University of Groningen
Faculty of Economics and Business
The influence of home and host institutional
factors on outward M&As performance – A
comparative study between Chinese and Indian
strategies of internalization
MSc Thesis in IE&B
Student name: S. da Costa Lamego (s2047462)
Student e-mail: sara.lamego@gmail.com
Thesis supervisor: Dr. Killian J. McCarthy
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Abstract
In the last decades the fast increase of outward M&A from emerging countries has attracted world’s attention. Using a sample of 203 Chinese OM&As and 491 Indian OM&As within 2001 and June of 2011, value creation of outward M&A by firms of two major Asian emerging countries are investigated. Considering the resource based view we conclude that international acquisitions by emerging economies contributes to firm’s performance. Furthermore, we test how differences in home and host institutional environment influence shareholder value. We conclude that in the context of emerging countries government support may insert positive influence on OM&As performance.
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1. Introduction
The increase of outward Foreign Direct Investment (FDI) from emerging countries has attracted the world’s attention, and it is one of the most important questions in the 21st century International Business research agenda (Mathews, 2006). In 2010, six emerging economies including China and India are part of the top-20 investors in terms of outward FDI flows (UNCTAD, 2011). China outward foreign direct investments (OFDI) reached a historical peak of 68 billion dollars, growing more than 10 billion dollars compared to 2009 (UNCTAD database). Particularly, it is interesting to detect that investments of both China and India are been promoted by increasing volumes of overseas merger and acquisitions (OM&As) with some of the deals valued at more than 1 billion dollars (UNCTAD, 2010). As is visualized in graph one, OM&A experienced a remarkable increase in the last decade. In 2010, China’s overseas acquisitions involved a deal value of around 29.2 billion dollars and a total of 26.4 billion dollars in the case of India (UNCTAD, 2011)1. M&A represent the main internationalization mode for emerging market companies to enter foreign markets (Sun, et al., 2010).
In general the last numbers shows that cross-border M&As from China and India have been increasing significantly, yet, in 2009, in general M&As from all over the world decline due the current financial crisis. Particularly, in this case is interesting to notice that India’s cross-border M&As shows a more considerable drop comparing to China, and in 2010 China was leading the recovery in cross-border M&As. However, besides the decline in 2009, overseas acquisitions activities by Indian MNEs are increasing considerably showing a fast recovery during 2010. Moreover, as predicted by UNCTAD’s World Investment Prospects Survey 2011–2013 (WIPS) investments from emerging economies are expected to increase their importance in the global economic environment and there are evidences to believe that overseas acquisitions from these countries will tend to continue growing in the following years. Furthermore, is important to notice that these investments are being conducted in a relative earlier time of their economic progress compare to developed countries (WIR, 2006). OM&As from emerging economies are definitely challenging the traditional theory of internationalization (Fortanier & Tulder, 2009) and seems essential to understand more about such strategies.
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5 *Source: Thomson One Banker Financial.
The question is, are being Chinese and Indian companies capable to gain from the synergies promoted by overseas M&As? What are the main drivers behind OM&A by emerging countries? In particular, how do Chinese and Indian institutional context dissimilarities influence OM&As?
Several articles and some studies have been addressing the rise of outward M&As by emerging countries and particularly there is a significant interest on China and India patterns of internalization. Nevertheless, literature remains very limitative to explain the impact of such strategies on firm acquirer’s performance. Of the few studies addressing this issue, there is a lack of statistical significant quantitative data due to the exigency of some measures. At the moment Gu & Reed (2010) for China and Gubbi, et al. (2010) for India are the main studies with enough sample size providing some conclusions about OM&As contribution to firm’s performance. Despite the dissimilar approaches is interesting to notice that both authors find that Chinese or Indian outward investments leads to an increase of shareholder’s value. Moreover, Bhagat, et al. (2011) investigating about emerging economies cross-border acquisitions and acquirers returns shows that the strategic orientations behind firms from emerging markets contributes to firm’s performance. Is question to under if emerging economies strategies of internalization and special emphasis on outward M&As diverge from the inconclusive evidence regarding OM&As from developed countries (e.g. Andrade, et al., 2001; Moeller & Schlingemann, 2005; Kuipers, et al.,
0 20 40 60 80 100 120 140 160 180 200 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010
Graph 1. The increase of OM&As by Chinese and Indian MNEs (1990 - 2010)
Number of effective deals per year*
6 2009). Therefore, in this study we will reconsider the impact of emerging economies strategies on firm’s attribution of value. Moreover, we extend our analysis to the influence of the institutional environment on OM&As performance. China and India are chosen in this context given their similar levels of development in the last years but different political and institutional contexts that affects their patterns of internationalization. To our knowledge a comparative analysis between Chinese and Indian OM&As regarding the relevance of home institutional environments and the affect on firm’s performance is not yet been done. Literature usually centres their attention on the host country government influences and business environment however is rather limitative to explain the influence of home country interactions on MNEs (Luo, et al. 2010). An institutional based view approach to explain firm’s performance has been considered in the recent literature (e.g. David et al., 2000; Hitt, et al., 2004 and Peng, et al., 2008). As consequence macro-level factors such as the role of legal and regulatory institutions are consider in our study. The integration of a recourse based view and an institutional based view can provide a more comprehensive analysis on the factors influencing firm’s performance. Furthermore we investigate the context of direct government financial support influencing Chinese acquisitions.
7 between acquisitions made in developing and developed countries entails non significant results in case of China.
The rest of the paper is organized as follows. Section two provides a thorough discussion of the relevant literature explaining the determinants and value creation of OM&As. Moreover the recourse- and institutional-based views are considered to construct our relevant hypotheses. Section three elaborates the research methodology used to test the hypotheses. Section four examines the results, sections five provides a comprehensive discussion of the results. The final sections draw important conclusions and provide guidelines for future research.
2. Literature Review
In this section, the motivations behind emerging market MNEs to expand abroad are elaborated. Furthermore, literature on outward M&As leading to creation of shareholder’s value are examined. In other words, why do Chinese and Indian firms look for opportunities outside their national boundaries? Moreover, why do these companies use M&A as their primarily vehicle of internationalization? Are shareholder’s interests being assured? In which extent does the intuitional context influences Chinese and Indian outward M&As and investors behaviour?
2.1. Determinants behind OM&As
Traditionally, conventional literature on outward M&A research focussed on economic perspectives such as the Dunning’s ownership location internalization (OLI) and the theory of transaction cost economics (TCE), as is appointed by several authors as Chiles & McMackin (1996) to explain why companies adopt such strategies to enter foreign markets. This stream focused on minimization of risks and transaction costs in order to choose whether a firm adopts OM&As as their primary mode of internalization over other forms of FDI. The economic theory also explains that one of the main reasons why M&As occurs is related with the creation of synergies (Capron, et al. 1998). These ―synergies‖ attend to gain economies of scale and are a way to promote efficiency gains and perhaps forming monopolies or oligopolies.
8 et al. 2007 and Sun, et al., 2010). According to a organizational learning perspective Mathews (2006) argues that international acquisitions from emerging countries is mainly driven by resource linkage and learning processes. Emerging economies ambidexterity faced in their environment, both at home and abroad leverage firms ―evolution, competence, co-competition and co-orientation‖ (Luo & Rui, 2009). In the same line, Shimizu, et al. (2004) suggests that international acquisitions are a form to increase firms’ knowledge and this process tend to be dynamic. Furthermore, the ―springboard‖ perspective suggested by Luo & Tung (2007), argues that firms from emerging countries undertake international acquisitions as a form to acquire strategic resources and diminish their market constrains. International acquisitions can therefore be a way to access important tangible and intangible resources Gubbi, et al. (2010), strengthen technological capabilities (Rui & Yip, 2008) and acquire strategic assets (Deng, 2007, 2009). As complementary, the industry-based view argues that some conditions within an industry is likely to influence firm value, has can happen with industries involving high technology, however, this theory emphasizes the efficiency gains as one of the primary reasons to outward M&As occur (Sun, et al., 2010).
Furthermore, recent literature has focus on the institution-base view to underline other important factors behind strategies of internationalization (e.g. Lau, et al., 2007; Lin & Peng, 2009; Meyer & Peng, 2005). An institutional theory considers that ―institutional pressures and organizational characteristics influence organizations to adopt environmental management practices‖ (Delmas & Toffel, 2004). According to Davis et al. (2000) the internal isomorphism in the home country is one of the primary influences on the choice of internationalization. Furthermore, Peng, et al. (2008) emphasizes the importance of institutional factors on encouraging or constrain international acquisitions.
2.2. Value Creation of Outward M&As
9 as Moeller & Schlingemann (2005) and Kuipers, et al. (2009) show a negative relationship between OM&A and firm performance. For instance, Denis et al. (2002) suggests that global diversification reduces shareholder value. In the same line, Aw and Chatterjee (2004) find a significant negative return and point out that, among other reasons, cultural differences might be a cause for value destruction related to acquiring companies.
The majority of literature addressing the question whether OM&A contributes to shareholder value is dominated by data from acquirers of developed countries, for instance data related to the United States of America (USA). At this moment, literature measuring the performance of outward M&As by emerging economies MNEs is rather limited.
Nevertheless, in contrast to incentives of developed country MNEs for investing abroad, recent literature investigating OM&As by emerging countries find important distinctions of the motivations behind the international acquisitions (Beausang, 2003; Buckley, 2004; Kumar, 2009).
2.2.1. Emerging economies MNEs and their strategies – a special case?
In contrast to companies from developed countries that engage in M&As principally for efficiency reasons (Kumar, 2009), firms from emerging economies usually undertake cross-border M&As to access critical resources that may be not accessible in their domestic market (Gubbi, et al., 2010). Hence, these emerging market MNEs use international expansion to overcome their competitive disadvantages (Rui & Yip, 2008). Examples of disadvantages of emerging market companies are a lack of technological and managerial knowledge, lack of recognized brand name, inability to supply foreign markets. Disadvantages that became more severe with the increase of competition in the domestic market at the time China and India open their doors to liberalization.
10 compared to firms in Western countries. In contrast to scholars finding a negative relationship between OM&A and firm performance, recent literature suggests a positive relationship. For example, Bhagat, et al. (2011) analyzes 698 OM&As made by emerging market MNEs between 1991 and 2008. Evidence is found in favour of a positive relationship of OM&A announcements and stock returns. Hence, investors express confidence in the OM&A conducted by firms originated from Brazil, China, India, Malaysia, Mexico, Philippines, Russia, and South Africa. Furthermore, a sound environment characterised by developed corporate governance measures in the target country increases the performance of emerging economy acquirer (Bhagat et al. 2011). In the same line, a study conducted by Gubbi et al. (2010) show that international activities of Indian MNEs increase firm performance. Based on a sample of 425 OM&As during the period of 2000 till 2007, they find an overall positive and significant cumulative abnormal stock returns related to the announcement of OM&A activities. Gu & Reed (2010) examine 145 Chinese OM&As completed between 1994 to 2008 and based on the cumulative abnormal return analysis they find also a positive relationship between investments abroad and the performance of the related Chinese enterprises.
11 combined with access to critical resources may therefore lead to a creation of important competitive advantages essential to Chinese and Indian MNEs.
Chinese and Indian firms tend to make friendly acquisitions with long term strategic perspectives (Sun, et al, 2010). These determinants are shown in literature to insert a positive influence on M&A performance. Long term perspectives from acquirer companies, unlike short-term profit orientation generally linked to developed countries, are likely to lead to a gradual integration of the target business process, with fewer interventions and lower employee-turnover. These characteristics have positive influence on acquirer’s performance since a smooth transition increases the likelihood of a solid integration of important resources (Zollo & Meier, 2008). Friendly acquisition promotes integration over hostile ones. The management from the target company can be reluctant to the new ownership, which may lead to a decrease of likelihood of a successful acquisition. Following these arguments we propose:
Hypothesis 1. Outward M&As from both China and India contribute positively to an increase of
shareholder value.
2.2.2. Institutional factors influencing Chinese and Indian OM&As
The literature above focussed on the main motivations behind OM&As from emerging economies as China and India from a resource and strategic point of view. Nevertheless, literature has found that the institution-based view seem to play a considerable role on facilitating or constraining strategies of internationalization of emerging economies (Luo et al., 2010; Peng et al., 2008).
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2.2.2.1 China’s institutional context
In the context of China, market-oriented economic reforms started around 1978 and have been implemented in a gradualist way (Buck et al., 2000). Before the 70s, economic performance and operational efficiency were insignificant factors to a certain extent (Naughton, 1995). However, during the 80s and 90s important reforms were undertaken to improve State-owned enterprise (SOE) performance. Two principal stock markets were created in Shanghai and Shenzhen. Moreover, the introduction of China’s Go Global policy in 1999 and the entrance of the World Trade Organization (WTO) in 2001 are at the basis of a significant increase in overseas M&As by Chinese firms in the last decade.
As a consequence of Chinese Go Global policy, Chinese MNEs are being able to gain from critical advantages of OM&As that are shaping the strategies of Chinese internalization. Relative to domestic firms that face strong rigid approval regulations to undertake M&As, firms with perspectives of internalization are encouraged to conduct OM&As (Xiao & Sun, 2005). The government intensively promotes these investments to ensure that there are ―sufficient resources to sustain China’s growth over the middle to long-term‖, ―reducing appreciation pressures on China’s currency‖ and to contribute to ―modernize Chinese business‖ (Gu, et al., 2010).
The role of the Chinese government behind outward FDI is recognized by several authors like Deng (2007); Rui & Yip (2008) and Morck, et al. (2008). Qiang, 2003 identifies that Chinese corporate governance relies on unique institutional system deeply involved in the Chinese political ideologies. For the Chinese Communist Party (CCP) development of economic prosperity is a way of ensuring political power (Bremmer, 2009). Famous sentences of Deng Xiaoping2 such as ―to get rich is glorious‖ and ―poverty is not socialism‖ suggest a new mentality relatively to ―old‖ socialism, but it also does not relax the intention of loosening government control.
The government is still the largest shareholder of the majority of the listed firms (Huang, 2008; Lau, 2007). Chinese business enterprises are under Chinese government control in diverse ways. If not by direct ownership, it can be in an indirect form via government control of shares. Besides that, managers are subject to national, provincial and municipal political control that influences Chinese M&A investments (Gu, et al., 2010). According to Liu (2005) Chinese listed
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13 firms are controlled around 61.4 percent by the local government, 15.3 percent by the central government and 3.4 by a cooperation of other forms of government control. Merely 12.8 percent was identified as only private controlled3. A significant part of the shares of Chinese listed firms is detained by the state or by legal persons which is usually an institutions with political influences, as the local government (Green, 2003; Sun, et al., 2002).
The state capitalism suggested by Bremmer (2009) or the state-led brand of capitalism referred by Huang (2008) is not only linked with the role of the Chinese government behind firm control, but is related to financial considerations as well. Significant accumulations of capital reserves allow intensive promotion of the Go Global policy. Chinese international acquisitions are mainly supported by direct government capital injections or are facilitated by the financial system. In a recent report develop by Green (2003) in association with the Cambridge University show that banks hold a dominant role in allocating capital in the Chinese economy. Besides that, the financial system is mainly monopolized by state-owned Chinese banks that are promoting easy access to capital, with low interest rates and extensive long term loans. These characteristics provide Chinese enterprises with singular advantages that have been promoting the increase of outward FDI and facilitating the financial support to conduct OM&As.
In 2003, private firms had the first opportunity to pursue international acquisitions. However, they still face serious restrictions (Sun, et al. 2010). Political considerations are likely to significantly increase of OM&As because of the financial and regulatory support provided by the Chinese government.
2.2.2.2. India’s institutional context
India’s first step in the turn to a market oriented economy started around the 80s. In the year 1991 decisive liberalization policies were introduced by Narsimha Rao4 that changed the route of India’s economic environment.
Two remarkable changes in the industrial policy were the opening up to FDI and the large privatizations. Out of eighteen industries initially under state control fifteen were privatized, maintaining only ―defence aircrafts & warships, atomic energy generation and railway transport‖ under state control (Ahluwalia, 2002).
3
The remains 7 percent could not be truly identified do to lake of ownership details.
14 The Bombay Stock Exchange (BSE) was established in 1875 and remained until 1991 the only stock market in India. With the reforms in the 90s other institutions were created. The foundation of the Securities and Exchange Board of India (SEBI) was important in the evolution of the Indian stock market and contributed to an increase in confidence of foreign investors to purchase shares of listed Indian firms. The National Stock Exchange of India (NSE) and the National Securities Clearing Corporation (NSCC) were created in this time.
Considering the role of investments’ credit allocation, Indian firms face considerable difficulties when undertaking OM&As. Local banks are restricted in many ways to offer funding of international investments (Afsharipour, 2011). One of the major concerns in financial policies is the prevention of bad loans by the banking sector. India allowed the entrance of commercial banks (Sáez, 2001). Furthermore, the Reserve Bank of India (RBI) put restrictions on the financial outflow by Indian banks to protect the sustainability of their financial system. ―Per existing instructions banks are not allowed to finance the promoters’ contribution towards the equity capital of a company as it should come from their own resources‖5
. Exceptions have to be approved by the Board policy that assures the eligibility of the borrowers and other important financial terms. However, banking presence in overseas M&As has been increasing at the time the market has more confidence in outward investments.
The stock market is an important alternative to provide the capital needed to finance international acquisitions. On the one hand, restrictions of some finance mechanisms, and on the other hand, the evolution of the stock market seems to promote the search for alternative capital support by the stock market. Following Gupta (2005), India has more market oriented mechanisms (comparatively to China), that enable private firms to finance their acquisitions in the stock exchange.
Moreover, some Indian firms are listed in foreign exchange markets and use the jurisdiction’ laws of the target country to obtain access to capital (Afsharipour, 2011). ―India’s state may be weak, but its private companies are strong‖ (The Economist, sep. 2010)6
. Around 70 percent of the total Bombay Stock Exchange’s market capitalization is due to the private owned firms or foreign joint ventures (Farrel & Lund, 2005). Moreover, according to Das
5
http://www.rbi.org.in/scripts/bs_speechesview.aspx?id=320 Overseas Investments by Indian companies - Evolution of Policy and Trends. Smt. Shyamala Gopinath, Deputy Governor, Reserve Bank of India at the International Conference on Indian cross-border presence/acquisitions, Mumbai, January 19, 2007.
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15 (2006) Indian entrepreneurs receive around 80 percent of the total loans. Small and midsize enterprises play an important role in India’s economy leading to more profit considerations.
In short, relative to China, OM&As in India face less financial government support. Moreover, companies investing abroad are faced with higher regulatory restrictions imposed by Indian’s government. On other hand, Indian outward acquisitions face more profit orientation compared to the Chinese environment, which is characterized by considerable political influence behind MNEs internationalization strategies.
2.2.3. Government influence on firm value
Much has been discussed about the role of the government in China’s economy and more specifically about their influence in firm performance. However, research in this area is still limited. Macro and micro economic aspects that firms from emerging economies face raises further concerns linked whether government influence is benefit to firm performance.
16 Morck et al., 2008; Yeung & Liu, 2008). Non-performing loans are a considerable problem in the Chinese bank system (Huang, 2003), which make us wonder until which point the investments are being well conducted. Relative to China, India’s government approach is more towards regulation than facilitation of outward FDI investment. India’s restrictions and regulation have been discouraging the excessive risk that can be behind political oriented investments. According to some authors, like Farrell & Lund (2005) and Huang (2003), India has been able to allocate capital more efficiently, especially to private firms, than China. The precise number is complex to achieve, however, currently non-performing loans are significant higher to China than India (9% of the total loans compared to 40% in China).
These arguments will lead us to consider that Indian firms may be perhaps better performing than Chinese firms engaged in outward acquisitions.
17 On other hand, Indian firms are less dependent of the State than Chinese ones when undertaking outward acquisitions. In this sense they may be pursuing strategies more focussed on profit creation to the shareholders, and investors show investment patters more similar to western countries.
Following the arguments above and the basis of an institutional based view we assume that Chinese and Indian institutional contextual dissimilarities insert influence on MNEs strategies. Moreover, as suggested by Buckley, et al. (2007) we consider that market imperfections of China may leverage Chinese ownership advantages. In this sense we propose the following hypothesis:
Hypothesis 2a: The role of the government in China has a positive impact on Chinese outward
M&As that leads to an increase of investors’ confidence comparatively to Indian ones.
Hypothesis 2b: Higher investors’ confidence contributes to higher abnormal returns to
shareholders.
2.2.4. Localization of Chinese and Indian OM&As and perceptions of risk
In this section we reconsider the institutional based view to observe the host country institutional environment. Following the arguments above, we argue that the dissimilarities between Chinese and Indian institutional context may influence investor’s reaction about the localization of outward M&As. Two points of view are formulated to investigate the impact of risk assessment by the investors.
2.2.4.1. Poor institutional environments
18 Ramasamy, et al. (2010) find evidence that Chinese international acquisitions are attracted to risky political environments. These studies suggest that regarding institutional aspects, Chinese seem to respond in a different way than other investors. This may be regarding the fact that Chinese investor’s privilege from critical access to capital and have less discipline of debt. In this sense, the factors behind such acquisitions do not have the same impact as the firm will be concerned mainly with the responsibility to assure their financial viability. As a consequence Chinese international investments tend to be less risk averse (Ramasamy, 2010).
On the other hand, Indian investors face more government constrains when engaging in outward M&As. Comparatively to China, Indian firms lack significant government financial support and may be more susceptible to investments that involve higher levels of uncertainly and risk. Indian investors higher perception to the risk and more profit orientation will therefore consider investments in developing countries and target nations with poor institutional environment as possible harmful for the safety of their investments. Therefore the following hypotheses are proposed:
H3a: Expectations of Chinese investors on firm’s performance are less susceptible to the risk
involved when outward M&A are undertaken in poor institutional environments comparatively to Indian investors’ expectations.
H3b: Indian investors consider investments in developing countries as risky.
2.2.4.2. Advanced institutional environments
19 & Yip (2007) support this idea since the quality of the resources accessible is related with countries with high levels of economic development.
Furthermore, the higher corporate governance of the target company can provide a positive assessment on the acquirer (Martynova & Renneboog, 2008).
The characteristics present above suggest that both Chinese and Indian firms can perceive investments made in developed institutional environments as an opportunity to increase firm value. The less risk associated with the location of these investments and the higher investment protection contributes to increase investors’ confidence. Therefore we argue:
Hypothesis 4. Chinese and Indian MNEs’ performance is positively associated to outward
M&As in host countries with high quality institutional environments.
3. Methodology
3.1 Time period
This study will focus on the OM&As announced and effectively completed between 2001 and the first semester of 2011 to highlight the recent acquisitions done after important policy changes undertaken by China (Go Global policy in 1999 and WTO in 2001) and following one decade of Indian market oriented reforms that started in 1991.
Previous to this period the numbers of international acquisitions were considerable low comparatively and do not seem to have a significant impact. In both cases, for China and India, the higher level of OM&As activity started around 2001 as we can observe in the graph showed during the introduction phase of this paper.
3.2 Data and Sample
20 period of 01/01/2001 till 30/06/2011. In addition, it is essential for the aim of this study that companies have to be listed in the stock market exchange. In this sense, the sample is restricted to deals with an acquirer DataStream code provided by Thomson Financial database. Daily stock return data for each company were collected from Thomson Reuters Datastream database, the world's largest financial statistical database.
The process was separately done for China and India and following the criteria explained in more detail in Appendix (Table 3). We firstly identified a total of 1999 OM&As from China and 1877 OM&As from India to the rest of the world, of which 903 and 1084 were unconditional completed within 01/01/2001 and 30/06/2011, respectively. The sample was sorter by companies listed, with DataStream Code identifier and with stock data available within an estimation period of 200 days. Besides, to increase the quality of the stock information an overlap window of 15 days was used in order to minimize the influence of events done by the same company in a short-period of time. Duplicate events announced in the same day were deleted and two events for each country were not consider in this study since the stock data did not seem to present information comparable to the rest of the sample (did not present stock alterations within a long period in one case and did not present stock values comparable to the other remained companies in order case). Following, McCarthy & Wietzel (2010)7 and in order to make the comparison more reliable events generating higher than 100% abnormal returns were consider outliers and were also excluded from the dataset. One event in the case of China was deleted in this circumstance. Finally, a total of 694 OM&As were collected of which 203 correspond to OM&As undertaken by Chinese firms and 491 by Indian firms.
The announcement day is important for the calculation of M&A performance in this study and is collected from Thomson Financial database. Nevertheless, we correct all announcement days register in weekends to the following Monday at the time the market can actually respond.
Furthermore, Hong-Kong and Macau are considered in our sample as China’s foreign target nations. These two countries are currently Special Administrative Regions (SAR) under the territory of People’s Republic of China (PRC). However, these regions privilege a high degree of autonomy, with distinct political entities which are significantly market orientated. Inclusion
7 By Killian J. McCarthy and Utz Wietzel (2010). Chapter five – Financial Resources (McCarthy, 2010). Additional
21 could misrepresent the reality of the Chinese institutional environment and patterns of internationalization. The sample is representative for the Chinese mainland.
3.3 Measures
3.3.1 Dependent Variable
Different approaches have been adopted within the literature to test M&As performance, they can either be subjective such as qualitative assessments of integration processes efficiency, or objective using financial and accounting figures (Zollo & Miere, 2008).
In the category of the quantitative measures addressing M&As performance the use of event study methodology is commonly used by other researchers to estimate if acquisitions are bringing value to their shareholders. This methodology allow us to measure the impact of a specific event such as a M&As on the value of a firm since it is expected that the market will express a collective opinion and the effects are reflected in the stock market prices of the acquirer company in a relative period of time (Mackinlay, 1997; Binder, 1998; Haleblian et al., 2006). Therefore, if investors expect a firm perform well, and the OM&As is being perceived as a positive strategic movement we will observe an increase of the firm’s share price since otherwise, if the investors expect a firm to do poorly they will eventually short or sell their shares in the company.
22 (McWilliams & Siegel, 1997). Besides, if the event window is too long the likelihood of having contemporaneous and inter-temporal correlations of residuals increases and therefore will lead to significant underestimates of standard errors (Salinger, 1992).
The dependent variable CAR is actually a ―market expectation about firm performance‖ (Zollo & Meier, 2008) and considers the variations of stock market returns around the announcement date to estimate if the value of the bidder increases during the process. The event window of 3 days (-1,+1) is one of the most commonly used to measure cumulative abnormal return within M&As performance research agenda (Andrade, et al., 2001, Moeller, 2004; Weston et al., 2004), and will be considered in order to observe how the investors are reacting one day before (-1) the announcement day (0) and 1 day after of the announcement of 1 day (+1). The short term event window period allow us to ensure that the estimates are less influenced by other events in the market. Moreover, to support my results and to test the efficiency of the information produced by the market different event windows of 5 days 3, +1) and 7 days (-5,+1) will be tested.
The abnormal return is the calculated by the difference between the return produced in the stock market when the event occurs and the expected returns if the event would not had occurred. Therefore, we need to predict the ―normal‖ returns expected for each event (i) at the time of the announcement day. Alternative statistics methods have been used within event study’s methodology to measure normal returns based on a benchmark model.
In similarity to Fuller et al. (2002), Dong et al. (2006) and McCarthy (2011), we estimate the following market adjusted return model:
Where, ARit is the acquirer’s abnormal return for each event (i) at the time (t), Rit the
actual return of the market per event (i) on the day (t) and Rmt the return for the market index (m)
at the time (t). We do not calculate market parameters within the estimation period since we observe frequent events close to each other and beta estimations will therefore be less meaningful.
In order to measure the return of the market index (Rmt) different benchmarks were
collected for China and India.
23 Most of the companies listed in these stock markets offer both A and B-shares. A-shares are denoted in Chinese Renminbi and generally are only available to mainland Chinese citizens with the exception for foreign investors that are under the regulation of the Qualified Foreign Institutional Investor (QFII) system. B-shares are traded in foreign currency and were initially only open to foreign investors although from 2001 national Chinese citizens can also traded B-shares in US dollars in the case of B-shares listed in Shanghai Stock Exchange and in Hong Kong dollars for shares listed in the Shenzhen Stock Exchange. Moreover, it is important to notice that A-shares exist in significant higher proportion comparatively to B-shares.
Moreover, we also indentified a benchmark produced by Morgan Stanley Capital International in order to compare with the market responses of firms listed in a foreign stock exchange where foreign investors have a free opportunity to detain shares of Chinese listed firms. The MSCI China index8 is calculated according to the MSCI Global Investable Market Index Methodology and coverage B-shares, Chinese H-shares, Red Chip and P Chip, therefore shares listed in the Hong Kong Stock Exchange and traded in a foreign currency.
In the case of India we use the BSE - Sensex index from Bombay Stock Exchange that is the oldest stock exchange in Asia and the Indian stock market with the largest number of listed companies registered9. In alternative, BSE – 500 and BSE – 100 were used to confirm the robustness of our results.
3.3.2 Regression analysis
The dependent variable CAR is calculated as a function of the total of abnormal returns (AR) produced in average by China and India OM&As separately within a three, five and seven days event period.
The first two hypotheses are tested using the dependent variable and the null hypothesis of whether the cumulative abnormal return is equal to zero is tested.
8
http://www.msci.com/products/indices/country_and_regional/domestic_equity_indices/china/
9
24 The remaining hypothesis are tested using the model bellow to measure the impact on shareholder value when Chinese and Indian firms undertake OM&As in developed countries, developing countries, in target nations with high levels of GDP and in target nations with poor institutions. 3.3.3 Regression model 3.3.4 Independent variables
Developed and developing countries are identified as a form to distinguish industrialized
countries with mainly safe environments and more open market mechanisms that facilitates investors trust (developed) against the opposite relation (developing). Moreover, we consider
economic disparity as an alternative form to identify the impact of investments on countries with
high level of economic development compared to the acquirer country. As alternative to developing countries measure, we determine institutional disparity to recognize investments that are undertaken in poor institutional environments.
We therefore identify developed countries using the OECD standards10. This measure is
commonly used in literature to identify the level of economic development in a country (e.g. Buckley, et al., 2007; Gubbi et al., 2010). DEVELOPED is a dummy variable that assumes value ―1‖ if the target firm is located in a developed market and ―0‖ if is located in countries non-OECD members.
The variable DEVELOPING measures the process inverse, and assumes value ―1‖ if the acquisition is made in a non-OECD country. However, we exclude Monaco, Hong Kong,
10
The OECD countries include Australia, Austria, Belgium, Canada, Chile, Czech Republic, Denmark, Estonia, Finland, France, Germany, Greece, Hungary, Iceland, Ireland, Israel, Italy, Japan, Korea, Luxembourg, Mexico, Netherlands, New Zealand, Norway, Poland, Portugal, Slovak Republic, Slovenia, Spain, Sweden, Switzerland, Turkey, United Kingdom, United States. Information collected from OECD website:
25 Singapore, Isle of Man, Bahamas, Cayman Islands, British Virgin, and Macau since they do not represent institutions with poor environments.
Economic disparity measures the impact of the economical developed between the
acquirer and target nation. The distance is higher, as the target country presents a higher level of capital gross domestic product (GDP). This variable is calculated as follow:
Institutional disparity is measured as a combination of the economic freedom index
developed by Heritage Foundation and with similarity to Meyer, et al. (2009) idea. The components: business of freedom, trade freedom, investment freedom, financial freedom and propriety rights are considered and are calculated in average (INST). To understand how poor institutional environment affects firm’s performance the follow formula is used:
100 is the higher score that a country can obtain, therefore, to investigate the affect in poor institutional environments the inverse is analysed.
3.3.5 Control variables
26 The variable EXPERIENCE measures the level of experience of the acquirer when undertake more than one acquisition. The level of experience may influence positively firm’s performance in the case the firm was successful with her first acquisitions. It may also be negative if the manager adopt an attitude of too ―self-confidence‖ and is not so careful on taking some important considerations that may be not consistent with firm’s performance. Experience was measured by several authors regarding M&As such as Hayward, (2002) and Haleblian & Rajagopalan, (2006). EXPERIENCE is a dummy variable that is equal to 1 if the acquirer made an acquisition previously.
An acquisition motivated by high tech industries is found in the literature to influence firm’s performance (Thornhill, 2006). Similarly, Makri, et al. (2010) suggests that firm performance is positively influenced by complementary technological knowledge and scientific knowledge and this is more highly to happen if an acquisition involves high tech industries. We measure
HTECH based in the OECD classification for high tech industries11. Therefore, the industries Aircraft and spacecraft; Pharmaceuticals; Office, accounting and computing machinery; Radio, television and communications equipment; medical, precision and optical instruments were incorporated. This method is based on both technology-producer and technology-user.
4. Results
The larger sample size collected permits us with confidence to generate results that are normality distributed and statistically reliable. The histograms provide in appendix (TABLE 3) suggests also that CAR is normally distributed in all cases. Heteroskedasticity is a usual problem in event study methodology and it is present in our analysis. Moreover, in order to deal with the heteroscedasticity problem all variables were calculated using robust standard errors from Huber-White sandwich estimators.
The table below shows that both China and India generates positive and significant abnormal return in an interval of confidence of 5 percent and 1 percent level.
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Table 1: Aggregated Cumulative abnormal return produced within 2001 and 1th S 2011
China India
SSE SZSE MSCI China
SENSEX BOMB-500 BOM-100
CAR (-1,+1) 0.0132746** 0.0124129** 0.0109717* 0.0123693*** 0.0123892*** 0.0123783*** (0.0056333) (0.005659) (0.0056979) (0.0025706) (0.0025439) (0.0025499) CAR (-3,+1) 0.0175366*** 0.0171074** 0.014137** 0.0140211*** 0.0141134*** 0.0141578*** (0.0066939) (0.0067093) (0.0068712) (0.002847) (0.0027987) (0.002794) CAR (-5,+1) 0.0240235*** 0.022594*** 0.020748 ** 0.0108595*** 0.0110801*** 0.0110928*** (0.0066939) (0.0079189) (0.0081189) (.0034755) (0.0034435) (0.0034331)
*p <0.1, ** p <0.05, *** p <0.01, (significance levels based on two-tailed tests). Number of observations for China and India equal to 203 and 491, respectively.
Our first hypothesis is therefore confirmed that overseas merger and acquisitions undertaken by Chinese and Indian MNEs during 2001 and the first semester of 2011 are contributing positively to an increase of shareholders value. In both cases the market has a positive response to the announcement of OM&As during the event period of 3 days (-1,+1). The event period of 5 days (-3,+1) and 7 days (-5,+1) support our results and contribute for the robustness of our findings. The results are also in some extent similar among different benchmarks within the same event window. For a event window of (-1,+1), China and India are producing positive and significant abnormal returns to their shareholders of around 1,33% and 1,11% at a confidence level of 10% and 1% level. When calculating the abnormal returns with an event period of 5 days, the results increase and stay between 1.75% and 1.40%. These results provide even more accurate support for our findings since the overall of the CARs calculated are statistical significant at 5 percent and 1 percent level. In the same line, the shareholders maintain a positive reaction within an event window of seven days and the results are highly significant at 1 percent level with the exception of one that is significant at 5 percent level. The exact percentage of positive performance due to a OM&A performance announcement is difficult to achieve. However, from the table presented above it is clear that OM&As from both China and Indian add positively to shareholder value.
28 shareholder value in the context of emerging economies. The results show slight differences among benchmarks and event windows as could be expected but in general they actually support the idea that Chinese investors perceive more favourably than Indian investors. The main differences that we can observe among the results produced for China can be justified by the fact that the different benchmarks are trading different types of shares, unlike in the case of India where all benchmarks include similar investor structure and both national and international investors are able to trade in the Bombai Stock Exchange. As explained previously the Shanghai and Shenzhen Stock Market trade A-shares detained principally by mainland Chinese investors and B-shares traded in different currencies that might in part explain the vaguely differences among the results produced for both cases. Therefore, using the benchmark SSE from Shanghai Stock Exchange to calculate the possible normal returns that would have happen if the event would not had occur, the abnormal return produced within a an event window of (-1,+1) around the announcement day is equal to 1,33% significant at 5% level. A similar result but slightly lower was found using SSZE benchmark from Shenzhen Stock Exchange. The cumulative abnormal return produced within the same event period contributes in average for an increase of shareholders value of 1.24% when Chinese firms undertake OM&As. The p-value corresponded is 0.029 who that means that this result is significant at 5%. In the same table, we observe that the CAR (-1,+1) calculated using MSCI-China benchmark is vague inferior to the ones calculated using SSE and SSZE. The benchmark MSCI – China was collected in order to compare the abnormal returns produced with the normal returns produced by listed companies traded in the Hong Kong Stock Exchange and where foreign individual investors are able to detain shares. The abnormal return produced using this benchmark was of 1.11% significant but this result is only significant at a 10% level.
29 periods are actually more significant for China, who may show that actually China is doing better. The CARs produced for India maintain the 1% level of significance but are in average lower to the ones produced for China.
Furthermore, regarding the particularities of Honk-Kong and Macau we test whether these two countries influence the cumulative abnormal returns produced for China. We find support that the CAR produced for China with or without Honk-Kong and Macau as foreign target nations sustain our main findings. These results can be observe in appendix (Table 5.2)
The following Table 2 provides the results regarding our third and four hypotheses. As expected the variables developed, developing, institutional disparity and economic disparity present multicollinearity problems (In appendix- Table 6.1 and 6.2). We then test four models analysing separately the influence of this factors on both Chinese and Indian firms.
Target firms situated in developed countries has a positive influence on OM&As. In line with our hypothesis, we found significance at 5% level that Indian firms perceiving outward acquisitions in developed countries contribute to an increase of 1% to shareholder’s value. Moreover, our results are supported measuring the level of economic disparity. At 1% level of significance we find a positive relationship between high levels of GDP in the target nation and acquirer’s firm performance. However, the impact of this result is in some extent very limitative since it just contributes of around 0.1% to an increase of shareholders’ value.
In other hand, acquisitions made in developing countries leads to a decrease of market expectations. Indian OM&As in developing markets seem to decrease their confidence in investments with high risk. The variable is significant at 10% level and neglects around 1% shareholder’s value. Testing for institutional disparity (poor environments) we find a negative impact of around 1.6% in acquirer’s firm performance. This result is negative as expected and is significant at 10% level.
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Table 2: Results of OLS Regression within 3 days event window (CAR (-1,+1))
China India
Model 1 Model 2 Model 3 Model 4 Model 5 Model 6 Model 7 Model 8
Developed nation 0.0064 0.0111 ** (0.0128) (0.0054) Developing nation -0.0078 -0.0096 * (0.0094) (0.0057) Economic disparity 0.0010 0.0011 *** 0.0017 (0.0004) Institutional disparity 0.0087 -0.0158 * (0.0158) (0.0095) Relatedness 0.0001 0.0011 0.0051 0.0018 0.0065 0.0067 0.0073 0.0063 (0.0115) (0.0110) (0.0115) (0.0110) (0.0055) (0.0056) (0.0054) (0.0055) Experience 0.0045 0.0047 0.0033 0.0051 0.0031 0.0032 0.0035 0.0036 (0.0109) (0.0110) (0.0114) (0.0114) (0.0052) (0.0052) (0.0052) (0.0053) High Tech -0.0300 -0.0320 -0.0363 -0.0316 -0.0040 -0.0037 -0.0030 -0.0030 (0.0275) (0.0261) (0.0315) (0.0259) (0.0064) (0.0064) (0.0064) (0.0064) Constant 0.0099 0.0135 0.0032 0.0081 0.0003 0.0104 ** -0.0062 0.0150 ** (0.0112) (0.0128) (0.0130) (0.0157) (0.0060) (0.0047) (0.0068) (0.0064) R-squared 0.01 0.01 0.01 0.01 0.01 0.01 0.01 * 0.01 N 203 203 187 203 491 491 487 486
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5. Discussion
5.1. Main findings
Our results contribute to the stream of international business and finance. Investigating two of the largest emerging countries – China and India, we find support that outward M&As from emerging economies are contributing to an increase of firm performance. Analyzing 203 international acquisitions undertaken by Chinese firms and 491 by Indian companies within January of 2001 and the first semester of 2011 we show that the market responds positively to the announcement of an acquisition leading to an increase of around one and two percent of firm value. We therefore support the empirical evidence that, in average, international acquisitions from firms of emerging countries add shareholders value. The results are in line with the few studies using event study methodology to analyse firm performance as Gubbi, et al. (2010) and Gu & Reed (2010), for India and China respectively.
Regarding the second hypothesis, our findings suggest that government support do not decrease firm performance and it may even contribute in some extent to an increase of shareholder value in the context of emerging economies. These findings are in line with Vinh & Buck (2011) and Sun et al. (2002). The results show that on average the cumulative abnormal return produced for China is slightly superior to the one produced for India. In part, the agency theory seems to fail to explain the performance of MNEs from emerging countries. This issue is also analysed by Chung, et al. (2007) suggesting the neo-institutional theory is more applicable to emerging economies. Moreover, government support adds to economic growth as well as to firm performance. According to Luo, et al (2010) governments from emerging economies should promote outward foreign direct investment. Companies from emerging economies lack considerable advantages compared to their counterparts in western countries and financial support is a form to overcome this issue. China’s government seem to promote national economic development with outward M&As as well as growth for individual Chinese firms. Furthermore, Buckley, et al. (2007) suggests that market imperfections in the case of China may leverage their own firm’s competitive advantages and further theories should be analysed to explain this context.
32 outward M&As have ―more to lose‖ since the government do not participate so actively in the provision of liquidity to the firm. Acquisitions undertaken in developed countries contribute positively to shareholders value. In the same line, countries with higher level of economic prosperity (GDP), which are representative for countries with higher levels of institutional environments are positively related to firm value. This results support Gubbi et al. (2010) findings and contribute to literature proving that developed countries can offer higher levels of intensive knowledge and critical assets, like recognized brand names and technological knowledge. Looking in the opposite relationship, we find that the market responds negatively to acquisitions made in developing countries and with higher institutional disparity in the India case. We confirm that Indian investors are more risk averse to acquisitions in poor institutional environments due to their institutional context and therefore firm’s performance is affected. The non-significant results in China’s case suggest further research.
5.2. Other relevant facts
Chinese policies with high government support may in some extent also explain the low affect of Chinese outward M&As during 2009. This year is perceived as one of the highest drops in M&As in all over the world due to the high instability promoted by the global financial crisis (WIR, 2010). Over the world investors were more cautious to undertake international M&As and this fact can be observed in India’s case. Outward acquisitions made by Indian firms dropped considerable in 2009 compared to Chinese ones. Nevertheless, in 2010 Indian numbers of outward M&As, that were considerable higher than China before 2009, increase significantly but remain lower than Chinese outward acquisitions.
Nevertheless, it may be relevant to refer that India has significant more public listed companies in the stock exchange comparing to China that may influence our sample size. Moreover, in the last ten years India closed more successful deals than China. From the total of 1,999 OM&As from China and 1,877 OM&As from India, just 45% were unconditionally completed by Chinese firms compare to 58% by Indian companies12. This could indicate that Indian firms privilege higher access to the international market and face lower barriers when engaging in OM&As.
12
33
5.3. Exploring data
In this sample, the majority of the international acquisitions from India are concentrated in the developed countries (72%). Developing countries count to 23% of the sample size and the remaining 5% goes to new industrialized countries or other developed countries not include in OECD measures (e.g. Monaco). In the case of China, the data show that Chinese firms have been increasing the acquisitions in the developed countries (OECD-members). The period analysed seem to represent a second wave compare to the previous period from 1990 to 2000 that was more concentrated in countries geographically closer and with more tight relationships. However, acquisitions in developed countries remain modest (46%) compared to India. Considering the developed countries, U.S.A and Australia are the most popular target nations, representing 35% and 19% respectively. Hong-Kong and Macau still represent significant and attractive investment destination for Chinese outward acquisitions, however it decreased in proportion compare to the first wave (27%). The remaining 27% is concentrated in developing countries (with 7% of OM&As flowing to tax havens).
In respect to MNEs’ experience of pursuing international acquisitions, Indian firms cover higher experience (33%) compare to China (12%). Indian firms tend also to acquire more often majority controls (85%) though it is not significantly different from China (72%).
In the table 8 in appendix the top Chinese and Indian acquisitions by deal value are listed. With one exception of the acquisition undertaken by the Indian firm Bharti Airtel Ltd involving 10,7 billion dollars, China firms tend to pay higher prices than Indian ones. It is interesting to notice that the highest values are been paid by Chinese SOEs to acquire oil & gas and metals & mining. The target industries involved are concentrated significantly in these two industries and banks. In the case of India, the highest deal values paid are to acquire most frequently software related firms and other industries involving high technology.
34
5.4. Limitations
In our analysis the use of an event study methodology to estimate firm’s performance demands that Chinese and Indian firms are public listed and have stock value available within a specific estimation period. This restriction is one of our primary limitations in this study that leads to exclusion of several Chinese and Indian outward M&As that could in some extent influence our results. Alternatively to an event study there are other methods to estimate M&As performance suggest by Zollo & Meier (2008) such as employee and customer retention, that involves a collection of questionnaires and accounting performance. However, they show to be very complex to achieve in the aim of this study and they do not reveal to be a complete satisfactory process since, for example, questionnaires are mainly subjective and accounting data is difficult to collect for Chinese and India companies in a relative short term period of investigation. In the current research agenda of M&A performance there are no ideal measures, but short-term event studies are the most commonly used within literature. Short-term event studies approaches market expectation and currently capital market is consider to provide information more independently. Further questions are raised about the efficiency of the stock market from emerging economies and this concern is more particularly headline in China’s case. However, despite the fact that Chinese stock markets are still relatively young they have been increasing significantly in market capitalization in the last years. Moreover, Chen, et al. (2001) shows that investors use value-relevance accountability in China’s stock market. Different benchmarks and different event-windows were tested to increase the robustness of our results. Moreover, base on the arguments presented above is highly liked that the sample is a good representation of the true population.
6. Implications
35 investigating the impact of institutional environments and government support encouraging firms to go abroad. Finally, our findings are special interesting to scholars researching M&As. International acquisitions from emerging economies represent a special case compared to the ones from developed countries that definitely are interesting to investigate.
7. Conclusion
This study examines the particularities behind outward M&As investments undertaken by Chinese and Indian MNEs. Moreover, our focus is on the motivations behind such strategies that contribute to an increase of firm’s performance. Resource based view is considered to highlight the main drivers behind emerging economies that can contribute to a creation of shareholder value. Moreover, the institutional based view is undertaken to understand how home institutional context dissimilarities between China and India affects firm performance and how that influences the localization of their investments. This is one of the first studies regarding the impact of home institutional context and the link of government financial support in firm performance of emerging economy MNEs. The risk averseness is tested in case firms do not privilege easy access to capital.
8. Future Research
Some authors suggest that there is a lack of experience and careful due-diligences that may affect Chinese firms’ value in long-term. Therefore, as future research we propose a use of a BHAR model to test whether our findings hold in a long-term perspective. Market expectations can be influenced by other factors post-acquisition that will influence firm performance. For example, is debatable until each extent the encouragement of several investments without a careful perception of the risk will harm Chinese MNEs.
37
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