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The effect of cash holdings on acquisitions for firms from the UK:
Financially constrained versus unconstrained firms
Milou Nijmeijer s2037432 Master Thesis Finance
Supervisor: Dr. J.H. von Eije June 13, 2016
10,995 words
Abstract
The agency theory of free cash flow suggests that firms with high cash holdings will spend more on acquisitions. However, more recently Gao (2015) found that firms with high cash holdings acquire less. Gao explains this from the fact that financially constrained firms accumulate cash for precautionary motives. We, however, find no relation between cash-rich firms and the probability to announce one or more acquisitions for the period 2000-2015 and this is the case for both financially constrained firms as well as financially unconstrained firms. Therefore, we neither find a confirmation for the agency theory of free cash flow nor for Gao’s theory of the precautionary motive. However, for the period after the financial crisis, we do find a negative relation between cash-rich firms and acquisitions for financially unconstrained firms and a positive relation for financially constrained firms. Therefore we suggest that, since the financial crisis, accumulating cash for precautionary motives has become less important for financially constrained firms. However, for financially unconstrained firms the agency theory may have shifted from spending cash on excess investments to stockpiling cash for safety and flexibility.
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1. Introduction
According to the agency theory of free cash flow we can argue that firms with high cash holdings are more likely to make acquisitions (Jensen, 1986; Harford, 1999; Harford, Mansi and Maxwell, 2006). However, particularly since the financial crisis, companies around the world reduce their leverage and create a financial buffer for the future. They have less need to invest their available capital and as a result companies are stockpiling cash (Bates, Kahle, and Stulz, 2009; Song and Lee, 2012). Therefore we can expect that firms invest less cash in acquisitions and that the relation between cash holdings and acquisitions has changed.
Despite the importance of cash reserves to corporate finance, effects of corporate cash holdings on acquisitions have achieved little attention. Furthermore, most of this literature mainly focuses on the bidder cash reserve effects on announcement returns (Freund, Prezas and Vasudevan, 2003; Harford, 1999; Lang, Stulz and Walkling, 1991; Schlingemann, 2004; Gao, 2015). In this paper, however, we are interested in the relation between cash-rich firms and acquisitions and investigate if the current trend of stockpiling cash (Bates, Kahle, and Stulz, 2009; Kling, Paul and Gonis, 2014) influences the acquisition behavior of companies.
Both Harford (1999) and Gao (2015) examined the relation between cash-rich firms and acquisitions. However, both studies observed reversed findings and explained their results based on two different theories, the agency theory of free cash flow and the precautionary motive of cash reserves respectively. Furthermore, both studies based their results only on bidders from the US. Since UK firms are facing increased corporate cash holdings in recent years (Kling, Paul and Gonis, 2014) it will be interesting to investigate this relation for UK firms. The relation between cash holdings and acquisitions has not been examined for UK firms until now. This paper, therefore, aims to investigate the effect of the excess cash ratio on acquisitions for UK firms. The following research question will be examined and answered in this paper:
What is the effect of the excess cash ratio on acquisitions?1
In addition, Gao (2015) argues that the relation between cash and acquisitions is related to the precautionary motive of holding cash reserves. This theory argues that, mainly financially constrained, firms stockpile cash to maintain the ability to finance potential future investments without having to incur the costs associated with external financing (Keynes,
1 This research is based on the assumption that an acquisition is determined by the characteristics of the acquirer
3 1936). Therefore, to test if financial constraints influences the relation between cash holdings and acquisitions, a second research question is formulated:
Is the effect of the excess cash ratio on acquisitions different for financially constrained firms than for financially unconstrained firms?
We use a panel dataset of 14,043 firm-years to examine the effect of the excess cash ratio on listed and unlisted acquisitions during 2000-2015. Furthermore, we make a distinction between financially constrained and unconstrained firms and use firm size as a criterion. Larger companies are better known, and therefore have better access to capital markets and are less financially constrained than smaller firms (Faulkender and Wang, 2006; Almeida, Campello and Weisbach, 2004).
The results of this study show no relation between the excess cash ratio and the probability to announce one or more acquisitions for the period 2000-2015 and this is the case for both financially constrained firms as well as financially unconstrained firms. Therefore, we neither find a confirmation for the agency theory of free cash flow nor for Gao’s theory of the precautionary motive. However, for the period after the financial crisis, we do find a negative relation between cash-rich firms and the probability to announce an acquisition and this relation is primarily caused by financially unconstrained firms. In contrast, for financially constrained firms we found a positive relation between the excess cash ratio and acquisitions. Therefore we suggest that, since the financial crisis, accumulating cash for precautionary motives has become less important for financially constrained firms. However, for financially unconstrained firms the agency theory may have shifted from spending cash on excess investments to stockpiling cash for safety and flexibility. Finally, we find a negative relation between constrained cash-rich firms and listed acquisitions. Therefore, we still find evidence for Gao’s precautionary motive of cash reserves related to acquisitions, but this theory is only valid for listed acquisitions.
4 cash holdings and acquisitions that includes both unlisted and listed targets in the dataset instead of only listed targets. We found that, mainly for financially constrained firms, the results for only listed acquisitions are different than for the results of both listed and unlisted acquisitions combined. This is important since private firms play a dominant role in the set of acquisitions. Third, in addition to studies done by Gao (2015) and Harford (1999), we do not only investigate the relation between cash-rich firms and acquisitions but also examine the relation between the cash ratio and acquisitions by means of a robustness check. Since the financial crisis, many firms increased their level of cash holdings without becoming a relatively cash-rich firm. By means of a robustness check we prove that, since the financial crisis, the probability to announce an acquisition also decreases for firms with a higher cash ratio.
This paper has implications for managers due to valuable insights about the acquisition behavior of firms. The fact that we demonstrate a negative relation between the excess cash ratio and acquisitions, since the financial crisis, gives managers the opportunity to re-evaluate their strategy regarding competition and M&A decisions in particular based on their own but also on the cash ratio of competitors. When competitors increase their cash ratio, managers do not have to worry that the competitors will announce more acquisitions. Moreover, since the financial crisis, the probability that cash-rich firms announce an acquisition even decreased.
This paper proceeds as follows. Section 2 will discuss research concerning cash holdings, the agency theory and the precautionary motive of cash reserves. In section 3 the methodology will be explained, and section 4 will describe the samples and data. Section 5 will report the results of the analysis and section 6 concludes the paper.
2. Literature review
2.1 Corporate cash holdings
Cash holdings are stockpiled free cash flows, as additions to cash holdings occur when cash flows are greater than what is required for firms’ investments. In line with Modigliani and Miller (1958), one can argue that in perfect capital markets cash holdings are irrelevant to company value. However, if there are market imperfections liquidity may be needed.
5 transaction-motive, the precautionary-motive and the speculative-motive. First, the transaction-motive argues that individuals and firms hold cash for current transactions in normal and business exchanges. Second, the precautionary-motive argues that individuals and firms stockpile cash to maintain the ability to finance potential future investments without having to incur the costs associated with external financing. Finally, the speculative-motive argues that firms reserve cash to secure profit from not investing yet, as they assume to know better than the market what the future will bring.
Several empirical studies discuss the importance of cash holdings and address reasons why companies reserve cash. Opler, Pinkowitz, Stulz and Williamson (1999) found that, in general, firms with riskier activities, strong growth opportunities and small firms hold more cash than other firms. Furthermore they argue that in the presence of agency costs, management may hold excess cash to pursue its own objectives at shareholders’ expenses. The main objectives for these managers to accumulate cash are that holding excess cash makes the firm less risky and gives them more flexibility. Accumulating cash reduces payouts to shareholders and keep some of the free cash flows within the company (Opler, Pinkowitz, Stulz and Williamson, 1999). Besides the stockpiling argument, there is also the possibility that firms spend the excess cash more quickly (Jensen, 1986). Also Harford, Mansi and Maxwell (2006) assume that firms with weaker corporate governance have smaller cash reserves. They find that self-interested managers in the US spend cash more quickly on acquisitions, rather than gain flexibility through stockpiling the cash.
2.2 Mergers and acquisitions
6 measured by means of the market-to-book ratio. Since mergers and acquisitions are more sensitive to its Q than direct investments, firms with a high Q have a greater probability to announce a merger or acquisition (Dong, Hirshleifer, Richardson and Teoh, 2006).
Some other factors that affects the probability to announce an acquisition are a company’s management efficiency and the firms’ financing capacity (Manne, 1965; Palepu, 1986; Morck, Shleifer and Vishny, 1990; Gao, 2015). Furthermore, larger firms, firms with higher abnormal returns and firms with higher sales growth are more likely to become a bidder (Asquith, Bruner and Mullins, 1983; Roll, 1986).
2.3 The agency theory
The agency theory is an analysis of the conflicting interests between principals and agents. According to Jensen and Meckling (1976) we can define an agency relationship as a contract under which the principal engages the agent to perform some service on his or her behalf while delegating some decision making authority. Since both parties want to maximize utility, the agent will not always act in the best interest of the principal. This will result in agency costs for both the principal as well as the agent. An example of these costs are the agency costs of free cash flow investigated by Jensen (1986). He argues that incompletely controlled managers with substantial free cash flow prefer to invest the cash below the cost of capital instead of paying it out to their shareholders. One of these methods is spending cash by means of acquisitions.
7 primarily on acquisitions. These firms prefer to spend the cash rather than gain flexibility through stockpiling it. 2
Summarized, we suggest that there is a distinction between two types of agency theory related to cash reserves. First, we have the agency theory related to spending cash. According to both Jensen (1986) and Harford, Mansi and Maxwell (2006) we can argue that self-interested managers spend cash more quickly on excess investments instead of paying it out to their shareholders. Second, we have the agency theory related to stockpiling cash. According to Opler, Pinkowitz, Stulz and Williamson (1999) we can argue that in the presence of agency costs, managers hold excess cash to make the firm less risky and to give them more flexibility.
2.4 The precautionary motive of cash reserves
We already indicated that Keynes (1936) distinguished three main motives of holding cash. In this section we will discuss the precautionary-motive of cash reserves in more detail. According to this motive we can argue that a reason to hold cash is to secure liquidity for contingencies or unforeseen opportunities of advantageous purchases. Therefore, the precautionary-motive increases with uncertainty about the future or absence of an organized market. Furthermore, Keynes (1936) also argues that liquidity-preference is influenced by the extent to which firms have access to external capital markets. Mainly financially constrained firms, firms with restricted access to external capital, need to be able to secure cash for future investments and liquidity becomes relevant. In contrast, for financially unconstrained firms liquidity management is no key issue.
Several studies provide empirical evidence for the precautionary motive of cash reserves. Opler, Pinkowitz, Stulz and Williamson (1999) find a positive relation between high growth firms and cash reserves. Bates (2009) observed that firms with high cash flow risk hold more cash. Almeida, Campello and Weisbach (2004) also link the precautionary motive to financial constraints and argue that financially constrained firms stockpile cash when they believe future investment opportunities are better than current opportunities. Therefore, financial constrained firms have a positive cash flow sensitivity, which is the propensity to save cash out of cash flows, and unconstrained firms do not. Luo (2011) also argues that financially constrained firms prefer to save cash for attractive projects in the future instead of
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8 wasting cash on negative NPV projects. Gao (2015) found that companies that hold more cash are less likely to announce an acquisition and relates this finding to the precautionary motive of cash reserves. He argues that financially constrained firms with high cash holdings are more cautious and selective in making acquisitions. Furthermore, Gao (2015) also argues that cash-rich firms under the precautionary motive have conflicting interests with targets on the means of payment, which make an acquisition less likely. Precautionary cash-rich firms prefer to pay with stock to save cash for future investment opportunities, although targets prefer cash to shares of partially overvalued companies.
According to the different theories described in the sections above, we will explain the effect of the excess cash ratio on acquisitions by making a distinction between financially constrained and unconstrained firms. The agency theory of spending cash can be applied to both financially constrained and unconstrained firms. Both self-interested managers of financially constrained as well as unconstrained firms can spend excess cash on acquisitions, instead of paying it out to their shareholders. Furthermore, since unconstrained firms do not stockpile cash for precautionary motives we apply the agency theory of stockpiling cash to financially unconstrained firms. Self-interested managers of unconstrained firm stockpile cash for safety and flexibility. Lastly, we relate the precautionary motive of cash reserves to financially constrained firms. Financially constrained firms stockpile cash when they believe future investment opportunities are better than current opportunities. This reasoning results in the following hypotheses.
The first hypothesis refers to the effect of the excess cash ratio on the probability to announce an acquisition:
H10 : There is no effect of the excess cash ratio on the probability to announce one or more acquisitions.
H1A : There is an effect of the excess cash ratio on the probability to announce one or more acquisitions.
9 H20 : The effect of the excess cash ratio on the probability to announce one or more acquisitions is not different for financially constrained firms than for financially unconstrained firms.
H2A : The effect of the excess cash ratio on the probability to announce one or more acquisitions is different for financially constrained firms than for financially unconstrained firms.
If the first null hypothesis (H10) is rejected, we prove that, in line with both Harford (1999) and Gao (2015), there is an effect of the excess cash ratio on acquisitions. However, this effect can be positive or negative. If the effect of H1A is positive, cash-rich firms have a higher probability to announce one or more acquisitions and we find evidence for the agency theory of spending. Self-interested managers with excess cash prefer to invest cash in acquisitions. However, if the effect is negative it is important to know what the outcome of the second null hypothesis (H20) is.
If H20 is not rejected, but the first hypothesis (H10) is, we can argue that there is an effect of the excess cash ratio on acquisitions but this effect is not significantly different for financially constrained than for unconstrained firms.
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3. Methodology
In order to test the relation between the excess cash ratio and the probability to announce one or more acquisitions, we follow Gao (2015), and perform a logistic regression analysis to predict which firms announce an acquisition. The dependent variable in the logistic model is 1 if the firm announces one or more acquisitions in year t and 0 otherwise. Furthermore, since Shumway (2001) argues that a panel data set is more appropriate for forecasting corporate events, the regression analysis is based on a panel data set. The primary variable of interest is the excess cash ratio.
The remaining variables used as additional controls are mainly based on control variables used by Harford (1999) and Gao (2015) namely: sales growth, non-cash working capital, leverage, market-to-book ratio and size. Furthermore, we include a crisis dummy. To control for endogeneity caused by simultaneity, we use the lagged variables of the excess cash ratio, sales growth, non-cash working capital, leverage, market-to-book ratio and size.
3.1 Control variables
11 changes in behavior pattern. To capture this effect for the financial crisis, we include a crisis dummy variable (CRISIS) for the years 2008 and 2009.
3.2 Regression models
The first regression model tests if the excess cash ratio has an effect on the probability to announce one or more acquisitions. Specifically, our baseline logistic model is as follows:
ACQUISITION𝑖,𝑡 = 𝛼 + 𝛽1EXCESS CASH RATIOi,𝑡-1 + 𝛽2GROWTH𝑖,𝑡-1 + 𝛽3NCWC𝑖,𝑡-1 + 𝛽4MB RATIO𝑖,𝑡-1 + 𝛽5LEVERAGE𝑖,𝑡-1 + 𝛽6SIZE 𝑖,𝑡-1 + 𝛽7CRISIS𝑖,𝑡 + 𝜀𝑖,𝑡
where ACQUISITION is the dependent variable that equals 1 for a firm-year if the company announces one or more acquisitions in year t and 0 otherwise. EXCESS CASH RATIO is measured as the residual from a regression that estimates the target level of the cash ratio. This measure is based on the method and variables used by Opler, Pinkowitz, Stulz and Williamson (1999). More details about estimating this cash residual can be found in Appendix A. GROWTH is measured as the annual sales growth. NCWC is measured as working capital net of cash and short-term investments divided by total assets. MB RATIO is the market-to-book ratio of the firm measured by the market value of equity to the market-to-book value of equity. LEVERAGE is measured by the book value of debt to the book value of equity. SIZE is measured as the natural logarithm of a firm’s total assets. CRISIS is a dummy variable equaling 1 for the years 2008 and 2009 respectively, and 0 otherwise. Furthermore, all financial variables are lagged to control for endogeneity and winsorized at 5% and 95% tails to ensure that outliers are not driving any of our results.
12 the relation between the excess cash ratio and the probability to announce one or more acquisitions. According to the precautionary motive of Gao (2015), we hypothesize that the coefficient of EXCESS CASH RATIO*CONSTRAINED will be negative. He argues that mainly financially constrained firms accumulate cash for precautionary motives and spend less on acquisitions.
3.3 Robustness tests
We analyze the robustness of the results by taking a different measure for the excess cash ratio. The aim of this analysis is to find out whether a different measure of cash will change the results. Since in recent years many UK firms increased their cash holdings (Kling, Paul and Gonis, 2014) without becoming a relative cash-rich firm, we will use the cash ratio as a robustness check. The same regressions will be performed. For consistency in the regression analyses we will change the interaction variable to CASH RATIO*CONSTRAINED.
4. Data
This section describes the generation of the dataset together with the characteristics of the firms and the acquisitions. Furthermore, the characteristics of the samples will be discussed.
4.1 Firm characteristics
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4.2 Acquisition characteristics
The acquisition sample is retrieved from Orbis based on several selection criteria. First, we only include acquisitions announced between the time period 2000-2015. Second, since we investigate the relation between cash and acquisitions for UK firms the acquirer has to be based in the United Kingdom (ISIN beginning with GB) and there are no country restrictions for the target. Third, the targets include listed, delisted and unlisted firms. The acquirers, however, only include listed and delisted firms. Last, since most of the time mergers arise on a friendly basis we only include acquisitions. Following Gao (2015) and Harford (1999) we include acquisitions of majority interests where an acquirer holds less than 50% of the target before and more than 50% after the transaction. These criteria yield a sample of 11,690 acquisitions, announced by 2,454 different bidders during 2000-2015. The generation of the acquisition dataset, criteria and number of observations can be found in Appendix B.
4.3 Sample characteristics
For each firm, information regarding their cash ratio is obtained for the announcement period 2000-2015, resulting in 17,878 firm-year observations. The cash ratio is measured as total cash and short-term investments divided by total assets. Furthermore, the cash ratio is lagged to control for endogeneity and winsorized at a 5% and 95% tail to mitigate the potential bias due to outliers.
14 < please, insert table 1 here >
Furthermore, we make a distinction between financially constrained and unconstrained firms. Table 2 shows the development of the average cash ratio for both financially constrained and unconstrained firms. For financially constrained firms we see that between 2000-2006, firms that announced one or more acquisitions had, on average, a higher cash ratio. However, between 2006-2015 this reversed, and firms that did not announce an acquisition had, on average, a higher cash ratio. For financially unconstrained firms we almost see the same development. However, the level of the cash ratio is, on average, higher for financially constrained firms compared to unconstrained firms. This is in line with the findings of Almeida, Campello and Weisbach (2004).
< please, insert table 2 here >
In table 3, we show the descriptive statistics of the variables for the total sample and sub-samples of financially constrained and unconstrained firms. The table reports the number of firm-year observations, the mean, the minimum and maximum value and the standard deviation of the variables. Furthermore, all the financial data are lagged to control for endogeneity and winsorized at a 5% and 95% tail to mitigate the potential bias due to outliers.
< please, insert table 3 here >
First, 15 percent of the total firm-year observations between 2000-2015, a firm announced one or more acquisitions. For constrained firms this percentage was almost the same. However, for unconstrained firms, in almost 30 percent of the firm-years a firm announced one or more acquisitions. The average cash ratio of constrained firms is with 0.251 higher than 0.124 of unconstrained firms. This is also the case for the excess cash ratio with 0.003 and -0.002 respectively, which is in line with the theory (Opler, Pinkowitz, Stulz and Williamson, 1999).
15 market-to-book ratio is a little higher and the leverage ratio a little lower. The average size, measured as natural logarithm of total assets, of all UK firms is 7.637. For financially constrained firms this is 6.826 and for the unconstrained firms 8.446.
5. Results
5.1 Logistic regression
First, we analyze the correlations between the individual variables to control for multicollinearity. Appendix C provides the correlation table and we can argue that multicollinearity is not a problem in our regression analysis.
The output of the logistic regression analysis to test the relation between the cash ratio and the probability to announce one or more acquisitions can be found in table 4. To correct for heteroscedasticity we use Huber–White standard errors.
< please, insert table 4 here >
From the results reported in table 4 (column 1-3) we observe no relation between the excess cash ratio and the probability to announce one or more acquisitions. This is the case for both constrained and unconstrained firms, as well as all UK firms. These observations are not in line with Harford (1999) and Gao (2015) that both found a significant effect of the excess cash ratio on acquisitions. Furthermore, we find that the probability to announce one or more acquisitions decreases for constrained firms (column 4), however the interaction effect (EXCESS CASH RATIO*CONSTRAINED) is not significant. Therefore we can argue that the effect of the excess ratio on acquisitions is not different for financially constrained firms than for financially unconstrained firms. Moreover, we find no significant relation between the excess cash ratio and the probability to announce one or more acquisitions for both financially constrained and unconstrained firms (column 4). Therefore we neither find evidence for the precautionary motive of cash reserves nor for the agency theory related to both spending and stockpiling cash.
16 announce one or more acquisitions. However, this theory is not valid for the non-cash working capital as measure for management efficiency since the probability to announce an acquisition decreases when the non-cash working capital ratio increases. Furthermore, we observe that the probability to announce an acquisition decreases when the leverage ratio increases for unconstrained but not for constrained firms. The probability to announce an acquisition increases when the size of the firm increases. This is the case for both groups of firms. The crisis dummy is negative for all firms, and reflects that, on average, the probability to announce one or more acquisitions was smaller for the years during the crisis.
In conclusion, from table 4 we can argue that hypothesis H10 is accepted: there is no effect of the excess cash ratio on the probability to announce one or more acquisitions. Hypothesis H20 is accepted either: the effect of the excess cash ratio on the probability to announce one or more acquisitions is not different for financially constrained firms than for financially unconstrained firms.
Until now, we neither find confirmation for the agency theory related to spending or stockpiling cash nor for the precautionary motive of cash reserves to explain the relation between the excess cash ratio and acquisitions. Since we suggest that particularly since the financial crisis companies are stockpiling cash and create a financial buffer for the future, we will perform a regression analysis where we split up the sample in UK firms that announced acquisitions before the crisis and firms that announced acquisitions after the crisis. The period before the crisis will be 2000-2009 and the period after the crisis will be 2010-2015.
The output of the logistic regression analysis to test the relation between the excess cash ratio and the probability to announce one or more acquisitions for both the sample before the crisis as well as after the crisis can be found in table 5. To correct for heteroscedasticity we use Huber–White standard errors.
< please, insert table 5 here >
17 Moreover, we also find no relation between the excess cash ratio and acquisitions for financially unconstrained firms before the crisis.
While the preceding analysis do not find any significant relation between the excess cash ratio and acquisitions for the period before the crisis, table 5 (column 3) do find a negative relation between the excess cash ratio and acquisitions for the period after the crisis. Furthermore, according to the interaction variable (EXCESS CASH RATIO* CONSTRAINED) in column 4 we find that the effect of the excess cash ratio on acquisitions is different for constrained firms than for unconstrained firms after the crisis. For financially unconstrained firms we find a negative relation between the excess cash ratio and acquisitions for the period after the crisis. This is in line with the agency theory related to stockpiling cash. Self-interested managers of unconstrained cash-rich firms prefer to accumulate cash and gain flexibility instead of spending it on acquisitions. However, for financially constrained firms we find a positive relation between the excess cash ratio and acquisitions for the period after the crisis. This is in line with the agency theory of spending and implies that, since the crisis, self-interested managers of constrained cash-rich firms prefer to spend more on acquisitions, rather than reserving cash for precautionary motives.
Finally, comparing to previous studies done by Harford (1999) and Gao (2015), this is the first study that includes both unlisted and listed targets in the dataset instead of only listed targets. Therefore, we are interested how the difference between listed and unlisted targets affects the relation between cash-rich firms and acquisitions. This is important since private firms play a dominant role in the set of acquisitions. Table 6 shows the results from the regression analysis about the relation between the excess cash ratio and the probability to announce a listed acquisition. The logistic analysis for listed acquisitions is based on a panel data set that only includes firm-years where a company announced zero or exactly one acquisition. The reason that we use this sub-sample is the fact that a firm can make both listed acquisitions and unlisted acquisitions in year t. To correct for heteroscedasticity we use Huber–White standard errors.
< please, insert table 6 here >
18 between the excess cash ratio and the probability to announce a listed acquisition. This means that constrained cash-rich firms have a lower probability to announce a listed acquisition. Since Gao (2015) investigated the relation between the excess cash ratio and acquisitions for only listed acquisitions, this replicates the results of Gao (2015). Therefore we find evidence for Gao’s theory that the negative relation between cash-rich firms and acquisitions is related to financially constrained firms that accumulate cash for precautionary motives. However, this theory applies only to listed acquisitions. Since we do not have enough listed acquisitions for the period after the financial crisis we cannot test this relation for the period after the crisis.
5.2 Robustness tests
Several robustness checks are performed using a different measure for the primary independent variable of the excess cash ratio, namely the cash ratio. Table 7 presents the outcomes of the baseline logistic regression model using the cash ratio instead of the excess cash ratio. Again, the regression analysis corrects for heteroscedasticity by using Huber– White standard errors.
< please, insert table 7 here >
Table 7 shows largely the same results as before. Again, we do not find a significant relation between the cash ratio and the probability to announce one or more acquisitions for both constrained and unconstrained firms, as well as, all UK firms (column 1-3). Furthermore, column 4 shows no difference in the relation between the cash ratio and acquisitions for financially constrained firms compared to financially unconstrained firms.
In conclusion, hypothesis H10 is accepted: there is no effect of the cash ratio on the probability to announce one or more acquisitions. Hypothesis H20 is also accepted: the effect of the cash ratio on the probability to announce one or more acquisitions is not different for financially constrained firms than for financially unconstrained firms.
Table 8 shows the results of the relation between the cash ratio and the probability to announce one or more acquisitions for both the sample before the crisis as well as after the crisis.
19 Again, according to column 1, we find no effect of the cash ratio on the probability to announce one or more acquisitions for the period before the crisis. This is the case for both constrained and unconstrained firms (column 2). Furthermore, we find no difference in the relation between the cash ratio and acquisitions between constrained and unconstrained firms for the period before the crisis (column 2). All the results of the period before the crisis are in line with our previous results of the excess cash ratio. For the period after the crisis we still find a negative effect between the cash ratio and acquisitions (column 3). This is also the case for financially unconstrained firms (column 4). However, in contrast with our previous results, we do not find a significant relation anymore between the cash ratio and acquisitions for constrained firms after the crisis (column 4). Furthermore, according to the interaction term, we find no significant difference in the relation between the cash ratio and acquisitions between constrained and unconstrained firms for the period after the crisis (column 4). In conclusion we can argue that for the period after the crisis, we do find some different results by using the cash ratio instead of the excess cash ratio.
Table 9 presents the outcomes of logistic regression of the robustness test of the relation between the cash ratio and the probability to announce a listed acquisition.
< please, insert table 9 here >
Table 9 shows largely the same results as before. In line with table 6, we find no effect between the cash ratio and listed acquisitions for unconstrained firms. However, we do find a negative relation between the cash ratio and listed acquisitions for constrained firms. Therefore we can argue that Gao’s theory of the precautionary motive of cash reserves is also valid for the relation between the cash ratio and listed acquisitions.
6. Conclusion
20 make a distinction between financially constrained and unconstrained firms to explain the effect of cash-rich firms on acquisitions.
We find no relation between the excess cash ratio and the probability to announce one or more acquisitions for the period 2000-2015. This is the case for both financially constrained firms as well as financially unconstrained firms. Therefore, we neither find a confirmation for the agency theory of free cash flow nor for Gao’s theory of the precautionary motive of cash reserves. However, for the period after the financial crisis, we do find a negative relation between cash-rich firms and the probability to announce an acquisition and this relation is primarily caused by unconstrained firms. Therefore, we find evidence for the agency theory related to stockpiling cash and argue that, since the financial crisis, unconstrained firms with high excess cash ratios prefer to accumulate cash and gain flexibility instead of spending cash on acquisitions. In contrast, for financially constrained firms we found a positive relation between the excess cash ratio and acquisitions after the crisis. Therefore we conclude that, since the financial crisis, accumulating cash for precautionary motives has become less important for financially constrained firms. However, for financially unconstrained firms the agency theory may have shifted from spending cash on excess investments to stockpiling cash for safety and flexibility. Finally, we find that financially constrained firms with a high excess cash ratio have a lower probability to announce a listed acquisition. Therefore we, nevertheless, find evidence for Gao’s theory that the negative relation between cash-rich firms and acquisitions is related to financially constrained firms that accumulate cash for precautionary motives. However, this theory applies only to listed acquisitions.
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24 Table 1 – Mean and median cash ratio in year t-1 related to announcement year t for the period 2000-2015
Year 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Average/ Overall Mean All 0.14 0.18 0.18 0.18 0.19 0.20 0.21 0.21 0.20 0.18 0.18 0.19 0.18 0.18 0.19 0.20 0.19 No acquisition 0.14 0.18 0.18 0.18 0.19 0.2 0.21 0.23 0.21 0.18 0.18 0.19 0.19 0.18 0.20 0.21 0.19 Acquisition 0.15 0.18 0.17 0.18 0.16 0.18 0.19 0.17 0.15 0.18 0.16 0.17 0.14 0.14 0.15 0.15 0.17 Median All 0.08 0.09 0.08 0.09 0.10 0.12 0.13 0.13 0.12 0.11 0.11 0.11 0.11 0.10 0.11 0.11 0.11 No acquisition 0.07 0.08 0.08 0.09 0.10 0.12 0.13 0.15 0.13 0.10 0.11 0.12 0.11 0.11 0.11 0.13 0.11 Acquisition 0.09 0.10 0.08 0.10 0.10 0.11 0.13 0.11 0.09 0.11 0.09 0.11 0.08 0.09 0.10 0.08 0.10
25 Table 2 – Mean cash ratio in year t-1 related to announcement year t of financially constrained and unconstrained firms for the period 2000-2015 Year 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Average Constrained All 0.18 0.24 0.25 0.25 0.25 0.26 0.28 0.29 0.26 0.24 0.23 0.24 0.24 0.24 0.25 0.27 0.25 No acquisition 0.17 0.23 0.25 0.24 0.25 0.26 0.28 0.30 0.27 0.24 0.23 0.25 0.24 0.24 0.26 0.27 0.25 Acquisition 0.23 0.28 0.26 0.27 0.25 0.27 0.26 0.25 0.20 0.27 0.26 0.23 0.22 0.23 0.23 0.24 0.25 Unconstrained All 0.10 0.11 0.11 0.11 0.12 0.13 0.14 0.14 0.13 0.12 0.12 0.13 0.12 0.11 0.12 0.12 0.12 No acquisition 0.10 0.11 0.11 0.11 0.12 0.13 0.14 0.15 0.13 0.12 0.13 0.13 0.13 0.12 0.12 0.13 0.12 Acquisition 0.10 0.13 0.12 0.13 0.12 0.13 0.13 0.13 0.13 0.12 0.11 0.14 0.11 0.10 0.12 0.11 0.12
26 Table 3 – Descriptive statistics for the 2000-2015 sample period
N Mean Median Max Min Std. Dev.
Total sample
ACQUISITION 29,600 0.151 0.000 1.000 0.000 0.358
CASH RATIO 17,878 0.187 0.107 0.734 0.001 0.206
EXCESS CASH RATIO 14,735 -0.001 -0.032 0.355 -0.224 0.149
GROWTH 15,370 1.177 1.077 2.476 0.543 0.431 NCWC 17,266 -0.028 -0.019 0.297 -0.431 0.177 MB RATIO 16,275 2.580 1.686 10.463 -0.450 2.678 LEVERAGE 17,895 1.094 0.734 5.461 -1.818 1.567 SIZE 17,888 7.637 7.581 9.529 5.930 0.991 CONSTRAINED 17,888 0.500 0.000 1.000 0.000 0.500 Constrained ACQUISITION 8,938 0.160 0.000 1.000 0.000 0.367 CASH RATIO 8,932 0.251 0.169 0.734 0.001 0.239
EXCESS CASH RATIO 6,915 0.003 -0.043 0.608 -0.546 0.206
GROWTH 6,873 1.214 1.086 2.476 0.543 0.519 NCWC 8,630 -0.038 -0.018 0.297 -0.431 0.197 MB RATIO 7,835 2.724 1.637 10.463 -0.450 2.993 LEVERAGE 8,934 0.770 0.410 5.461 -1.818 1.524 SIZE 8,938 6.826 6.893 7.761 5.930 0.510 Unconstrained ACQUISITION 8950 0.299 0.000 1.000 0.000 0.458 CASH RATIO 8,946 0.124 0.076 0.734 0.001 0.140
EXCESS CASH RATIO 7,820 -0.002 -0.029 0.686 -0.369 0.124
GROWTH 8,486 1.147 1.073 2.476 0.543 0.340
NCWC 8,636 -0.019 -0.021 0.297 -0.431 0.153
MB RATIO 8,437 2.446 1.715 10.463 -0.450 2.339
LEVERAGE 8,950 1.420 1.060 5.461 -1.818 1.542
SIZE 8,950 8.446 8.330 9.529 7.419 0.626
27 Table 4 – The effect of the excess cash ratio on the probability to announce one or more acquisitions for constrained and unconstrained firms for the period 2000-2015
Constrained Unconstrained All firms
(1) (2) (3) (4)
EXCESS CASH RATIO 0.215 -0.276 -0.104 -0.376
(0.229) (0.197) (0.487) (0.099) GROWTH 0.368** 0.282** 0.321** 0.321** (0.000) (0.000) (0.000) (0.000) NCWC -0.583** -0.340* -0.446** -0.465** (0.002) (0.042) (0.000) (0.000) MB RATIO 0.042** 0.088** 0.071** 0.070** (0.001) (0.000) (0.000) (0.000) LEVERAGE 0.012 -0.051** -0.034* -0.031* (0.656) (0.008) (0.026) (0.047) SIZE 0.417** 0.470** 0.537** 0.463** (0.000) (0.000) (0.000) (0.000) CRISIS -0.290** -0.409** -0.371** -0.370** (0.006) (0.000) (0.000) (0.000) CONSTRAINED -0.180** (0.009) EXCESS CASH RATIO
* CONSTRAINED 0.508 (0.098) C -5.046** -5.174** -5.797** -5.150** (0.000) (0.000) (0.000) (0.000) NUMBER OF OBSERVATIONS 5,844 7,604 13,448 13,448 MC FADDEN R2 0.016 0.028 0.048 0.049
This table reports the logistic regression estimates of the effects of a firms excess cash ratio on its probability to announce one or more acquisitions for the period 2000-2015. All variables are lagged and winsorized at a 5% and 95% tail. The dependent variable is 1 if a firm announces at least one acquisition in year t and 0 otherwise. EXCESS CASH RATIO is measured as the residual from a regression that estimates the target level of the cash ratio. GROWTH is the annual sales growth between year t and t-1. NCWC is measured as working capital net of cash and short-term investments to total assets. MB RATIO is the market-to-book ratio of the firm measured by the market value of equity to the book value of equity. LEVERAGE is the book value of debt to the book value of equity. SIZE is measured as the natural logarithm of a firm’s total assets. CONSTRAINED is a dummy variable indicating 1 for financially constrained firms and 0 otherwise. EXCESS CASH RATIO*CONSTRAINED is an interaction variable that capture the effects of a financially constrained firm on the relation between the cash residual and the probability to announce an acquisition. CRISIS is a dummy variable equaling 1 for the years 2008 and 2009 respectively, and 0 otherwise. The coefficients are reported together with the p-Values in the parentheses.
28 Table 5 – The effect of the excess cash ratio on the probability to announce one or more acquisitions for the periods before and after the crisis
This table reports the logistic regression estimates of the effects of a firms excess cash ratio on its probability to announce one or more acquisitions for the period 2000-2009 and 2010-2015. All variables are lagged and winsorized at a 5% and 95% tail. The dependent variable is 1 if a firm announces at least one acquisition in year
t and 0 otherwise. EXCESS CASH RATIO is measured as the residual from a regression that estimates the target
level of the cash ratio. GROWTH is the annual sales growth between year t and t-1. NCWC is measured as working capital net of cash and short-term investments to total assets. MB RATIO is the market-to-book ratio of the firm measured by the market value of equity to the book value of equity. LEVERAGE is the book value of debt to the book value of equity. SIZE is measured as the natural logarithm of a firm’s total assets. CONSTRAINED is a dummy variable indicating 1 for financially constrained firms and 0 otherwise. EXCESS CASH RATIO*CONSTRAINED is an interaction variable that capture the effects of a financially constrained firm on the relation between the cash residual and the probability to announce an acquisition. CRISIS is a dummy variable equaling 1 for the years 2008 and 2009 respectively, and 0 otherwise. The coefficients are reported together with the p-Values in the parentheses.
* Significant at 5%; ** Significant at 1%
Before crisis (2000-2009) After crisis (2010-2015)
(1) (2) (3) (4)
EXCESS CASH RATIO 0.234 0.269 -0.689** -1.481**
(0.207) (0.342) (0.008) (0.000) GROWTH 0.347** 0.348** 0.167* 0.164 (0.000) (0.000) (0.049) (0.056) NCWC -0.572** -0.571** -0.376 -0.423* (0.000) (0.000) (0.056) (0.034) MB RATIO 0.061** 0.061** 0.077** 0.073** (0.000) (0.000) (0.000) (0.000) LEVERAGE -0.025 -0.026 -0.060* -0.049 (0.202) (0.199) (0.016) (0.055) SIZE 0.516** 0.499** 0.603** 0.496** (0.000) (0.000) (0.000) (0.000) CRISIS -0.544** -0.543** (0.000) (0.000) CONSTRAINED -0.042 -0.255* (0.631) (0.030)
EXCESS CASH RATIO
29 Table 6 – The effect of the excess cash ratio on the probability to announce a listed acquisition for the period 2000-2015
(1) (2)
EXCESS CASH RATIO -1.352 -0.218
(0.552) (0.924) GROWTH 0.948 0.981 (0.086) (0.061) NCWC -2.854 -2.565 (0.147) (0.154) MB RATIO 0.211** 0.225** (0.001) (0.001) LEVERAGE -0.218 -0.227 (0.361) (0.334) SIZE 1.107** 0.731 (0.000) (0.086) CRISIS 0.586 0.570 (0.364) (0.380) CONSTRAINED -11.607** (0.000) EXCESS CASH RATIO *
CONSTRAINED -52.724** (0.000) C -17.708** -14.340** (0.000) (0.000) NUMBER OF OBSERVATIONS 12,214 12,214 MC FADDEN R2 0.099 0.123
This table reports the logistic regression estimates of the effects of a firms excess cash ratio on the probability to announce a listed acquisition in the period 2000-2015. The panel data set only includes firm-years where a company announced zero or exactly one acquisition. All variables are lagged and winsorized at a 5% and 95% tail. The dependent variable is 1 if a firm announces a listed acquisition year t, respectively, and 0 otherwise. EXCESS CASH RATIO is measured as the residual from a regression that estimates the target level of the cash ratio. GROWTH is the annual sales growth between year t and t-1. NCWC is measured as working capital net of cash and short-term investments to total assets. MB RATIO is the market-to-book ratio of the firm measured by the market value of equity to the book value of equity. LEVERAGE is measured as the book value of debt to the book value of equity. SIZE is measured as the natural logarithm of a firm’s total assets. CONSTRAINED is a dummy variable indicating 1 for financially constrained firms and 0 otherwise. EXCESS CASH RATIO*CONSTRAINED is an interaction variable that capture the effects of a financially constrained firm on the relation between the cash residual and the probability to announce an acquisition. CRISIS is a dummy variable equaling 1 for the years 2008 and 2009 respectively, and 0 otherwise. The coefficients are reported together with the p-Values in the parentheses.
30 Table 7 – The effect of the cash ratio on the probability to announce one or more acquisitions for constrained and unconstrained firms for the period 2000-2015
Constrained Unconstrained All firms
(1) (2) (3) (4) CASH RATIO -0.017 -0.387 -0.245 -0.316 (0.921) (0.054) (0.057) (0.102) GROWTH 0.339** 0.278** 0.303** 0.304** (0.000) (0.000) (0.000) (0.000) NCWC -0.653** -0.381* -0.506** -0.512** (0.000) (0.022) (0.000) (0.000) MB RATIO 0.045** 0.095** 0.076** 0.076** (0.001) (0.000) (0.000) (0.000) LEVERAGE 0.002 -0.068** -0.047** 0.003** (0.932) (0.001) (0.003) (0.001) SIZE 0.423** 0.438** 0.513** 0.436** (0.000) (0.000) (0.000) (0.000) CRISIS -0.327** -0.428** -0.395** -0.396** (0.002) (0.000) (0.000) (0.000) CONSTRAINED -0.218** (0.006) CASH RATIO * CONSTRAINED 0.154 (0.521) C -5.033** -4.851** -5.543** -4.857** (0.000) (0.000) (0.000) (0.000) NUMBER OF OBSERVATIONS 6,172 7,871 14,043 14,043 MC FADDEN R2 0.016 0.027 0.047 0.048
This table reports the logistic regression estimates of the effects of a firms cash ratio on its probability to announce one or more acquisitions for the period 2000-2015. All variables are lagged and winsorized at a 5% and 95% tail. The dependent variable is 1 if a firm announces at least one acquisition in year t and 0 otherwise. CASH RATIO is measured as cash and short-term investments to total assets. GROWTH is the annual sales growth between year t and t-1. NCWC is measured as working capital net of cash and short-term investments to total assets. MB RATIO is the market-to-book ratio of the firm measured by the market value of equity to the book value of equity. LEVERAGE is the book value of debt to the book value of equity. SIZE is measured as the natural logarithm of a firm’s total assets. CONSTRAINED is a dummy variable indicating 1 for financially constrained firms and 0 otherwise. CASH RATIO*CONSTRAINED is an interaction variable that capture the effects of a financially constrained firm on the relation between the cash ratio and the probability to announce an acquisition. CRISIS is a dummy variable equaling 1 for the years 2008 and 2009 respectively, and 0 otherwise. The coefficients are reported together with the p-Values in the parentheses.
31 Table 8 – The effect of the cash ratio on the probability to announce one or more acquisitions for the periods before and after the crisis
This table reports the logistic regression estimates of the effects of a firms cash ratio on its probability to announce one or more acquisitions for the period 2000-2009 and 2010-2015. All variables are lagged and winsorized at a 5% and 95% tail. The dependent variable is 1 if a firm announces at least one acquisition in year
t and 0 otherwise. CASH RATIO is measured as cash and short-term investments to total assets. GROWTH is
the annual sales growth between year t and t-1. NCWC is measured as working capital net of cash and short-term investments to total assets. MB RATIO is the market-to-book ratio of the firm measured by the market value of equity to the book value of equity. LEVERAGE is the book value of debt to the book value of equity. SIZE is measured as the natural logarithm of a firm’s total assets. CONSTRAINED is a dummy variable indicating 1 for financially constrained firms and 0 otherwise. CASH RATIO*CONSTRAINED is an interaction variable that capture the effects of a financially constrained firm on the relation between the cash ratio and the probability to announce an acquisition. CRISIS is a dummy variable equaling 1 for the years 2008 and 2009 respectively, and 0 otherwise. The coefficients are reported together with the p-Values in the parentheses. * Significant at 5%; ** Significant at 1%
Before crisis (2000-2009) After crisis (2010-2015)
32 Table 9 – The effect of the cash ratio on the probability to announce a listed acquisition for the period 2000-2015
(1) (2) CASH RATIO -1.621 -0.501 (0.458) (0.802) GROWTH 0.939 1.006 (0.094) (0.074) NCWC -2.950 -2.882 (0.143) (0.132) MB RATIO 0.238** 0.247** (0.002) (0.002) LEVERAGE -0.264 -0.265 (0.282) (0.275) SIZE 1.044** 0.676 (0.000) (0.117) CRISIS 0.586 0.588 (0.365) (0.364) CONSTRAINED 0.088 (0.948) CASH RATIO * CONSTRAINED -25.172** (0.000) C -17.006** -13.934** (0.000) (0.001) NUMBER OF OBSERVATIONS 12,761 12,761 MC FADDEN R2 0.099 0.119
This table reports the logistic regression estimates of the effects of a firms cash ratio on the probability to announce a listed acquisition in the period 2000-2015. The panel data set only includes firm-years where a company announced zero or exactly one acquisition. All variables are lagged and winsorized at a 5% and 95% tail. The dependent variable is 1 if a firm announces a listed acquisition year t, respectively, and 0 otherwise. CASH RATIO is measured as cash and short-term investments to total assets. GROWTH is the annual sales growth between year t and t-1. NCWC is measured as working capital net of cash and short-term investments to total assets. MB RATIO is the market-to-book ratio of the firm measured by the market value of equity to the book value of equity. LEVERAGE is measured as the book value of debt to the book value of equity. SIZE is measured as the natural logarithm of a firm’s total assets. CONSTRAINED is a dummy variable indicating 1 for financially constrained firms and 0 otherwise. CASH RATIO*CONSTRAINED is an interaction variable that capture the effects of a financially constrained firm on the relation between the cash ratio and the probability to announce an acquisition. CRISIS is a dummy variable equaling 1 for the years 2008 and 2009 respectively, and 0 otherwise. The coefficients are reported together with the p-Values in the parentheses.
33
Appendix A. Estimating cash-rich firms by means of the cash residual.
Table A1 - OLS regression estimates of the cash ratio from 1999-2014
This table reports the OLS regression estimates of the cash ratio from 1999 to 2014. This analysis is based on a panel dataset including all UK listed firms. All variables are winsorized at a 5% and 95% tail. The dependent variable is the CASH RATIO and is measured as cash and short-term investments to total assets. MB RATIO is the market-to-book ratio of the firm measured by the market value of equity to the book value of equity. CASHFLOW RATIO is the operating income before depreciation net of interest expense, tax and dividend payment to total assets. NCWC is measured as working capital net of cash and short-term investments to total assets. CAPEX RATIO is the capital expenditure to total assets. LEVERAGE is measured by means of the book value of debt to the book value of equity. DIVIDEND is a dummy variable reporting 1 if a company pays dividend in year t and 0 otherwise. P-Values are in parentheses. The cash residual, as a proxy for cash-rich firms, is the residual from this regression.
34
Appendix B. Creation of the dataset
Table B1 – Creation of the potential acquirer sample
Table B2 – Creation of the acquisition sample
Criteria Nr. of remaining
acquisitions
Acquisitions announced between 2000-2015 556,519
Acquirer listed and delisted; target listed, delisted and unlisted 338,058
UK acquirer (ISIN GB) 13,099
Acquisitions of majority interests 11,690
Criteria Nr. of remaining firms
All active companies Orbis 163,507,140
United Kingdom 5,598,012
Publicly listed and formerly public listed 3,622
ISIN GB 3,185
Exclude financial and utility firms 2,008
Exclude firms with no information about cash & short-term investments
35
Appendix C. Correlations between the individual variables occurring in the regression analysis.
Table C1 – Correlation table
1 2 3 4 5 6 7 8
1 ACQUISITION 1.000
2 EXCESS CASH RATIO -0.004 1.000
3 GROWTH 0.038 -0.015 1.000 4 NCWC -0.036 -0.023 -0.016 1.000 5 MB RATIO 0.078 0.016 0.118 -0.093 1.000 6 LEVERAGE 0.070 0.018 -0.042 -0.138 0.429 1.000 7 SIZE 0.203 0.007 -0.081 0.027 -0.019 0.261 1.000 8 CRISIS -0.054 0.007 0.067 -0.013 -0.023 0.003 -0.027 1.000
