The effect of institutional quality on Mergers & Acquisitions performance
in emerging economies and the moderating role of host country corruption
Master thesis for IB&M
University of Groningen
Faculty of Economics and Business Master thesis for IB&M
Author: Martijn Robin van der Kamp Email: M.R.van.der.Kamp@student.rug.nl Student number: 2618591
Abstract
M&A is the preferred international business strategy of firms, although many deals do not live up their expectations in practice. After decades of research it is still unclear what drives M&A performance. Suggesting that there are unidentified variables that may explain significant variance in M&A performance. Scholars argue that institutional measures are better able to explain differences in firm performance. However, previous studies failed to explain if driving forces of the institutional environment have an impact on M&A performance in emerging economies. This study examines if these institutional factors play a role when it comes to M&A performance in emerging economies. This is done by regressing M&A performance as a dependent variable on the institutional areas: political stability and the rule of law. Followed by a multiple regression analysis which is conducted to test what the moderating role is of host country corruption. The key findings are that political stability has a negative impact on M&A performance, and that relative size matters. No supporting evidence was found for the impact of rule of law and the moderating role of host country corruption. Finally, future studies should focus on the application of institutional measures on M&A performance in different and contrasting contexts.
Key words
Emerging economies, host country corruption, institutional quality, and M&A performance.
Supervisor: Dr. O. Lindahl Co-assessor: Dr. M. M. Wilhelm
Table of content
1. Introduction 5
2. Literature review 8
2.1 Mergers and Acquisitions 8
2.2 Institutions 10
2.3 Host country corruption 13
2.4 Hypothesis development 14
2.4.1 Political stability and M&A performance 14
2.4.2 Rule of law and M&A performance 15
2.4.3 Introducing host country corruption 17
2.4.4 Host country corruption, political stability, and M&A performance 17 2.4.5 Host country corruption, rule of law, and M&A performance 18
2.5 Conceptual model 19
3. Methodology 20
3.1 Data and sample 20
5. Conclusion 33 5.1 Discussion 33 5.2 Implications 35 5.2.1 Theoretical implications 35 5.2.2 Managerial implications 36 5.3 Limitations 36
5.4 Charting areas for future research 37
5.5 Concluding thoughts 38
6. References 40
7. Appendices 45
7.1 Factor analysis host country corruption 45
7.2 Reliability analysis host country corruption 45
7.3 Linearity test 46
7.4 Multicollinearity test 48
7.5 Homoscedasticity test 49
7.6 Normality test 51
1. Introduction
In 2016, the worldwide announced number of Mergers & Acquisitions (M&A) transactions was 47.540. The total value of these transactions was more than 3.508 billion US dollars (Institute for Mergers, Acquisitions & Alliances, 2017). According to these enormous numbers you should expect that M&A transactions create shareholder value. But studies show that many M&A transactions do not live up their expectations in practice.
Lewis and Mckone (2016) found that more than 60% of the M&A transactions destroy shareholder value. Most people have heard about the failures of AOL-Time Warner, HP-Compaq, and Quaker-Snapple. It’s a remarkable paradox; the number and value of M&A transactions is rising despite their high failure rates. Lewis and Mckone (2016: p.3) stated that: “even in the light of such daunting data, many corporate leaders feel compelled to pursue growth through M&A, figuring the risks of inaction are just as high”. It seems that many corporate leaders feel the pressure to boost growth, and they are not discouraged by the enormous failure rates. M&A performance became therefore a central theme within the field of strategic management, corporate finance, and organizational behavior.
Previous studies (Zollo & Meier, 2008; Wang & Moini, 2012) found that M&A performance is a complex and multifaceted construct. The assessment of M&A performance varies along accounting, financial and operational dimensions. However, there are major disagreements across and within the disciplines when it comes to identifying factors that affect M&A performance. So far, empirical studies are not consistent and they have difficulties with explaining what drives M&A performance. Despite decades of research it is unclear what affects the financial performance of firms who are involved in M&A activities. Additional theory and changes to M&A research methods are needed to discover unidentified variables that may explain significant variance in M&A performance (King et al., 2004).
According to Bradt (2015) many M&A transactions are doomed to fail because they do not ensure cultural compatibility. Therefore, his main advice is to merge cultures well if you want to create more shareholder value. Whereas Singh (2007) argued that culture is no longer the underpinning part of global strategies. He explained that culture can be seen as a micro factor that influences firm performance.
2008). Previous studies proved that the institutional environment affects the frequency of M&A transactions, the choice for equity ownership, and the likelihood of completing M&A transactions (Dutta et al., 2016; Xie et al., 2017). On top of that, current debates in the field of global strategy argue that institutional measures better explain differences in firm performance than cultural measures (Drummond 2002; Singh 2007). However, feasible conclusions cannot be drawn as long as there are limited empirical tests available about the effect of institutional measures on firm performance (Peng & Pleggenkuhle-Miles, 2009). The authors described the essence as they emphasize in their article that future research should focus on the application of institutional measures in different and contrasting contexts.
It is important to shed a new light on the discussion, because the focus was always on culture and firm performance. Although it seems that it doesn’t sort effect, as the M&A failure rate has not changed overtime (Wang & Moini, 2012). It points out the relevance of this study, as the underlying root cause of M&A failures is not fully discovered yet.
Xie et al. (2017) searched in the literature for country-specific determinants of cross-border M&A and found that no articles have been published since 2004. The reviews and contributions are also limited when it comes to the effect of the institutional environment on M&A performance. Xie et al. (2017; p. 155) concluded that previous studies on M&A performance lack because they: “have overlooked some important driving forces of the institutional environment in emerging economies”. Areas as political stability, contract enforcement and judicial systems deserve more attention in future studies. In light of these conclusions it is interesting to test what the effect of institutional quality is on M&A performance in emerging economies.Lebedev et al. (2015) called for more research on M&A in and out of emerging economies, as these countries ‘grow more weight’ when it comes to the worldwide economy.
governance practices and markets (Lebedev et al., 2015). Especially, since emerging economies are often characterized by low quality institutions and host country corruption (Svensson, 2005).
To sum up, empirical studies are not consistent about what drives M&A performance (King et al., 2004). There are unidentified variables and Peng & Pleggenkuhle-Miles (2009) explained that the impact of the institutional environment on firm performance is not clear yet. More empirical tests are needed to draw feasible conclusions about; if institutional measures play a role, and if so, what role they play. They also suggest that future studies should test the impact on firm performance in different and contrasting contexts. Xie et al. (2017) added that previous studies failed to explain the impact of driving forces of the institutional environment on M&A performance in emerging economies. Finally, it is likely that the outcomes are different since emerging economies differ from developed economies. The following research question is framed to find an answer on these questions:
What is the effect of institutional quality on M&A performance in emerging economies, and what is the moderating role of host country corruption.
This study has a number of theoretical and managerial implications. First it has sought if institutional measures are the unidentified variables that may explain significant variance in M&A performance. Secondly, this study was a first attempt to test the impact of institutional areas that have been overlooked by other studies on M&A performance in emerging economies. It revealed if institutional measures play a role, and if so, what role they play. Third, the moderating variable tested the impact of institutional measures in different and contrasting contexts. Fourth, it will help managers to understand what the effect is of institutional quality on M&A performance. Zhou et al. (2016) explained that this is important for the decision-making process of managers. As firms are challenged by differences in the legal and regulatory environment, which can lead to complexities that cannot be understand.
2. Literature review
The goal of the literature review is to get an insight in M&A performance, institutional quality, and host country corruption. In section 2.1 is explained why firms decide to go abroad, followed by what a merger or acquisition is. Different perspectives on M&A performance are discussed to understand when a merger or acquisition is considered as successful. Section 2.2 is about institutions; different perspectives are discussed to understand the complexity of the institutional environment. The main message of each perspective is shared, followed by the differences, and critiques to arrive at a manageable picture. Section 2.3 is about host country corruption, which is highly debated since corruption is a worldwide problem (Transparency International, 2017). Different views on corruption are therefore highlighted in section 2.4, which will help to realize what the effect of host country corruption is on the relationship between institutional quality and M&A performance. Lastly, the conceptual model is presented to grasp the concepts and relations between them.
2.1 Mergers and Acquisitions
The global market landscape is changing due to globalization and firms are challenged by global market forces. For most firms, it is no longer profitable to focus only on the home market since they are affected by the growing international competition. International firms have to become more aware of the actions of other firms. Therefore, they have to make important strategic decisions in order to stay competitive in the global market economy. Decisions which will influence their future, long-term performance, and survival (Fung, 2014).
enhance the competitiveness of the new firm (Cuypers et al., 2016). The overall conclusion is that firms choose for M&A if they want to pursue growth or/and when they want to create more shareholder value. However, former studies taught us that more than 60% of the M&A destroy shareholder value (Lewis and Mckone, 2016). Which encouraged this study to look upon when a merger or acquisition is considered as successful.
M&A performance is a complex and multifaceted construct, and there are different methods to assess whether a merger or acquisition is successful. The selection of a method depends on three dimensions (Zollo and Meier, 2008):
• 1. The choice for objective or subjective measurements; • 2. The use of a short- or long-term time horizon;
• 3. The feasible unit of analysis.
2.1.1 Methods to assess M&A performance (Zollo and Meier, 2008)
Table 2.1.1 gives an impression of the concept M&A performance and the scope of measures. The methods vary along several dimensions, which means that it must be clear what the objective of the study is. For this study, the unit of analysis is firm, as the aim is to analyze what the impact of the institutional environment is on M&A in emerging economies. The chosen time horizon is short-term based as the goal is to investigate if M&A create shareholder value or not. Which leads to the objective measurement; short-term financial performance based on an event study.
selected accounting-based measures, and the last 31% used other approaches. These results show that event studies are the dominant approach to assess M&A performance. It is an effective method, as it reflects if the acquiring firm succeeds or fails in capturing value for its shareholders (Wang and Moini, 2012). An acquiring firm is thus successful if it can capture value for its shareholders. Which confirms that an event study based on stock prices is the most appropriate method for this study, as it reflects the true value of the firm.
2.2 Institutions
The institution-based view of global strategies became more important through the years. Peng et al. (2008) discovered the underlying root cause, and found that firms are enabled and constrained by the rules of institutions. However, the institutional environment can be considered as complex, since the literature distinguish three different perspectives. To get a better understanding of each perspective and their impact it is essential to unpeel each concept. Zhou et al. (2016) showed already that firms are challenged by differences in the legal and regulatory environment, which can lead to complexities that cannot be understand by firms. Which implies that it is necessary to understand what the main message, differences among, and critiques of each perspective are to assess their impact and usefulness. The most appropriate theories are selected in the end, to answer what the effect of institutional quality on M&A performance is in emerging economies. Institutions can be understood from the following perspectives:
1. New institutional economics (NIE)
North (1991: p.97) defines institutions as: “the humanly devised constraints that structure political, economic and social interactions. They consist of both informal constraints (sanctions, taboos, customs, traditions, and codes of conduct), and formal rules (constitutions, laws and property rights)”. Institutions are developed by humans to create order, to enable cooperation and to reduce the uncertainty in exchange. Another function is that it acts as an incentive structure of society, since it indicates what type of behavior is profitable.
The involvement of risks leads to higher transaction costs, since it includes negotiating and writing contracts, monitoring the performance of the partner, and lastly haggling or renegotiating (Teece, 1986). Based on the NIE theory, the goal of the informal constraints and formal rules is to solve this problem by indicating how to foster exchange. Contracts are for example a tool to control the other partner for opportunistic behavior or to reduce the uncertainty in exchange. The enforcement of informal constraints and formal rules is carried out on three different levels. Formal rules as the law are enforced by the state, informal constraints as reputational pressures and reciprocity are enforced by communities and networks. When rules are internalized through socialization it can be said that the enforcement is by means of mental constraints. Formal institutions are needed when it comes to large-scale and anonymous exchange, small-scale / non-anonymous exchange relations are governed by informal and mental constraints. The NIE theory assumes that there is only one institutional profile within a country, but the institutional quality differs across countries (North 1990; North 1991).
2. Neo-institutional sociology (NIS):
Scott (2013; p. 57) defines institutions as: “multifaceted, durable social structures, made up of symbolic elements, social activities, and material resources”. These social structures will foster meaningful social interactions and effective communication. It is about actions that have consequences and the society have to agree upon these consequences. The NIS perspective perceived that a society can do meaningful things when there is an agreement about the actions and consequences.
3. Institutional logics-approach (IL).
Thornton and Ocasio (1999: p. 804) define institutional logics as: “the socially constructed, historical patterns of material practices, assumptions, values, beliefs and rules by which individuals produce and reproduce their material subsistence, organize time and space, and provide meaning to their social reality”. The IL approach believes that institutions cause a strong pressure for conformity within a society. But it assumes that there are more institutions within a country, and these will compete with each other. This complexity makes it difficult for organizations to understand the institutional environment (Thornton and Ocasio, 1999).
Overview and conclusions
The main message of new institutional economics is that without shared rules it is hard to trust each other. The theory is built on informal constraints and formal rules (North, 1991). Whereas Neo-institutional sociology addresses that without agreed social structures and meanings it is more difficult to understand and accept each other’s behavior. Which is structured by the regulative, normative, and cognitive pillars (Scott, 2013). Both perspective expect that cooperation is limited in the case of inefficient institutions. Although, the critique of the IL approach on the NIE and NIS theories is that they are focusing too much on imposed constraints, which lead to too much uniformity and homogeneity in societies. The IL approach believes that there are strong pressures for conformity within a society, but that there is also strong competition between the institutional systems. (Thornton and Ocasio, 1989).
The institutional environment is complex and covers a lot of ground as presented above. As a result, the institutional aspects that are most relevant for M&A performance in emerging economies are included in this study. Xie et al. (2017) found that institutional areas as political stability, contract enforcement and judicial systems deserve more attention in future studies. Consequently, this research will build further on the NIS and NIE theories. As both perspectives cover these institutional areas and assume that there is only one institutional profile within a society.
The institutional areas placed in the perspective of the theories
are perfectly covered by the rule of law. Which is an indicator of the World Bank (2017), it shows if parties have trust in and comply with the rules of society.
Placing these areas in perspective of the NIE theory it can be concluded that political stability and the rule of law are represented by the formal rules within a society. Institutions function more effectively in a political stable environment (Tao et al., 2017). Which indicates that more effective institutions are better able to create order, to enable cooperation and to reduce uncertainty in exchange. According to the NIS theory, political stability and the rule of law can be classified as elementary components of the regulative pillar. The pillar is about the rules and laws within a country (Scott, 2013). It is likely that a political stable environment, and a high developed rule of law foster meaningful interactions and lead to effective communication between parties.
2.3 Host country corruption
Corruption can be explained as the misuse of the public office for private gain. Corruption is caused by country’s legal, economic, cultural, and political factors. In the case of favorable or damaging rules it is likely that corruption arise. Svensson (2005; p.20) explained this phenomena by using the following example: “corruption appears in response to benevolent rules when individuals pay bribes to avoid penalties for harmful conduct or when monitoring of rules is incomplete, as in the case of theft”.
Which implies that corruption is more likely to happen in countries with inefficient policies and bad functioning systems. As they give individuals the opportunity to bend around them by paying bribes. Although, corruption shows also similarities with taxes or fees since it creates a wedge between the actual and privately marginal product of capital (Svensson, 2005). The difference between taxes and bribing is that bribing includes risks, which lead to higher transaction costs because of the increased uncertainty in exchange (Shleifer and Vishny, 1993).
rules and policies”. The numbers of the corruption perceptions index (2016) show that almost two-third of all the countries in the world have to deal with corruption.
Corruption can be considered as an enormous problem, whereas the government is accountable for the fight against corruption. Citizens become skeptical and lose faith once it becomes clear that the government is not able to control corruption. Parties who are involved in bribing are vulnerable for extortion. It can be described as a vicious circle between corruption, inequality of power and wealth. In contrast, countries with a low level of corruption are characterized by more press freedom, integrity, and transparency. The access to information is better organized and independent judicial systems are present. But this does not mean that the society is not confronted by or immune to corruption. Conflict of interest and inefficient regulations can still affect the public policy, and thus corruption can still occur (Transparency International, 2017).
2.4 Hypothesis development
The institutional areas political stability and the rule of law, whereas the latter on consist of contract enforcement and judicial systems are discussed in the hypothesis development. The institutional areas are placed in the perspectives of the NIE and NIS theories. Both areas are linked with M&A performance in section 2.4.1 and 2.4.2. In the last two sections is proposed what the moderating role of host country corruption would be.
2.4.1 Political stability and M&A performance
Political stability can be considered as an elementary component of the institutional environment. As it affects the way institutions function within a society (Tao et al., 2017). It affects the way institutions function because national politics and their behavior is deep-seated within the power and ruling system of a country. In the end, the ruling party is responsible for the administrative and policy decisions (Xie et al., 2017).
However, Peng et al. (2008) explained that firms are enabled and constrained by the rules of institutions. Which indicates that a political stable environment not necessarily lead to higher M&A performance, especially when firms are constrained by the rules of the ruling political party. Opposed evidence from Xie et al. (2017; p. 133) suggest that political instability in the host country has a negative impact on M&A: “several cross-border deals were delayed or abandoned due to erratic behavior of government agencies, interventions by the ruling political party, and regulatory hurdles”. An explanation could be that be that firms are puzzled by imperfect knowledge and uncertainty, as they don’t know with which rules they have to comply. Which is an essential aspect according to the NIS theory, as a society is only able to do meaningful things when there is an agreement about the actions and consequences of institutions.
Tao et al. (2017) proved that political stability also affects M&A performance. By showing that Chinese firms gain higher cumulative abnormal returns when they acquire a firm in a political stable environment. It seems logical, as institutions are developed to create order, to enable cooperation and to reduce the uncertainty in exchange (North, 1990). Based on these arguments it could be perceived that political stability has a positive effect on M&A performance.
Hypothesis 1: A higher level of political stability in the target country leads to higher M&A
performance.
2.4.2 Rule of law and M&A performance
Rule of law is an important aspect of the institutional environment as it shows if parties have trust in and comply with the rules of society (Kaufmann et al., 2013). Scott (2013) proposed that interactions are only meaningful and effective if parties agree upon the actions and consequences of institutions. Which indicates that M&A need to have trust in and comply with the rules in order to create shareholder value.
preferred firm behavior (Stevens et al., 2015). It demonstrates that firms perform worse when they don’t trust and comply with the rules of society.
The rule of law includes contracts and judicial systems as they can help to enhance that M&A have trust in and comply with the rules of society. Klein Woolthuis et al. (2005) explained that both serve as mechanisms to mitigate relational risk. It will refrain other parties from opportunistic behavior, as it will restrict the range of parties’ actions. M&A. Due to these mechanisms it is likely that M&A perform better because less risk leads to lower transaction costs. However, contracts can also be interpreted as a sign of distrust, as parties in a trusting atmosphere do not fear for opportunistic behavior (Klein Woolthuis et al., 2005).
According to the transactions cost economics theory, parties can reach more efficient outcomes when contracts reduce the uncertainty in exchange, describe the extent of asset specificity and frequency of the transaction (Williamson, 1985). Complete contracts will also contain clauses concerning the safeguarding of property rights, sanctions on spill-over, and the management of the relationship. The safeguarding of property rights is an important aspect during a merger or acquisition as the allocation of ownership has to be clear for both parties. But also, clauses on the aim of the take-over, the responsibilities, size of investment and accountability can help to reduce uncertainty and enhance trust. Furthermore, lower uncertainty in exchange will positively affect M&A performance as investors want to avoid risks (Pastor and Veronesi, 2012)
Klein Woolthuis et al. (2005) concluded that contracts are only a useful mechanism if they are enforceable through the availability of qualified judicial systems. The risks and uncertainty in exchange will be lower when the M&A is in possession of legally enforceable safeguards. Which can be explained by the fact that legally enforceable safeguards can be defended in court. Based on this it is likely that M&A will perform better when the quality of the rule of law is high.
Hypothesis 2: A higher level of the rule of law in the target country leads to higher M&A
2.4.3 Introducing host country corruption
This chapter will start with some background information about host country corruption in emerging economies. It is relevant for both hypothesis, and thus shared before the rationale of hypothesis 3 and 4 is introduced in section 2.4.4 and 2.4.5.
The corruption perception index of Transparency International (2017) revealed that emerging economies are often challenged by high levels of corruption. Their study showed as well that these countries are characterized by untrustworthy and bad function systems. The main problem of corruption is that once an individual starts bribing, it cannot maintain his position and it will be confronted with continuing extorting (Transparency International, 2017).
2.4.4 Host country corruption, political stability, and M&A performance
Hardstad and Svensson (2011) found that firms are involved in bribing because they don’t want to comply with the rules. In most cases, firms bribe government officials to bend the rules. It could be said that the main function of institutions, which is creating order according to North (1991) is undermined by host country corruption. As bribing leads to imperfect knowledge between parties and a higher level of uncertainty in exchange.
Corruption makes it thus more difficult for M&A to interact effectively with other parties and the host government. In contrast when a M&A pay bribes to push their own agenda, they can decline the regulatory distance between the home and host country in an illegal way. Getz (1997) supported this by explaining that government officials in emerging economies are often self-interested and that they are not constrained by the regulations. It shows that there are opportunities for firms when it comes to bribing.
However, parties who are involved in corruption are challenged by higher risks. Investors want to avoid risk, and if they presume that individuals of a merger or acquisition are involved in corruption it will negatively affect M&A performance. Pastor and Veronesi (2012) stated that firms who are involved in lower risks activities will perform better, because it will positively affect the risk perception of investors. Which implies that M&A involved in less risk-taking activities will perform better than M&A who are involved in risky activities.
nationalistic sentiments will grow. Due to this foreign firms can be seen as territorial threats, which can negatively affect M&A performance. As result of this the expectation is that a low level of host country corruption will strengthen the positive effect of political stability on M&A performance.
Hypothesis 3: A lower level of host country corruption will imply a higher positive effect of
political stability on M&A performance.
2.4.5 Host country corruption, rule of law and M&A performance
Bribing can be seen as an illegal activity to bend the rules. It is a temporary activity of an individual or organization, which is not tolerated by society and because of this it cannot be defended by judicial systems (Hardstad and Svensson, 2011). It could be said that the regulatory component of institutions is undermined by corruption. As M&A who are involved in bribing don’t comply with the rules of society.
In a corrupted environment, there is a lack of freedom, integrity, and transparency (Transparency International, 2017). These factors have an impact on the main problems in society, which are described by North (1991); imperfect knowledge and uncertainty in exchange. It can be said that corruption leads to opportunistic behavior, as contracts and judicial systems are less able to create order. Evidence showed that parties have more trust in contracts and judicial systems when the level of corruption is low (Transparency International, 2017). Which implies that a low level of corruption has a positive impact on the rule law and M&A performance.
Feinberg and Gupta (2009) stated that corruption will influence post-acquisition activities. They found that when the level of corruption is low, it is easier to establish and enforce contract agreements. Because of this the uncertainty in exchange is reduced, and as a result M&A face lower transactions costs.
Therefore, the perception is that a low level of corruption will strengthen the positive effect of rule of law on M&A performance, as firms are able to generate higher financial returns.
Hypothesis 4: A lower level of host country corruption will imply a higher positive effect of
rule of law on M&A performance.
2.5 Conceptual model
The first hypothesis proposes that a higher political stability in the target country will enhance M&A performance. The second hypothesis assumes that a higher rule of law in emerging economies will lead to higher M&A performance. The third and fourth hypothesis presume that a low level of host country corruption will strengthen the positive effects of political stability and the rule of law on M&A performance.
3. Methodology
3.1 Data and sample
To test the above hypotheses, it is important to gather data about institutional quality, M&A performance, and the level of host country corruption in emerging economies.
The selection of emerging economies is the first step in the approach to answer the research question. The market potential index of Global Edge (2016), which is also used by the Economist, is chosen to identify emerging economies. Every year they publish a list of the most promising economies. Brazil, Czech Republic, India, Indonesia, Malaysia, Mexico, Poland, Republic of Korea, Thailand, and Turkey can be classified as emerging economies. The sample selection is further based on eight conditions:
(1) The acquiring firms are from everywhere, (2) The target firms are located within an emerging economy(3) the deal type is a cross-border merger or acquisition within one of these countries, (4) the merger or acquisition is announced within the period 01/01/2012 up to 31/12/2014, (5) the acquirer is listed and the target is listed or unlisted, (6) the percentage of the acquired stake is minimal 50.1%, (7) the current deal status is completed, and (8) data about the transaction value and market capitalization value is accessible.
Zephyr is issued to determine the sample, and these eight conditions led to the inclusion of 110 M&A in the final sample. DataStream is used to gather information about the stock prices and market indexes, where the acquiring firms are listed on. The World Bank is consulted to get an insight in the institutional quality of the selected emerging economies. Lastly, Transparency International is used to generate data about the level of host country corruption. These sources and the accompanying data are discussed in detail in the following sections.
3.2 Measures
3.2.1 Dependent variable
analysis is to assess whether M&A create shareholder value. The advantages and limitations of each measure are weighed to select the most appropriate measure for this study.
Barber and Lyon (1996) found that return on assets (ROA) can be used to measure accounting performance. Brockman et al. (2013) agreed upon this and used ROA to measure what the effect is of institutions and political connections on M&A performance. The ROA indicates till what extent a firm is profitable relative to their total assets. In other words, the ROA measures the long-term performance of M&A and the corresponding anticipated synergies. The main problem of the accounting-based method is that it does not consider the different accounting standards across countries. Secondly, accounting-based results can be manipulated since managers can determine the procedures. This can lead to measurement problems, as the indicator does not reflect the actual performance of M&A.
In contrast, event studies became the dominant approach to assess M&A performance. The advantage of an event study is built on the stock-market-based approach, which is not a subject to manipulation. It can be perceived that stock prices represent the true value of the firm, as they incorporate the discounted value of cash flows and other relevant information. An event study can measure the financial impact of a merger or acquisition announcement, by using stock price changes. Which works more effectively to measure the financial impact of an event than the accounting-based method (McWilliams & Siegel, 1997).
An event study will thus be conducted to measure the valuation effects of a merger or acquisition announcement. This is done by observing the stock price of the acquirer around the announcement date, compared to the stock market’s reaction. McWilliams and Siegel (1997) stated that for the identification of abnormal returns, researchers should be aware of three underlying assumptions:
(1) An important requirement is to assume that the stock market is efficient, which means that stock prices react directly and accurately to new information. Otherwise it is not clear what the impact of the event is on the stock price.
(3) The researcher should isolate the impact of the M&A announcement from other effects. The reasoning is that effects that could have an impact on the stock price are excluded during the chosen event window.
Brown and Warner (1980) agreed upon this by explaining that an event study is a useful measure to determine the performance of the acquirer. It shows how a merger or acquisition announcement will affect the value of the firm. An acquiring firm can be considered as successful if it is able to capture value for its shareholders.
Event study methodology
The procedure for an event study consist of various steps. During these steps, it is important to define the estimation window, event window and post event window. However, the post event window is not applied during this study as it is focused on long-term M&A
performance.
The first step in the procedure is to identify the event of interest, which is the day that the merger or acquisition is announced (Figure 3.2.1.1, value 0). Followed by the selection of the event window [T1; T2]. The stock prices of the acquirer are observed during this period. McWilliams & Siegel (1997) stated that researchers should isolate the impact of the event from other effects. Therefore, they recommended researchers to use a short event window. Which is in line with Brown and Warner (1980) since they found that a long event window will negatively affect the power of the test. Empirical tests (Ryngaert & Netter, 1990) showed as well that a short event window [-5; +5] will caputure the significant effect of a merger or acquisition announcement. Based on these arguments an event window of 11 days is adopted, whereas T1 = -5, and T2 = +5.
Figure 3.2.1.1 Event study time line (MacKinlay, 1997)
Figure 3.2.1.2 Daily returns model (Doukas and Travlos, 1988)
Previous studies (Doukas & Travlos, 1988; Verzhykovskiv, 2016) advised to use an estimation window of 250 trading days. Which implies that the estimation window is from [-256; -6] trading days before the merger or acquisition announcement. Whereas (T0) is -256 and (T1) stands for -6 trading days before the event. Thomson Reuter’s DataStream is consulted to gather data about the stock prices of the acquirer and the accompanying market portfolio. After the calculation of the daily returns, Doukas and Travlos (1988) are followed by applying the abnormal returns model:
Figure 3.2.1.3 Abnormal returns model (Doukas and Travlos, 1988)
Figure 3.2.1.4 Cumulative abnormal returns model (Doukas and Travlos, 1988)
3.2.2 Independent variables
The independent variable reflects the institutional quality within a country. Scholars (Acemoglu et al., 2001; Besley and Ghatak, 2009; Barbopoulos et al., 2012; Che et al., 2017; North, 1990) demonstrated that there are several ways to measure institutional quality. They argue that the protection of property rights and legal enforcement are key elements of the institutional environment. Whereas Levchenko (2004) from the International Monetary Fund stated that institutional areas as contracts, shareholder protection, and property rights received a lot of attention.
The institutional areas were acknowledged by Xie et al. (2017), and they concluded that previous studies revealed already their impact on M&A performance. However, the focus of this study lies on indicators which represent the institutional areas political stability, contract enforcement and judicial systems. Which implies that specific measures need to be found to cover these areas of the institutional environment.
The driving forces of the institutional environment that have been overlooked by other studies are perfectly covered by indicator 2 and 5. Whereas political stability is represented by indicator 2, and contract enforcement and judicial systems are expressed by indicator 5. The notification of the indicators below is based on the report of Kaufmann et al. (2013).
Indicator 2: measures the political stability within a country. It indicates if there is a possibility that the ruling party will be destabilized by unconstitutional or violent means.
Indicator 5: measures the rule of law. It shows if parties have trust in and comply with the rules of society. The quality of contract enforcement and judicial systems are elementary components.
Political stability and the rule of law are selected to test what the impact of institutional quality is on M&A performance in emerging economies.
3.2.3. Moderator variable
The moderating variable represents the level of host country corruption. The corruption perceptions index from Transparency International (2017) is used to measure the level of host country corruption. Every year they announce the corruption perceptions index: “which ranks countries/territories based on how corrupt a country’s public sector is perceived to be. It is a composite index, drawing on corruption-related data from expert and business surveys carried out by a variety of independent and reputable institutions”. The two most significant indicators of the index are adopted to create a reliable profile of each country. Below is discussed how the indicators can be interpret:
Indicator 1: Each country receives a score based on the level of corruption in a country. The scores vary from 1 till 100, countries with a low score are challenged by an extremely high level of corruption, whereas countries with a high score have to deal with an extremely low level of corruption.
Indicator 2: The indicator reflects till what extent a country can control the level of corruption. It indicates if public power is used for private gain. The scores are normally distributed and range from -2.5 (extremely low control of corruption) up to 2.5 (extremely high control of corruption).
can be consulted for the results of the factor analysis. The value of each indicator should be higher than 0.5, the results for indicator 1 (0,984) and, indicator 2 (0,984) satisfied the condition. After this a KMO and Bartlett’s is conducted to test if the data provided by the variables can be summarized into one factor, the two variables passed the test.
The two indicators are standardized to overcome the problem of different measurement scales, the Z-scores will help to arrive at one single measure for host country corruption. The values are now expressed in terms of a distribution with a mean of zero and a standard deviation of one. It shows as well how many standard deviations each value lies from the mean of the distribution (Field, 2009). Lastly, it is important to test if the indicators pass the reliability analysis, the value of the Cronbach Alpha analysis should exceed the >0.7 condition (Field, 2009). Appendix 7.2demonstrates that the Cronbach Alpha exceeds the condition, with a value of 0,967. The indicators satisfied all the conditions and are computed into one new variable, which represents the level of host country corruption in a country.
3.2.4 Control variables
Control variables are included to understand the relationship between the other variables. In order to clarify the relationship, it is important that the control variables are kept the same throughout the analysis. The selected control variables are factors found in other studies that affect the dependent variable; M&A performance.
Relative size and industry relatedness are included as control variables. Relative size is chosen because Moeller et al. (2004) explained that the size of both firms and thus their relative size matters when it comes to post acquisition performance. They found that larger acquirers will generate lower returns, whereas smaller acquirers gain higher returns. Relative size is calculated by using the transaction value divided by the market capitalization of the acquirer. The market capitalization value of one year before the acquisition was announced is used to determine the relative size, as recommended by Moeller et al. (2004).
3.2.5 Analytic procedure
Hypothesis 1 and 2 were tested by regressing M&A performance as a dependent variable on political stability and the rule of law, with the control variables relative size and industry relatedness. Hypothesis 3 and 4 were tested by using host country corruption as a moderator in the multiply regression analysis. According to Field (2009) it is important to test for several assumptions, before it is possible to draw conclusions about the sample. If the following assumptions are met it means that the model can be applied to the population of interest. The following assumptions are checked: (1) sample size, (2) linearity, (3) multicollinearity, (4) outliers, (5) homoscedasticity, and (6) normality.
(1) Green (1991) advised that the sample size should satisfy two conditions. The first condition is that the sample size should be higher than (50 + 8 * predictors) to test the overall fit of the regression model. Secondly, the minimum sample size should be higher than (104 + predictors) in order to test the effect of the individual predictors. Both conditions are met with a sample size of 110.
(2) For the generalizability of the results it is essential that the relationship between the independent variables and the dependent variable is linear (Field, 2009). Appendix 7.3 showed that both relationships are linear.
(3) A collinearity diagnostics test is carried out to detect if there are any signs of multicollinearity. According to Rogerson (2001) the variance inflation factor (VIF) should be lower than 5. Appendix 7.4 showed that there are no signs of multicollinearity as the highest VIF value is 2,156. The second condition is that there should be no perfect linear relationship between the independent variables. According to Field (2009) the correlation coefficient should not exceed a value of 0,800. The second condition is met, as the descriptive statistics (table 4.1.1) described that the highest correlation coefficient is 0,631.
(4) SPSS is used to detect outliers in the dataset. Outliers are removed to arrive at a more reliable analysis. Table 4.1.1 indicates that there are no outliers in the dataset.
(6) Lastly, for the normality assumption the residuals should be random, and normally distributed with a mean of zero, or close to zero (Field, 2009). Appendix 7.6 showed that the dependent variable is normally distributed.
4. Results
4.1 Descriptive statistics
The sample selection criteria presented in chapter 3.1 led to the inclusion of 110 M&A in the final sample. The M&A are distributed over 11 target countries, whereas Indonesia (N=16), Brazil (N=14) and Malaysia (N=14) are the most popular target countries.
M&A performance is measured by using cumulative abnormal returns and the values varied from -9,52% up to 11,85% (M=0,98 and SD=4,80). The lowest cumulative abnormal return is reported by an acquirer who targeted a firm in the Republic of Korea. The highest cumulative abnormal return is obtained by an acquirer who targeted a firm in Turkey.
Relative size is calculated by using the transaction value divided by the market capitalization, the values ranged from 0,00 up to 0,09 (M=0,03 and SD=0,03). The lowest value belongs to an acquirer who targeted a firm in Indonesia, the highest value to an acquirer who targeted a firm in India.
Industry relatedness is determined by using US SIC codes from Zephyr, the values varied from 0,00 up to 1,00 (M=0,59 and SD=0,49). 65 M&A transactions took place in a related industry, and 45 M&A transactions in a non-related industry.
Political stability and the rule of law are measured by using the World Governance Indicators. The values ranged from -1,43 up to 1,93 and from -1,48 up to 1,46 (M=0,00 and SD=1,00). The level of political stability was the lowest in Thailand, whereas the highest level of political stability was in Czech Republic. Rule of law was the lowest in Thailand and the highest value was achieved by Brazil.
Host country corruption is measured by combining two variables from Transparency International. The values varied from -1,72 up to 1,29 (M=0,00 and SD=1,00), the control of host country corruption was the lowest in Mexico, and the highest in Poland.
4.2 Results H1 & H3
Table 4.2.1 presents the results for testing hypothesis 1 and 3. The first hypothesis perceived that a higher level of political stability in the target country leads to higher M&A performance.
Table 4.2.1 Regression results for hypothesis 1 and 3
Two regression models are presented for hypothesis 1. Model 1 consist of the dependent variable M&A performance and the control variables relative size and industry relatedness. Model 2 tested the first hypothesis using political stability as independent variable on M&A performance. There was a negative and significant relationship between political stability and M&A performance, B = -1,310**, P-value < 0,05. Which implies that an increase in one’s political stability will lead to a decline in M&A performance. According to these results the first hypothesis is rejected because when political stability increases with one’s M&A performance will decline. Which indicates that political stability has a negative effect on M&A performance.
decline in M&A performance. According to these results the third hypothesis is rejected because when political stability increases with one’s M&A performance will decline. Which indicates that political stability has a negative effect on M&A performance. There was a positive and non-significant interaction effect between political stability and a low level of host country corruption on M&A performance, B = 0,011, P > 0,10. Which means that the direct negative effect of political stability on M&A performance will be weaker in the presence of a low level of host country corruption. However, the interaction term political stability x host country corruption presents a positive non-significant coefficient. Therefore, hypothesis 3 is not supported because with the presence of a low level of corruption the relationship between political stability and M&A performance is more positive.
4.3 Results H2 & H4
Table 4.3.1 demonstrates the results for testing hypothesis 2 and 4. The second hypothesis assumed that a higher level of the rule of law in the target country leads to higher M&A performance.
Table 4.3.1 Regression results for hypothesis 2 and 4
performance. There was a negative and non-significant relationship between rule of law and M&A performance, B = -0,276, P-value > 0,10. Which implies that an increase in one’s rule of law will lead to a decline in M&A performance. According to these results the first hypothesis is rejected because when rule of law increases with one’s M&A performance will decline. Which indicates that rule of law has a negative effect on M&A performance.
5. Conclusion
The findings are new and interesting in light of what we knew before. The empirical results are discussed in more detail in the sections below. Subsequently, the theoretical and managerial implications of this study are presented in section 5.2. The limitations of this study are described in section 5.3 and section 5.4 provides ideas for future research. This chapter ends with section 5.5 which presents the concluding thoughts.
5.1 Discussion
Liu et al. (2016) reported that M&A in emerging economies tend to build a relationship with the host government. M&A want to create shareholder value through bribery and connecting with government officials. However, relying on a relationship with government officials includes risks for shareholders. Which implies that M&A can’t maximize shareholder value if they are not able to establish a relationship or if they lose an important connection. This can be a serious problem in a political stable environment as firms are enabled and constrained by the rules of the ruling political party.
Croci et al. (2017) found that acquirers are often not familiar with the political environment of the target firm. Whereas target firms are better able to develop ties with the local government in times of political stability. Inkpen and Beamish (1997) stated that non-capital resources as knowledge of the political environment determine the bargaining power of firms. Acquirers have thus a disadvantage compared to target firms, as they are challenged by a lack of political knowledge. Bertrand et al. (2016; p. 2071) revealed that: “with decreasing political affinity, the host government becomes increasingly likely to intervene against foreign firms in a deal”. Because of this, politically connected target firms charge higher takeover premiums. Target firms can command higher prices since political knowledge is seen as a valuable and difficult to replicate resource, that can boost the growth opportunities of M&A (Croci et al., 2017).
less likely to be acquired. Another key finding is that the M&A takeover process takes more time due to complex negotiations (Croci et al., 2017). It seems that political stability is not always in favor of enhancing cooperation and reducing the uncertainty in exchange. Acquiring firms are challenged by higher premium prices, complex negotiations, and motives of politicians. Which explains why M&A in emerging economies perform worse in a political stable environment.
Secondly, there is no supporting evidence for the role of host country corruption on the relationship between political stability and M&A performance. Table 4.2.1 showed that a low level of corruption leads to a more positive relationship between political stability and M&A performance. The positive effect can be clarified by the fact that firms with less capital are more likely to bribe government officials, whereas firms with financial capacity will choose for lobbying (Hardstad and Svensson, 2011). It is likely that M&A choose for lobbying instead of bribing, since M&A is considered as a capital-intensive strategy. Although, Vinning et al. (2005) revealed that lobbying is only successful once long-term relationships are established. Therefore, it could be argued that the result is non-significant as most acquirers do not possess the capabilities to establish a long-term relationship with the local government.
Third, table 4.2.1 (model 1) and table 4.3.1 proved that relative size matters when it comes to post-acquisition performance. The findings are in line with the results of Moeller et al. (2004); smaller acquirers gain higher returns, as opposed to larger acquirers who gain lower returns. A takeover announcement by a small acquirer is profitable for shareholders, as it includes positive synergy effects. Whereas the control variable industry relatedness does not show any significant result.
Finally, no support was found for the role of host country corruption on the relationship between rule of law and M&A performance. It seems that a low level of corruption will strengthen the negative effective of rule of law on M&A performance. Which suggest that M&A perform better in a corrupted environment where the quality of the rule of law is low. Cuervo-Cazurra (2006) found that investors who are familiar with home country corruption may target firms in countries with high levels of corruption. The reasoning is that investors have experience with this phenomena in their home country and as a result they are not deterred by corruption. An explanation for the non-significant result could be that corruption does not affect all investors equally (Cuervo-Cazurra, 2006). Although, the reader must be aware of the fact that it is not exactly clear what’s going on here. As more studies are needed to draw feasible conclusions about the the impact of host country corruption on the relationship between rule of law and M&A performance in emerging economies.
5.2 Implications
5.2.1 Theoretical implications
From a theoretical point of view, three contributions can be highlighted based on the empirical results of this study. Previous studies have difficulties with identifying factors that affect M&A performance (Zollo & Meier, 2008; Wang & Moini, 2012). The empirical results are not consistent and there are unidentified variables that may explain significant variance in M&A performance (King et al., 2004). This study was an attempt to identify variables in the light of the institution-based view that may explain significant variance in M&A performance. It revealed that political stability explains a significant variance (up to 7,3%) in M&A performance. Whereas rule of law is identified as a factor that does not have a significant effect on M&A performance in emerging economies. Which led to the conclusion that there are still unidentified variables that explain significant variance in M&A performance.
Peng & Pleggenkuhle-Miles (2009) suggested that researchers should test the impact of institutional measures on M&A performance in different and contrasting contexts. This study was focused on M&A in emerging economies, and investigated the moderating role of host country corruption. The outcomes demonstrated that the institutional environment cannot be ignored, whereas it seems that host country corruption does not play a significant role. Researchers should consider if they want to include host country corruption in their model, as it seems that it does not explain additional variance in M&A performance.
5.2.2 Managerial implications
From a managerial point of view there are a number of implications. This study revealed that acquirers lack knowledge of the political environment (Croci et al., 2017). Managers of foreign acquirers should increase their political affinity with the host country to improve their bargaining position. They have to consider that ‘buying’ political ties results in lower M&A performance, since acquirers have to pay a premium price (Bertrand et al., 2016). Managers have to be prepared for complex negotiations and need to align their interest with the motives of the host government in order to be successful. However, this study is focused on short-term M&A performance and it would be interesting to test what the effects are on the long-term. Furthermore, it seems that the rule of law and host country corruption are less relevant for M&A in emerging economies. Managers should be aware of this by focusing on institutional areas that do affect the value of the firm.
5.3 Limitations
There are several limitations in this study. First, M&A performance is measured by using an event study based on stock prices. The assumption is that the market is efficient, although there are external factors that influence the stock market performance. Which implies that the stock prices immediately express all public available information (McWilliams and Siegel, 1997)
Third, this study is based on secondary data from existing databases. Consequently, the institutional areas contract enforcement and judicial systems are conceptualized by using the rule of law as an indicator. It would have been ideal if an independent indicator measured both institutional areas separately. Although, it was not possible given the short time-horizon. Future studies should verify if independent indicators for contract enforcement and judicial systems will led to the same results.
Lastly, as mentioned before this study is limited by the use of secondary data. Because of this the sample size is reduced from 506 to 110, mostly due to missing values and the quality of the observed data. In order to guarantee the reliability and validity of the dataset it was necessary to remove observations. However, it could be that valuable observations have been lost during the analysis. Therefore, is proposed that researchers should use primary data as well, if they have the possibility and resources.
5.4 Charting areas for future research
This paragraph highlights some points for a future research agenda. It provides several ideas to encourage researchers to look upon these points. First, this study proved that political stability has a negative impact on short-term M&A performance. Which is mainly caused by higher premium prices, complex negotiations, and motives of politicians. It would be interesting to test if political stability has a differential effect on long-term M&A performance. Especially, since Liu et al. (2016) found that building a relationship with the host government takes time.
Secondly, this study tried to find empirical evidence for emerging economies. As explained by Lebedev et al. (2015), emerging economies are different from developed countries regarding the institutional environment and therefore there is reason to expect different results. Future studies should investigate why the rules of the game are different for M&A in emerging economies. Suggesting that additional theory is needed to understand why the rule of law and host country corruption do not play a significant role in emerging economies.
Fourth, the institutional areas in emerging economies that have been overlooked by other studies are tested. This study was a first attempt to identify their impact on M&A performance, as far as we know. More empirical studies are needed to benchmark the empirical results. Suggesting that researchers should test these specific institutional areas on M&A performance in emerging economies to enlarge the number of empirical results.
Finally, there are multiple institutional measures which could have an impact on M&A performance in emerging economies. Researchers could use other institutional quality proxies to measure if they have the same or a differential effect on M&A performance. Interesting alternatives are the WGI indicators; government effectiveness and regulatory quality.
5.5 Concluding thoughts
This study has sought if, institutional measures are the unidentified factors that explain significant variance in M&A performance. It revealed as well what role institutional measures play when it comes M&A performance in emerging economies. More empirical tests, in different and contrasting contexts were needed in order to draw feasible conclusions (Peng & Pleggenkuhle-Miles, 2009). The institutional areas that have been overlooked by other studies: political stability, contract enforcement and judicial systems are tested to fulfil the research gap (Xie et al., 2017). Furthermore, the expectation was that the results could be different as emerging economies differ from developed economies in terms of the institutional environment (Lebedev et al., 2015).
The control variable relative size demonstrated that smaller acquirers gain higher returns. Which is in line with the findings of Moeller et al. (2004); relative size matters for post-acquisition performance. Whereas the control variable industry relatedness does not show any significant result.
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