6.1 Limitations

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issues which occurred during my regression analysis. This might be caused by my small sample size or because I used different data than the other authors. Second, I used only European countries in my dataset. Reason for this sample selection is the focus on US bidders in the literature. The problem that arises is the definition of cross-border acquisitions. Borders in Europe are becoming less strict and the European Union is unitizing the legal system in many ways. This might influence the perception of the markets and hence, influence the assessment of markets whether geographical

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