|Title:||India number of domestic and foreign acquisitions according to bid features for the period 1997 to 2008|
|Source:||International Journal of Commerce & Management|
Start of full article - but without data
Distribution of acquisitions according to bid features
Domestic Foreign Bid features acquisitions acquisitions
Cash-financed acquisitions XX XX Stock-financed acquisitions X -- Acquisitions with mixed financing X X Acquisitions with multiple acquirers X X Acquisitions with single acquirer XX XX Hostile acquisitions X X Friendly acquisitions XX XX Related acquisitions XX XX Unrelated acquisitions X -- Direct acquisitions XX XX Indirect acquisitions X XX
Purpose--This paper seeks to compare target shareholders' wealth gains in domestic and cross-border acquisitions in India. Two existing schools of thought namely, the industrial organizational theory and bid-specific factors theory have been compared to identify which of these two theories affect the target shareholders' announcement wealth gains in India.
Design/methodology/approach--Standard event study methodology has been applied to compute the announcement returns for domestic and cross-border acquisitions. Cross-border effect is calculated to compare the value creation in the two sets of acquisitions. Furthermore, cross-sectional regression analysis is conducted to capture the impact of bid-related features on target shareholder's value creation.
Findings--The results indicate that both domestic and cross-border acquisitions have created value for the target company shareholders on the announcement. Nonetheless, the analysis of cross-border effect as well as regression analysis makes it evident that value creation is higher for domestic acquisitions as compared to cross-border acquisitions due to the influence of various bid-specific factors. Thus, in India, bid-related variables are the fundamental drivers of the target's announcement wealth gains irrespective of the nationality of the acquirer.
Originality/value--The paper extends the discussion on the target's wealth creation in domestic and cross-border acquisitions by segregating the existing literature into two schools of thoughts namely, the industrial organizational school and bid-specific factors school in an emerging economy like India. Moreover, various reasons specific to Indian mergers and acquisitions have been forwarded to explain the subdued market reaction to cross-border acquisitions.
Keywords Acquisitions and mergers, Shareholders, Wealth, Organizational theory, India
Paper type Research paper
Literature on cross-border acquisitions presents two schools of thought regarding value creation for the target company's shareholders around the announcement of these acquisitions. One school of thought is based on the industrial organization theory that relates value creation in cross-border acquisitions to various market imperfections namely, financial/capital, labor, and product market imperfections. This school of thought suggests that the target company's shareholders are able to enjoy significantly higher abnormal returns on the announcement of a cross-border acquisition as compared to a domestic acquisition. The reason being is that cross-border acquisitions are used as a means to overcome various market imperfections across the national boundaries by multinational corporations/enterprises (MNCs/MNEs) which in turn help these enterprises in maximizing the wealth of their shareholders. While, the second school of thought states that the value creation for target company's shareholders does not depend upon the nationality of the acquirer per se, the announcement gains are influenced by different bid-specific factors like hostility, mode of payment, relatedness, competition among bidders, size of the target, etc.
This section presents a review of industrial organization theory juxtaposed to bid-specific factors theory as drivers of target's value creation in domestic and cross-border acquisitions. First, the hypotheses as propounded by the proponents of industrial organization theory have been discussed to explain how MNCs take advantage of the market distortions to earn monopoly rent in cross-border acquisitions that in turn enable these companies to generate higher wealth gains for the target's shareholders in these acquisitions as compared to the domestic ones. Subsequently, the bid-specific factors theory has been discussed to elaborate the role of various bid-related characteristics in influencing the target's announcement wealth gains.
Industrial organisation theory as the driver of target's value creation
An explanation of various hypotheses supporting industrial organization theory as the driver of the target's value creation is detailed as follows.
International diversification hypothesis. This hypothesis states that the main motive of MNCs for expanding their operations in different countries is to take advantage of imperfections in the financial markets (Kindleberger, 1969; Hymer, 1976). When financial markets are not properly integrated across boundaries, the rate of return on securities, for a given level of risk, is not similar in different financial markets. Hence, it gives an individual investor an opportunity to maximize his returns by diversifying his portfolio internationally. However, due to various governmental restrictions on the individual portfolio investment and because of information asymmetry on the part of the individual investor, he is not able to optimally diversify his portfolio. Hence, in case of imperfect capital market, corporate diversification is favored over individual diversification. MNCs invest abroad directly in the form of foreign direct investment (FDI) and take over firms in different countries and help the individual investors in reducing the variability of their earnings. As this diversification is a source of additional value to the foreign acquirer (MNC), he would therefore be ready to pay a higher price for the acquisition of a foreign target company than its domestic counterpart. Hence, target company shareholders would be able to gain higher returns on the announcement of such foreign acquisition. Errunza and Senbet (1981) suggest that larger monopolistic rents are enjoyed by the companies involved in international operations when the barriers to capital flows are higher. Adler and Dumas (1983), in support of the imperfect market hypothesis, state that some market imperfections are essential prerequisites for international corporate diversification. Various studies have found the results in corroboration with the said hypothesis. Agraon and Lessard (1977) examine the diversification hypothesis and find that MNCs that expand their operations in varying countries have lower betas, and the share prices of such companies fluctuate less in response to domestic conditions as their portfolios comprise of the securities of different nations. Doukas and Travlos (1988) suggest that the MNCs that are able to diversify their operations in different geographies are able to exploit unique international distortions in the capital market and are able to create greater wealth for their shareholders. Cheng and Chan (1995) examine the price premium paid by international bidders and propose that the US targets receive higher premiums from those acquirers that diversify their operations for the first time in the USA to exploit synergies and market imperfections. Similarly, Markides and Ittner (1994), Kiymaz and Mukherjee (2000) and Kiymaz (2004) support the international diversification hypothesis. However, Harris and Ravenscraft (1991) and Danbolt (2004) do not find any support for this hypothesis.
Internalization hypothesis. According to this hypothesis the main motivation for MNCs expanding globally is to internalize intangible and non-tradable assets like knowledge, managerial skills, production skills, patents, technology, etc. The value of these assets enhances in direct proportion to the scale of the company's operations that in turn depends upon the number of markets in which it operates. These assets are based on the proprietary information and are difficult to organize externally (Morck and Yeung, 1991). Hence, MNCs create internal avenues for optimum usage of such assets by expanding abroad and taking over companies across the geographies. Magee (1981) opines that one of the reasons for MNCs engaging in cross-border takeovers is to internalize the information through intra firm transfer to optimally utilize it. Dunning (1973) and Buckley and Casson (1998) also support the internalization theory and state that firms possessing superior resources expand internationally to properly utilize them. Morck and Yeung (1991) find that multinationality enables the firms to increase advertising spending that in turn increases the market value in terms of Q ratios of the firms. They suggest that investors do not value multinationality as a diversification strategy, rather they value internalization as it gives the company scope to judiciously utilize its intangible assets. Seth et al. (2002) suggest that MNCs that go in for cross-border acquisitions derive most of the value from asset sharing and reverse internalization of valuable intangible assets. When expertise of a target firm is combined with that of the bidding firm, it leads to valuable new production and investment opportunities for the combined firm. Thus, the hypothesis states that cross-border acquisitions provide MNCs with an opportunity to create an internal market for reutilizing the existing stock of its intangible, non-marketable, and indivisible assets. Hence, in order to tap a profitable opportunity, the foreign acquirer is ready to pay a higher price for acquiring such a target company than the domestic acquirer. Therefore, cross-border acquisitions tend to create more wealth for the target shareholder than for the domestic ones.
Exchange rate hypothesis. The exchange rate hypothesis is based on the imperfections in the foreign exchange market and states that the foreign acquirer is able to take advantage of exchange rate fluctuations by buying firms in foreign countries. When the currency of the target's country is cheap, it is less expensive for the foreign acquirer to acquire a company in the target's country. If the target firm is valuable to the foreign acquirer and also if the currency of the target is cheap, the foreign acquirer is motivated to pay a higher price for such a target company by outbidding the domestic acquirer. Hence, due to this phenomenon, the cross-border acquisitions yield greater wealth for the target companies in foreign acquisitions as compared to the domestic ones. Froot and Stein (1991) developed a model to study the relationship between exchange rates and FDI. They suggest that a depreciated currency of the target's country gives the foreign acquirer an edge in buying the control of a company as it makes the buy inexpensive for the acquirer. Harris and Ravenscraft (1991) conclude that takeover gains are strong for target firms when the buyer's currency is strong. Morck and Yeung (1991) and Cushman (1985) find results in support of the exchange rate hypothesis. Thus, as per this hypothesis, the target company's gains are inversely related to its currency valuations. The cheaper the target's currency, the higher the price paid by a foreign acquirer and the more the value creation for the target firm. However, Danbolt (2004) finds contrary results and states that the target returns increase when the target's currency is strong. Further, Dewenter (1995a) and McCorriston and Sheldon (1998) find no support for exchange rate hypothesis.
Based on the discussion of the above-stated hypotheses, it can be deduced that the announcement of a foreign acquisition generates higher wealth gains for the target company shareholders as compared to the domestic ones because it gives the acquirer an opportunity to diversify its operations across the geographies and thus spread its risk; to utilize its indivisible assets and also to acquire the target company's valuable assets at a cheaper price taking advantage of a weak currency. Calvet (1981), while summing up the findings of prior studies attributed to the industrial organization school, concludes that geographic diversification, exploitation of firm-specific advantages, and exchange rate fluctuations are the main motivators for international expansion of the firms. Hence, these are the factors that motivate the foreign acquirer to pay a higher price for a target as compared to its domestic counterpart. That is why foreign acquisitions on announcement create greater wealth gains for the target company shareholders as compared to the domestic ones.
Bid-specific factors theory as the driver of target's value creation
Contrary to the above-stated hypotheses, researchers like Cebenoyan et al. (1992), Dewenter (1995b), Danbolt (2004), Goergen and Renneboog (2004) and Donohoe (2006) support the school of thought proposing that the target company's value creation does not depend upon the nationality of the bidder per se. Rather, the takeover gains in domestic and cross-border acquisitions vary according to bid-specific variables like hostility, mode of payment, relatedness, competition among bidders, the size of the target company, etc. Hence, it is interesting to note how these bid-specific factors affect the wealth of the target company shareholders. The detailed explanation of these factors is given as follows.
Mode of payment. The mode of payment used in financing the acquisitions is important for determining the announcement returns of target shareholders. In an acquisition, the acquirer can satisfy the claims of the target shareholders either by paying cash or by issuing shares or by a combination of both cash and shares. It has been found by the researchers, internationally, that cash offers are accompanied with higher returns to the target company shareholders than the stock offers. The reason being, cash is usually employed in financing an acquisition when the information asymmetry on the part of acquirer about the true value of the target company's assets is less. On the contrary, in transactions where the acquirer is skeptical about the exact value of the target company's assets, he will use stock to finance such transactions because stock has a contingent pricing effect and enables the acquirer to share the risk of overvaluation/misvaluation with the target shareholders in the post-acquisition period (Hansen, 1987; Martin, 1996). Also, cash acquisitions create immediate tax liability for the target company shareholders. Hence, in order to offset the additional tax burden in cash offers, the target company shareholders command more premiums from the acquiring company. On the other hand, stock offers are tax-free transactions because the capital gain tax is deferred until the stock is sold (Davidson and Cheng, 1997). Moreover, cash financing is employed in those acquisitions where the managers hold significant shareholding of the acquiring company (Amihud et al., 1990). Such managers pursue value-enhancing acquisitions as their interests are aligned with those of the acquiring company. Kummer and Hoffmeister (1978), Carleton et al. (1983), Wansley et at (1983), Huang and Walkling (1987) and Davidson and Cheng (1997), who study target shareholders wealth gains in domestic acquisitions, conclude that the target shareholders experience larger returns when an acquisition is financed with cash rather than with exchange of shares. Danbolt (2004), who compares the target shareholders returns in domestic and cross-border acquisitions, concludes that rather than nationality of the bidder per se, the target shareholders gains are linked to bid-specific factors, more specifically to the mode of payment. Likewise, Harris and Ravenscraft (1991) and Goergen and Renneboog (2004) also conclude that the target company shareholders gain more in cash offers than in stock offers. Hence, it can be inferred that there is a positive relation between cash as a mode of financing and the target shareholder returns.
Relatedness. Review of literature illustrates that the target firms engaged in related acquisitions generate more wealth for the shareholders (Bettis, 1981; Shelton, 1988; Singh and Montgomery, 1988). When both the acquirer and the target belong to the same industry, the combined firm gets an opportunity to realize various scale and scope economies by combining the assets of the two companies. However, Lubatkin (1987), Barney (1988), Seth (1990), Cheng and Chan (1995) and Danbolt (2004) do not find any support to the relatedness hypothesis and conclude that relatedness is not the only precondition for higher value creation in acquisitions. Thus, there is conflicting opinion among the researchers on the issue of relatedness.
Hostility. Kummer and Hoffmeister (1978), Huang and Walkling (1987) and Dewenter (1995b) suggest that higher value is created for the target shareholders when a bid is resisted by the managements of the target companies. The reason being, hostile acquisitions give the target managers more leeway for bargaining and commanding a higher premium from the acquirer. Goergen and Renneboog (2004), who compare the target shareholder gains in domestic and cross-border acquisitions, contend that the target company shareholders earn higher wealth gains in domestic acquisitions because the proportion of hostile deals is higher. Hence, there is a positive relation between a particular transaction being hostile and the target shareholders returns.
Multiple bidding. Bradely et al. (1988) conclude that competition among the bidders increases returns to target shareholders. The reason being multiple bidders are attracted towards a particular target company when they expect more synergistic gains by combining the resources of the target company with their own. This competition among the acquirers to win the target company enables it to fetch a higher price. Cebenoyan et al. (1992) also suggest that the cross-border acquisitions have created higher wealth gains to the target shareholders compared to the domestic ones only when the competition amongst the bidders forces them to pass entire gains to target company shareholders by offering them higher prices. Thus, there exists a positive relation between the competition among the bidders and the target shareholders returns.
Size of the target company. Danbolt (2004) states that the acquiring companies pay more premiums to small targets, as it is believed that integrating a small target is easier compared to a larger one. However, there is hardly any consensus among the researchers for the size variable. Hansen (1987), Travlos (1987) and Zhang (2003) support the above notion while Martin (1996) does not find any support for this hypothesis and concludes that size of the target company is a poor indicator of an acquirer sharing the risk with the target company. Similarly, Ghosh and Ruland (1998) also do not find any support for the size hypothesis. Thus, there is conflicting opinion among the researchers on the issue of the size of the target company and its role in value creation.
Direct and indirect acquisition. In India, there are two types of cross-border acquisitions namely, direct acquisitions and indirect acquisitions (Kumar, 2000; Basant, 2000). A direct acquisition has been defined as an acquisition whereby a foreign acquirer directly acquires a stake in the target company either from the target's promoters via memorandum of understanding (MOU) or from the open market. On the other hand, an indirect acquisition has been defined as an acquisition that is driven by the acquisition of the target company's parent globally by a foreign acquirer. Thus, indirect foreign acquisition is the outcome of the restructuring of the target company internationally. These acquisitions are often considered to be lesser value creating as these are forced on the acquirers. Further on, these acquisitions get entangled in litigations in India and take more time to complete. Thus, a negative relation is expected between an acquisition being indirect and the target shareholders' wealth gains.
From the above discussion, it is evident that various bid-related characteristics significantly influence the target shareholders wealth in an acquisition rather than the nationality of the acquirer per se. Hence, if cross-border acquisitions are devoid of the above-stated factors, these may not essentially yield higher wealth gains to the target shareholders compared to the domestic acquisitions (Goergen and Renneboog, 2004; Donohoe, 2006).
Thus, existing literature presents differing views regarding the value creation for target company's shareholders in domestic and foreign takeovers. On the one hand, the industrial organization theory states that foreign acquisitions yield higher gains because the foreign acquirer is able to take advantage of various market imperfections. On the other hand, the second school of thought states that other than nationality of the acquirer, the bid-specific characteristics like hostility, mode of payment, relatedness, competition among bidders, and the size of the target company influence the target's announcement returns. Nevertheless, it is worth considering that the target company shareholders gain in both domestic as well as cross-border acquisitions and the wealth gains can either be attributed to the industrial organization theory or to the bid-specific factor theory.
Further, in India, there is hardly any study that has analyzed cross-border acquisitions excepting Kumar (2000) who studies the patterns and implications of M&As by MNEs. Thus, understanding the target wealth gains in cross-border acquisitions is a relatively unexplored area in India. Besides, cross-border takeover activity has shown tremendous growth since the opening up of the Indian economy in the year 1991. The value of inbound acquisitions has increased from $X.X million in the year 1991 to $X,XXX.X million in 1997 and further to $X,XXX million in 2006 [X]. Moreover, large-sized inbound cross-border acquisitions are becoming the order of the day.
Thus, keeping in view the dearth of M&A literature in India and the recent spurt in inbound M&A activity, the objective of the present study is to evaluate target company's shareholder gains in cross-border acquisitions as well as domestic acquisitions. Moreover, an attempt has been made to compare the target company's shareholder gains in cross-border acquisitions vis-a-vis domestic acquisitions to ascertain the source of value creation; that is, whether value creation for the target shareholders is driven by the industrial organization theory or due to the presence of certain bid-specific features. Specifically, the following hypotheses have been tested:
HX. Target company shareholders earn positive returns in both cross-border and domestic acquisitions.
HXa. Cross-border acquisitions create higher wealth gains vis-a-vis domestic acquisitions for the target shareholders due to market imperfections.
HXb. Domestic acquisitions create higher wealth gains vis-a-vis cross-border acquisitions for the target shareholders due to the influence of bid-specific factors.
Database and sample selection
For appraising the announcement effect of domestic and foreign acquisitions on the wealth of target companies' shareholders, the acquisitions announced during the period X January 1997 to XX March 2008 are considered. Information regarding announcement date; outcome date; and bid-specific factors like mode of financing, relatedness, hostility, and competition among acquirers has been obtained by scanning two leading financial dailies namely, The Economic Times and The Financial Express/World for the above-stated period. Moreover, to cross check the announcement and outcome dates of mergers and takeovers, official web sites of the Securities Exchange Board of India (SEN) and the Bombay Stock Exchange (BSE) have been consulted. Data regarding assets of various companies and the daily returns of individual stock of companies are obtained from PROWESS, the database software developed by Centre for Monitoring Indian Economy.
The sample is restricted to only those acquisitions that are successful and where the objective of the acquirer is to acquire a majority control of the target company. For this, the shares acquired through MOU as well as acquired through open offer are taken into consideration. Such acquisitions have been deleted where the mode of payment and the type of diversification (whether related or unrelated) are not clear. Deletions have also been made for those companies where data regarding daily returns of the target company is not available. After making the above deletions, we got a final sample of XXX acquisitions out of which XX acquisitions are made by domestic acquirers and XX by foreign acquirers. The yearly distribution of the acquisitions as well as distribution according to different bid characteristics is detailed in Tables I and II, respectively.
To appraise whether target company's shareholder wealth gains around announcement are driven by various market imperfections or whether bid-specific factors play a dominant role in affecting value creation, we conducted the analysis in two parts. First, the standard event study methodology has been employed to assess the announcement return of target shareholders separately in domestic and in cross-border acquisition. Further, cross-border effect is calculated to compare the value creation in domestic as well as foreign acquisitions and to evaluate which of these two sets of acquisitions is creating more value for the shareholders on announcement. Second, cross-sectional regression analysis is run on the entire sample of domestic and foreign acquisitions to discern the impact of various bid-related features on the announcement returns of target shareholders in these acquisitions.
Event study measures the impact of any unanticipated event on the wealth of a company's shareholders by analyzing the abnormal returns around that event period (Brown and Warner, 1980, 1985). To examine the market reaction to the announcement of domestic and cross-border acquisitions, risk- and market-adjusted variant of standard event study methodology as propounded by Fama and MacBeth (1973) and Fama (1976), which is better known as the market model, has been employed. First, an estimation period is selected for computing the parameters ([alpha] and [beta]) of the market model. The estimation period used here is t = -XXX to t = -XX, relative to the first public announcement date [X] of an acquisition (t = X). Daily abnormal return on a particular day t is the excess of the actual return on the day t over the expected return on that day. The expected return for a particular day t is computed as follows:
[[??].sub.it] = [[alpha].sub.i] + [[beta].sub.i][R.sub.mt] + [[epsilon].sub.it]
where [[alpha].sub.i] presents the normal return of the security i when [R.sub.mt] is X, [[beta].sub.i] measures the risk of the security i that is, the sensitivity of [R.sub.it] to the market-wide factors. [R.sub.mt] is the return on market index (BSE Sensex in this case). Thus, [[beta].sub.i][R.sub.mt] collectively captures the effect of variables that affect the return on all securities or at least most securities while [[epsilon].sub.it] captures the effect of variables more specific to the prospects of a security i.