How do US investors perceive the risk of local political corruption? Evidence from acquisition announcement

This study examines the impact of local political corruption on investors’ evaluation of firms’ mergers and acquisitions (M&As) in the US. Using the number of corruption convictions of government officials reported by the US Department of Justice, we find that acquirers in more corrupt court districts experience lower acquirer announcement returns, lower combined acquirer and target announcement returns, and are less likely to complete acquisitions. We further find that the relation between local political corruption and acquirer announcement returns is worsened when acquirers operate primarily in the headquarters state. Overall, the results suggest that local political corruption has an adverse impact on investors’ evaluation of a firm’s M&A profitability.     

The informational consequences of good and bad mergers

We study the information production dynamics in financial markets in response to Mergers and Acquisitions (M&As) announcements. We find that acquirers with low levels of pre-announcement stock price informativeness experience a substantial increase in their corresponding post-announcement stock price informativeness in response to positive Cumulative Abnormal Returns (CAR). We show that this increase is due to the enhanced prospect of deal completion. By contrast, high levels of acquirer pre-announcement stock price informativeness limit traders' incentives to search for, and acquire, new information. We also find that similar dynamics apply to the changes in acquirers' analyst coverage. Emphasizing the important role of information acquisition costs in influencing informed trading, a positive acquirer CAR increases the acquiring firm's post-announcement stock price informativeness in M&As involving public rather than private and subsidiary targets. Overall, we show that M&As have important informational consequences beyond their immediate effects on stock prices.     

Stock market valuation of R&D spending of firms acquiring targets from technologically abundant countries

In this paper, we aim to extend the internalization theory by Buckley and Casson [Buckley, P.J., Casson, M., 1976. The Future of Multinational Enterprise. Holmes & Meier, New York] and Caves [Caves, R.E., 1971. International corporations: the industrial economics of foreign investment. Economica 38, 1–27] in two respects. First, we hypothesize that synergies arising from a technology-oriented cross-border M&A increase the stock market value of an acquirer’s R&D spending. Second, we hypothesize that an acquirer’s access to a country with more favorable R&D environment through the target firm is the main source of synergy arising from intangibles in these M&As. Our empirical results of analyzing data from 10 most R&D active countries in Europe are consistent with these hypotheses and support our extension of the internalization theory. Specifically, we find that multinationality of a firm with intangible assets as such does not add value to R&D, but the combination of its own R&D with that of a firm located in a country with highly favorable R&D environment.     

The Relation Among Targets' R&D Activities, Acquirers' Returns, and In-Process R&D in the US

Abstract:  Using a sample of 129 mergers and acquisitions (M&As) in the US between publicly traded acquirers and targets in research and development (R&D) intensive industries over the period of 1994-2004 and a size- and industry-matched sample, we examine the relation among targets' R&D activities, the probability of acquirers' writing-off in-process R&D (IPRD), and acquirers' returns around the time of M&A announcements. We find that firms acquiring targets with higher R&D investments tend to write off some of the acquired R&D assets upon the completion of the M&As. We also find that the median cumulative abnormal return during the three days around M&A announcements for acquirers with subsequent IPRD write-offs is −2.73% while the return for acquirers without IPRD write-offs is −0.60%. This suggests that acquirers' stock returns around M&A announcements are much lower when investors expect acquirers to expense IPRD. The results are consistent with our conjecture that acquirers tend to write-off IPRD when they acquire overvalued targets. We also find that IPRD write-offs do not increase earnings or stock returns of acquirers after M&As, which is inconsistent with an earnings management hypothesis.     

Liquidity and information asymmetry considerations in corporate takeovers

ABSTRACT

We examine how stock market liquidity and information asymmetry considerations influence the wealth effects of Mergers and Acquisitions (M&As). We present a simple model predicting that M&As of listed targets that have relatively illiquid stocks are profitable for acquirers due to (a) the weak bargaining power of the targets’ shareholders, and (b) the limited information asymmetry concerns when evaluating takeover synergies. Our results show that cash-financed M&As of listed targets that have relatively illiquid stocks are associated with an increase in acquirer risk-adjusted returns. These gains are equivalent to those realized from comparable private target M&As. When engaging in stock-financed listed-target M&As, acquirers with liquid stocks enjoy significant gains when the targets have relatively illiquid stocks. This result holds especially when the deal is announced during periods of deterioration in the overall stock market liquidity. Lastly, we find that liquidity considerations affect the acquirer’s choice of the target firm’s listing status, as well as the M&A method of payment.     

The size,concentration and evolution of corporate R&D spending in U.S. firms from 1976 to 2010: Evidence and implications

The use of research and development (R&D) spending as an empirical proxy for managerial discretion, information asymmetry and growth opportunities, is pervasive in empirical corporate finance research. Underlying this is the implicit assumption that firms choose levels of R&D to maximize value, given firm and industry characteristics. An alternative framework views the level of R&D spending as subject to idiosyncratic behavior as managers myopically manipulate R&D expenditures to meet short-term earnings goals. Using aggregate firm and industry level data, we find evidence consistent with the view that R&D is determined by firm and industry characteristics. Time invariant firm and industry fixed effects explain most of the cross-sectional variation in observed R&D spending, while time-varying factors like size, profitability, or market-to-book explain little of the cross-sectional variation. We find that R&D spending continues to grow faster than advertising and capital expenditures. We also find no evidence of managerial myopia as corporate aggregate R&D expenditures are growing faster than aggregate profitability and the number of firms that undertake R&D has increased over the period from 1976 to 2010.     

The potential for expropriation through joint ventures

We examine the potential expropriation of a firm's intellectual capital that results from joint venture agreements when a firm's joint venture partner becomes the target of an acquisition attempt. We find that: (1) non-targeted joint venture partners often suffer losses in value upon the announcement of the acquisition; (2) the magnitude of the loss increases with the R&D intensity of the non-targeted joint venture partner; and (3) average bidder returns are less negative for acquirers if the affected joint venture partners report R&D spending and are in the same line of business as the acquirer. Our estimate of the average loss is $843 million per firm, roughly 3% of the non-targeted firm's pre-announcement equity value. Our evidence suggests a previously unrecognized merger motive in that joint ventures expose a firm's intellectual capital to the risk of expropriation.     

Incentive‐compatible contracts in merger negotiations: The role of acquirer idiosyncratic stock return volatility

We show that the acquiring firm's idiosyncratic stock return volatility (sigma) is an important determinant of the selection and perceived valuation effects of earnouts in Mergers and Acquisitions (M&As). Earnout‐based M&As are more often announced by high‐sigma acquirers (nearly 40% of all earnout‐based M&As), yet the documented higher risk‐adjusted returns accrued to acquirers in earnout‐based M&As, relative to M&As settled in cash, stock or mixed payments (the earnout effect), appear in deals announced by low‐sigma acquirers (nearly 20% of all earnout‐based M&As). High‐sigma acquirers employing earnouts appear to break even, or even experience losses, relative to their counterparts employing single up‐front payments. These results are confirmed based on a quasi‐experimental design through which the earnout effect is measured in isolation. We argue that in M&As announced by high‐sigma acquirers, the earnout effect is potentially elusive due to the presence of an acquirer‐specific information revelation effect, resulting from the heightened extent of information asymmetry between (small) acquirers’ managers and outside investors. On the contrary, the use of earnouts in M&As announced by low‐sigma (large) acquirers, whereby the acquirer‐specific information revelation effect is likely negligible, sends a strong signal for value creation that also prevents investors from inducing a size‐related discount.     

Divergence of Opinion and Post-Acquisition Performance

Abstract:  We examine the relation between divergence of opinion about the value of the acquiring firm in the pre-acquisition announcement period and post-acquisition stock returns. We find that acquirers subject to high opinion dispersion earn lower future returns than acquirers subject to low dispersion. It appears that, on average, only acquirers in the high divergence of opinion subset experience significant negative post-event abnormal returns. In the spirit of Miller (1977) , such evidence implies that high pre-event investor disagreement leads to systematic overpricing of acquirers that manifests itself through long-run underperformance of their stock. The documented misvaluation persists irrespective of the opinion divergence proxy and performance evaluation method used and after controlling for several common deal and acquirer characteristics.     

An empirical investigation of mergers and acquisitions by Chinese listed companies, 1997–2007

We examine 136 M&A deals from 1997 to 2007 initiated by Chinese companies listed on the Shanghai and Shenzhen Stock Exchanges, where the acquirer gains complete control of the target. Our data shows that the Chinese M&A market is dominated by domestic deals with unlisted targets that are either stand-alone private firms or wholly owned subsidiaries. Acquirers experience significant positive abnormal stock returns around the announcement date and over the three years after the acquisition. These results are largely driven by state-owned firms, cash acquirers and firms that acquire related targets. Cross-sectional tests show that announcement period returns are related to the acquirer's ownership status, industry relatedness of the acquirer and target, capital structure changes of the acquirer and the nature of the unlisted target. We find no change in operating performance from the pre to the post acquisition period for the acquirers.     

Does the Management's Forecast of Merger Synergies Explain the Premium Paid,the Method of Payment,and Merger Motives?

I study a sample of 336 mergers and acquisitions (M&A) deals to investigate the effect of managements’ estimate of synergy on the reservation price and the payment method. I find that synergy does not explain the premium paid implying that it may have been announced to induce shareholders to endorse the deal. Acquiring firms are more likely to overpay if they have low growth potential, while the target firm is large, has higher premerger operating performance, and high growth potential. Acquirers may be serving their own self‐interests as they are more likely to exceed their reservation price if they receive low compensation and if entrenchment provisions are in place. I also find that these acquisitions lead to postmerger shareholders’ wealth destruction, which is more pronounced when acquirers overpay. I document that the greater the synergy and the acquirer firm‐specific overvaluation, the higher the likelihood of settling the deal with more shares.     

The impact of state ownership,formal institutions and resource seeking on acquirers’ returns of Chinese M&A

We examine the effects of state ownership, institutions and resource-seeking behavior on post-acquisition stock price returns of Chinese cross-border mergers and acquisitions over the period 1998–2008. Chinese acquiring firms experience negative returns ranging from 2.92 to 10.80 % in 12- and 60-month post-event periods, respectively. State ownership (SOE), interaction between R&D and SOE, formal institutional distance and acquirer size have a positive and significant impact on the long-term acquirer returns. However, the interaction between tangible resources and SOE and acquirer cash holdings appears to have a negative and significant impact on long-term returns. Overall, our results suggest that the state and institutions constitute important sources of long-term value creation for Chinese acquirers.     

POSTCRISIS M&As AND THE IMPACT OF FINANCIAL CONSTRAINTS

We find that mergers and acquisitions (M&As) occurring after the 2007–2009 financial crisis were significantly more value enhancing than precrisis M&As, in both the short and long term. This superior postcrisis performance can be attributed to an increase in external financing constraints following the crisis that caused a decline in general financing availability. This decline restricted the universe of potential acquiring firms to those that were less financially constrained, whereas the typical postcrisis target firm was more financially constrained. As a result, postcrisis acquirers were able to obtain targets at more attractive prices relative to their intrinsic value during the precrisis period when external financing was much less constrained. We also find that the typical postcrisis acquirer had greater long-term focus than their precrisis counterparts and used their financial strength to capitalize on strategic opportunities.     

DO INSIDERS PRACTICE WHAT THEY PREACH? INFORMED OPTION EXERCISES AROUND MERGERS AND ACQUISITIONS

We examine executive stock option exercises around a sample of merger and acquisition announcements between 1996 and 2006, focusing on a subset we identify as potentially informed. For stock‐financed acquisitions, we find a surge in informed exercises by acquirer insiders in the year leading up to the acquisition announcement, but target insiders display no similar increase. We find the market reaction upon the announcement for acquirers is negatively related to extreme early exercises and find some evidence of long‐run underperformance. Overall, our evidence indicates that insiders knowingly bid for firms when they personally believe their own firm is overvalued.     

Board connections and M&A transactions

We examine M&A transactions between firms with current board connections and find that acquirers obtain higher announcement returns in transactions with a first-degree connection where the acquirer and the target share a common director. Acquirer returns are also higher in transactions with a second-degree connection where one acquirer director and one target director serve on the same third board. Our results suggest that first-degree connections benefit acquirers with lower takeover premiums while second-degree connections benefit acquirers with greater value creation. Overall, we provide new evidence that board connectedness plays important roles in corporate investments and leads to greater value creation.     

Glamour Acquirers, Method of Payment and Post‐acquisition Performance: The UK Evidence

We study the effect of different acquirer types, defined by financial status and their payment methods, on their short and long‐term performance, in terms of abnormal returns using a variety of benchmark models. For a sample of 519 UK acquirers during 1983–95, we examine the abnormal return performance of acquirers based on their pre‐bid financial status as either glamour or value acquirers using both the price to earnings (PE) ratio and market to book value ratio (MTBV). Value acquirers outperform glamour acquirers in the three‐year post‐acquisition period. One interpretation is that glamour firms have overvalued equity and tend to exploit their status and use it more often than cash to finance their acquisitions. As we move from glamour to value acquirers, there is a greater use of cash. Our results are broadly consistent with those for the US reported by Rau and Vermaelen (1998). However, in contrast to their study, we find stronger support for the method of payment hypothesis than for extrapolation hypothesis. Cash acquirers generate higher returns than equity acquirers, irrespective of their glamour/ value status. Our conclusions, based on four benchmark models for abnormal returns, suggest that stock markets in both the US and the UK may share a similar proclivity for over‐extrapolation of past performance, at least in the bid period. They also tend to reassess acquirer performance in the post‐acquisition period and correct this overextrapolation. These results have implications for the behavioural aspects of capital markets in both countries.     

Mergers and acquisitions in the US property-liability insurance industry: Productivity and efficiency effects

This paper analyzes the productivity and efficiency effects of mergers and acquisitions (M&As) in the US property-liability insurance industry during the period 1994–2003 using data envelopment analysis (DEA) and Malmquist productivity indices. We seek to determine whether M&As are value-enhancing, value-neutral, or value-reducing. The analysis examines efficiency and productivity change for acquirers, acquisition targets, and non-M&A firms. We also examine the firm characteristics associated with becoming an acquirer or target through probit analysis. The results provide evidence that M&As in property-liability insurance were value-enhancing. Acquiring firms achieved more revenue efficiency gains than non-acquiring firms, and target firms experienced greater cost and allocative efficiency growth than non-targets. Factors other than efficiency enhancement are important factors in property-liability insurer M&As. Financially vulnerable insurers are significantly more likely to become acquisition targets, consistent with corporate control theory, and we also find evidence that M&As are motivated to achieve diversification. However, there is no evidence that scale economies played an important role in the insurance M&A wave.     

Determinants of M&A success in the European insurance industry

This research analyzes the success of mergers and acquisitions (M&A) for European acquiring insurers using a stock market perspective. In contrast to previous papers that use an event study approach, our analysis is based on the stochastic dominance methodology, in which we analyze short and long term capital market reactions following an M&A announcement. In addition, we examine firm- and transaction-specific determinants associated with superior M&A success. Using a sample of 102 European insurance M&A transactions over the period 1993–2009, our results indicate that acquiring insurers are second-order dominated by their benchmark portfolio in the short term. In the long run, we find no evidence of stochastic dominance compared to their non-acquiring counterparts. Moreover, we find that geographically diversifying acquirers are rewarded by the market, and that transactions in which the acquirer and target have a business relationship before the M&A announcement outperform transactions without pre-M&A participation in the short-term. Finally, we detect a positive relationship between cash payment and acquirers’ M&A success.     

The medium of exchange in acquisitions: Does the private information of both acquirer and target matter?

We present a direct test of the choice of the medium of exchange in acquisitions when both acquirers and targets possess private information about their own intrinsic values. We test three hypotheses: first, whether acquirers are more likely to choose a stock offer as their equity is more overvalued; second, whether acquirers facing a greater extent of information asymmetry in evaluating targets are more (or less) likely to use a stock versus a cash offer; and third, whether a cash offer deters competing bids. Our findings are as follows. First, acquirers choosing a stock offer are overvalued and those choosing a cash offer are correctly valued. Second, the greater the extent of acquirer overvaluation, the greater the likelihood of it using a stock offer; further, the greater the extent of information asymmetry faced by an acquirer in evaluating its target, the greater its likelihood of using a cash offer. Third, the extent of an acquirer's under- or overvaluation significantly affects the abnormal returns to its equity upon the acquisition announcement. Finally, the use of cash by an acquirer deters competing bids. We conclude that private information held by both acquirers and targets together determine the medium of exchange.     

The role of investment banks in M&A transactions: Fees and services

We examine the pricing and performance of advisers in M&A transactions. We determine adviser quality on the basis of a contemporaneous market share measure and show that high quality advisers receive higher M&A advisory fees. High quality advisers also complete deals faster, but their superiority is not reflected in increasing the likelihood of deal completion or delivering greater abnormal equity returns to their clients. It is well known that stock bids are received more negatively than cash bids, so we further partition the sample of acquirers by consideration type and examine the abnormal returns of each partition. We find that high quality investment banks are able to differentiate themselves by delivering greater abnormal returns to their acquirer clients in deals involving stock.