Global diversification and bidder gains: A comparison between cross-border and domestic acquisitions

Abstract

We provide empirical evidence on how cross-border acquisitions from the perspective of an US acquirer differ from domestic transactions based on stock and operating performance measures. For a sample of 4430 acquisitions between 1985 and 1995 and controlling for various factors we find that US firms who acquire cross-border targets relative to those that acquire domestic targets experience significantly lower announcement stock returns of approximately 1% and significantly lower changes in operating performance. Stock returns are negatively associated with an increase in both global and industrial diversification. Cross-border takeover activity has increased during the past decade and the observed difference in bidder gains is more pronounced for the latter half of the sample period. We find that bidder returns are positively related to takeover activity in the target country and to a legal system offering better shareholder rights. With the exception of the UK, the target country's degree of economic restrictiveness is negatively related to bidder returns.

Introduction

Product and capital markets continue to become more integrated, new markets are emerging, and globalization has become an important strategic issue for corporations. Consequently, investment opportunities for US corporations have increased while the market for corporate control and corporate assets has become more integrated. This has resulted in both an absolute and relative increase in cross-border acquisitions activity involving US acquirers as well as an increase in the average proportion of firm-level sales that come from foreign operations during our sample period 1985–1995 relative to earlier time periods.¹

In this paper we compare announcement returns for US acquirers engaged in cross-border acquisitions versus domestic acquisitions and find these to be significantly different from each other. We define the difference as the cross-border effect. We analyze the cross-sectional and time-series variation of the cross-border effect and relate the effect to differences in changes in operating performance and cross-country characteristics. The emphasis in this paper is on bidder returns, and hence on the valuation consequences for the existing shareholders of the firm that initiates the bid. Given that we do not consider target returns, we will not make any statements concerning the overall welfare implications of these transactions, or attempt to distinguish between changes in the overall gain and/or the ability of the bidder to capture the gain.

The literature proposes a number of hypotheses for why a cross-border effect could exist. This paper presents a horserace among the potentially non-mutually exclusive theories and provides insight into which of these, if any, dominate in explaining the data.

The bright side of a high degree of market integration is that US bidders have an expanded investment opportunity set, which increases the likelihood of realizing synergistic and efficiency gains. While subject to many of the same influences and motivations as domestic transactions, acquisitions abroad present opportunities that are different from domestic transactions. For example, the acquisition of foreign assets can provide the acquirer with valuable opportunities like risk management, improved technology, and favorable government policies.² For instance, according to the theory of the multinational enterprise (MNE), firms with intangible assets can create synergies, which translate into shareholder value by internalizing their international transactions in the form of foreign direct investments (see e.g., Caves, 1982). All else equal, if higher integration implies higher synergy and efficiency gains, this hypothesis of expanded investment opportunities predicts a positive cross-border effect on average.

However, a high degree of market integration may also result in a dark side for US corporations involved in cross-border transactions. First, market integration may cause an increase in the level of competition in the market for corporate control, which would result in a smaller portion of any synergistic gains being captured by the bidder. Second, an increase in integration accompanied by a reduction in costs of cross-border acquisitions could lead to an increase in hubris and agency problems resulting in culture clashes and lower bidder returns (see e.g., Roll, 1986; Denis et al., 2002). An example of this is the merger between US based Upjohn and Sweden based Pharmacia in 1995. While initially the merger was well received by investors, only a year later the CEO resigned amidst speculation that he could not run the combined company as predicted. Cost-cutting was behind schedule, key executives had left, and integrating the two companies had proven tougher than expected with restructuring costs related to the deal 50% or $400 million higher than originally estimated. According to insiders, as well as several rival executives and consultants, a culture clash between the two companies – exacerbated by the CEO's hard-edged, tightly centralized management style was at the root of the problems.³

Third, lower costs associated with individual portfolio diversification may imply that the benefits for the acquirer no longer outweigh the costs of internalization through cross-border acquisitions. Finally, to the extent that cross-border acquisitions represent an explicit increase in a firm's level of global diversification while domestic transactions represent a decrease, acquirer gains may be lower for cross-border transactions if diversification is considered to be value decreasing.⁴ Hence, all else equal these four hypotheses would predict a negative cross-border effect.

Finally, to the extent that integration has changed during our sample period – rather than relative to earlier time periods, the cross-border effect, if any, could have changed during the sample period as well. Another reason why the cross-border effect could have changed during our sample period is the change in the relative strength of the dollar during our sample period. According to the literature based on international capital markets and perfect capital mobility, exchange rate movements cannot result in a systematic cost of capital advantage to either foreign or domestic investors (Mundell, 1968). However, the literature on asymmetric information suggests that external financing is more expensive than internal financing and the relative strength of the dollar could therefore affect the demand for foreign direct investments (Froot and Stein, 1991). We therefore also examine whether the relative strength of the dollar affects our cross-border effect.⁵ Using a sample of 4430 acquisitions in the period 1985–1995, the results can be summarized as follows:

• Compared to domestic transactions, cross-border transactions exhibit a smaller relative deal size, larger acquirers, higher market-to-book values, more free cash flow, less often involve private targets, and more often involve cash payment, tender-offers, and hostile offers.

• Using univariate analysis, a matched sample analysis, and cross-sectional regressions, controlling for several firm and deal characteristics know to affect bidder returns, cross-border acquirers have announcement returns of approximately hundred basis points less than domestic acquirers.⁶

• The cross-border effect is stronger for the second half of the sample period, as a result of cross-border returns decreasing absolutely and relatively to domestic bidder returns. In fact, domestic bidder returns increase, primarily because of a stark increase in the nineties in domestic bidder returns involving subsidiary takeovers. The cross-border effect remains negative and significant after controlling for the organizational form of the target (i.e., public, private, and subsidiary).

• Transactions that increase global diversification exhibit lower announcement returns. This result is even more pronounced for transactions that increase the level of both global and industrial diversification.

• Cross-border acquirers experience lower merger-induced changes in operating performance, again, particularly for the later half of the sample period. Also, merger-induced changes in operating performance and bidder returns are positively and significantly related.⁷

• Finally, acquirer gains are lower for transactions involving countries with more restrictive capital markets, transactions involving countries with French civil-law systems, less activity in the takeover market, and less concentrated ownership. A notable exception is the UK, for which bidder returns are found to be significantly lower than the returns for the domestic transactions. While the UK ranks high in terms of economic freedom and corporate governance, the competition in the market for corporate control is significantly higher than for the US.

In recent work, Chatterjee and Aw (2000) and Eckbo and Thorburn (2000) for UK and Canadian targets respectively, also show that acquirers of foreign targets under perform acquirers of domestic targets. Our results for the second half of the sample period show that the average abnormal return for cross-border bidders is positive at 0.3%, but is statistically indistinguishable from zero. This is consistent with a recent survey-based study conducted by KPMG which concludes that 83% of 700 cross-border deals in the period 1996–1998 have not delivered shareholder value.⁸

The remainder of the paper is organized as follows. Section 2 discusses reasons for a cross-border effect to exist and briefly summarizes the relevant literature. Section 3 describes the sample selection. Section 4 presents the univariate, multivariate, and target country announcement performance analysis. In Section 5 we use changes in operating performance to support our findings. Section 6 addresses robustness issues and Section 7 concludes the paper.