Annals of the University of North Carolina Wilmington International Masters of Business Administration.

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1 Annals of the University of North Carolina Wilmington International Masters of Business Administration

2 STOCK PRICE REAСTION TO M&A DEALS IN ASIA AND SOUTH AMERICA Olga A. Chibinyaeva A Thesis Submitted to the University of North Carolina Wilmington in Partial Fulfillment of the Requirements for the Degree of Master of Business Administration Cameron School of Business University of North Carolina Wilmington 2012 Approved by Advisory Committee Nivine Richie Peter Schuhmann Joseph Farinella Chair Accepted by Dean, Graduate School

3 TABLE OF CONTENTS ABSTRACT... iii LIST OF TABLES... iv LIST OF FIGURES...v INTRODUCTION...1 LITERATURE REVIEW...5 HYPOTHESIS AND RESEARCH QUESTIONS...10 DATA DESCRIPTION...14 METHODOLOGY...16 EMPIRICAL RESULTS...22 CONCLUSIONS AND IMPLICATIONS...24 REFERENCES...27 APPENDICES...29 ii

4 ABSTRACT This paper focuses on the stock price reaction to M&A deals in the emerging markets of Asia and South America from 2000 to It supports the notion that M&A announcements positively affect the shareholders abnormal returns, both for the target and the bidding firms. The present study aims to test the hypothesis of stock returns reactions and to find the main determinants of the shareholders returns in the new area because almost all of the previous research focused on the developed markets of the USA and Europe. The main findings show that target firm shareholders receive, on average, a statistically significant cumulative abnormal return of 19.3% in a 4 month window around the announcement date. Acquirers cumulative abnormal returns are 0.16% on average. The results show that the main determinants of the returns are geographical issues and payment types. Domestic mergers generate higher returns than cross-border M&As, and stock is more preferred as a method of payment than cash or other types. Also, the study reveals that the companies financial data, such as market capitalization, dividend per share multiple, interest coverage ratio, and price to cash flow multiple, influence the shareholders returns. The findings are consistent with the existing literature in the field. The results obtained from this study may be useful for investors, both individual and institutional, managers of companies already operating or considering operation in Asia and South America or other emerging markets, and may be inspiring for further research on a related topic. iii

5 LIST OF TABLES Table Page 1. Composition of deals by year and by country Descriptive statistics for the dependent and independent variables for target companies Descriptive statistics for the dependent and independent variables for bidding companies...19 A1. Simple regression results for the CAR for bidding firms...28 A2. Simple Regression Results for the CAR for target firms...29 A3. Multiple regression for the CAR for bidding firms...29 A4. Multiple regression for the CAR for target firms...30 A5. Correlation coefficients for bidding companies...30 A6. Correlation coefficients for target companies...31 iv

6 LIST OF FIGURES Figure Page 1. Composition of the final sample divided by the payment method Composition of the deals separated by the geographical issue...16 v

7 INTRODUCTION During the past decades, a huge wave of merger and acquisition (M&A) deals have appeared worldwide. The companies see them as a fast and effective way to expand into new markets, acquire new technologies, create economies of scale, globalize, spread the risk, or even dominate existing markets (Mukherjee, Kiymaz and Baker, 2003). There are, however, a lot of unsolved issues and tough disputes concerning the ways of achieving the efficiency of these deals and concerning the benefits to stockholders of the target and bidding companies. The emphasis on this topic, in academic literature, began in the early 1980s, when the business world experienced a substantial increase in M&A activities. The authors started to examine the nature of movements in M&As. Golbe and White (1987) showed that M&A deals happen periodically and have a certain cycle. They tested the M&A transactions in the USA in two time series: the post-world War II and prewar periods (from 1895 to 1920). The results discovered the fact that M&As occur in waves. More recent studies have confirmed the cyclical character of M&A (Town, 1992). There is, however, an alternative view on the M&A activity as a long-memory dynamics, occurring due to the forecasting of M&As (Barkoulasa et al, 2001). This evidence of long-term dependence is robust to the estimation method employed and the potential presence of shifts in the mean of the series, thus suggesting that long memory is an essential feature of the M&As. Nevertheless, all of the authors admit the dynamic behavior of M&As. This fact gives the business world more motivation to analyze the subject of M&As, now, as the new wave is coming just after the crisis of 2008, according to the Future of M&As report (Merill Datasite, 2011). One of the main issues concerning M&A deals, which is widely discussed nowadays, is

8 the shareholders return. The first studies concerning this subject relied on the data with M&A deals in the USA (Lubatkin, 1987), as it is always considered to be the center of M&A activities. In this research, the author discovered the relationship between shareholders gains and the relatedness of merging companies. Over 1000 firms were assembled and grouped into four categories, depending on the level of their relatedness. The results show that the investors do not have more favorable expectations for the mergers of related firms rather than for unrelated ones. Moreover, the shareholders gains are higher when the merger is vertically integrated. More recent studies have investigated the short-term market response associated with the announcement of large domestic mergers and acquisitions particularly in the USA. Kiymaz and Baker (2008) examined US M&A deals from 1989 to 2003 and found out that abnormal returns are significantly negative for acquirers but significantly positive for targets. Also, the results show that the industry determines the wealth effects to acquirers; however, the targets earn positive short-term abnormal returns almost in all of the industries. Another factor, which can influence the shareholders returns, is whether the bidding firm is a foreign company or not. Cebenoyan, Papaioannou and Travlos (1992), observed 134 US targets acquired by domestic companies, and 73 US targets acquired by foreign firms in the period 1978 through They found that cross-border expansions are positively correlated with the shareholders gains of the target companies in the respective industry. In conformation of the fact that cross-border deals influence shareholders returns, the authors try to understand the factors that affect the choice of foreign partners for the M&A deal. Cartwright and Price (2003) examine whether the preferences of international M&A partners are similar worldwide. The authors formed a questionnaire which consisted of three parts: an organizational information part (items relating to nationality of respondents, parent company, 2

9 organizational activity, size, and experience in the M&A); an attitudinal preference part (inviting respondents to place in rank order (1 3) their preferred/least preferred choice of a foreign merger partner or an acquirer and the rationale for their choice); and a compatibility part (requiring respondents to indicate which foreign country they considered was most/least compatible in terms of the managerial style). A sample of 480 questionnaires were distributed and analyzed among businessmen. Completed questionnaires were returned by 22 different nationalities (in order to cover more nationalities, the survey was administered in the UK International Airport). The results show that managers prefer to choose foreign companies with the similar culture or with very similar positions on the Power Distance Index 1 as a potential M&A partner. So we can see that cross-border M&As are difficult to integrate because they require double layered acculturation (Barkema, H.G. Bell, J.H.J. Pennings, J.M.E., 1996) which means that the firms have to combine not only different corporate cultures, but also different national cultures. It is also important to mention that some studies show that not all of the M&A deals achieve the positive results. Moeller, Schlingemann and Stulz (2005) compared the M&A wave of 1990s with the one in the 1980s, in terms of acquirers returns. They found that, from 1997 through 2001, many US acquiring companies lost around $240 billion on the acquisition compared to the 1980s when they lost only $7 billion. The fact that there are many unsuccessful deals makes the companies more accurate in choosing the right moment for the M&A process. And what is more significant is that the investors became more cautious because the acquirers strategy of expanding through the M&As is not sustainable. 1 Power Distance Index. An index developed by G. Hofstede (1970s) that measures the distribution of power wealth between people in a nation, business or culture 3

10 Nonetheless, as shown by recent studies, there is a growing interest to the M&A deals in the world outside of the US. Goergen and Renneboog (2004) investigated the short-term gains of large European domestic and cross-border takeover bids over the period They tried to analyze the extent that the type of offer, different means of payment, level of stock market development, and corporate governance regulations affect the abnormal returns of both acquirer and target companies. Their sample consisted of 187 M&A announcements with a value of at least $100 million. The results showed 9% announcement effects for the target firms and the abnormal return of about 23%; however, for the acquirers the announcement effect is only 0.7%. The authors find that the type of deal highly correlates with the short-term wealth effects for both targets and bidders. If it is a hostile takeover, the shareholders returns will be higher (around 12.6% on day 0 and 30% on day 5), but if there is a merger of a friendly takeover, the returns will be lower (8% on day 0 and 22% on day 5). Another interesting fact is that the location of the companies in M&A deals impacts the returns. For instance, the UK targets and the bidders generate more shareholders returns than companies from Continental Europe. Also, the evidence of the degree of returns to shareholders worldwide can be found in a recent study by Alexandridis, Petmezas and Travlos (2010). They examined over 4,000 M&A deals in almost 40 countries, in the period between 1990 and 2007, to discover whether M&As can create value for acquiring firms shareholders in countries where there is not a long history of M&A transactions, like the USA, UK, and Canada. The research also focused on whether returns to acquirers (premium and returns to target firms) are negatively (positively) correlated with the level of competition for listed targets. The results show that M&A announcements enhance acquirers value in countries beyond those with the most competitive takeover markets. The authors find that the level of competition is negatively associated with acquirer returns and 4

11 positively associated with target returns. In this study, we investigate cumulative abnormal returns to shareholders of bidder and target firms in the developing markets of Asia and South America around the day of M&A deals, and we investigate the factors that mostly affect these returns. The remainder of the paper is structured as follows: Section II contains a summary of the relevant literature. Section III discusses the data. Section IV addresses the methodology used in the empirical study. Section V presents the results. Section VI presents the conclusions and the implications for investors and managers. LITERATURE REVIEW Much academic research has been done to understand the profitability of M&A activity. Bruner R.F. (2001) combined 130 studies from 1970 to 2001 to examine what, in fact, influences shareholders returns for both target and bidder firms. His analysis combines different methods and techniques for evaluating the success of M&As in different time periods. There has always been a problem measuring the success of M&A deals. The author suggests, however, that there are only three outcomes of such activities: value conserved, value created, or value destroyed. All of these outcomes depend on whether the investment return is the same as, higher than, or lower than the required return. It is very important to mention that everybody focuses mostly on the returns to shareholders, but not on the managerial issues, while assessing the M&As profitability. The reasons for this fact are quite obvious. Managers may pursue their own objectives, which can be disruptive to the company or only short-term. But, the evaluation of the returns gives the entire picture of the company s achievements. Moreover, it is more convenient to compare the results of M&A deals between different firms using such a benchmark. 5

12 Bruner indicates four different methods of extracting the information about M&A profitability: event studies, accounting studies, survey of executives, and clinical studies. The first two approaches are mostly used for scientific purposes (their methods are based on hypothesis testing), while the survey of executives and clinical studies help to describe the existing situation rather than explain why it happens. All of these methods are present in Bruner (2001) where he summarizes the results of 130 different studies. The series of research papers that use the method of event study show that the average abnormal returns to target firms are around 30% to 40% (Jarrell, Poulsen (1989); Franks, Harris, Titman (1991); Smith, Kim (1994); Maquieira, Megginson and Nail (1998) etc.). The returns to buyers, however, are not as attractive. A summary of 41 studies shows that most of the returns to acquirers are negative and vary between one and three percent. There is a certain trend for bidders returns to decrease over time: in the 60s and 70s they were higher than in the 80s and 90s, excluding the deals in banking and technology which show better returns in the 90s (Langetieg (1978); Dodd (1980); Jennings, Mazzeo (1991); Bannerjee, Owers (1992) etc.). The accounting studies method, which focuses mostly on companies financial figures, such as profit margins, return on assets, growth rates etc., is presented in 13 studies, including Meeks (1977); Salter and Weinhold (1979); Mueller (1980); Mueller (1985); Ravenscraft, Scherer (1987); Herman, Lowenstein (1988). These papers reveal some drivers of profitability. The first finding is that an M&A deal between unrelated firms destroys value and, on the contrary, creates value in firms with related businesses (Berger and Ofek, 1995). According to Houston, James and Ryngaert (2001), the other determinant of profitability in M&A activities is the expected synergies from the deal, such as the revenue enhancement and cost savings. Rau and Vermaelen (1998) suggest that the determinant of profitability for the acquirer is the book- 6

13 to-market ratio. The firms with a low book-to-market ratio enjoy pretty high abnormal returns of around 8%, while those firms with high book-to-market ratio have negative returns of 17%. Also, other papers find the method of payment is a highly important factor, which can influence the bidder returns. For instance, stock-based deals usually result in negative abnormal returns (Huang and Walkling, 1987; Yook, 2000). According to Myers and Majluf (1984), bidders prefer cash payments if they believe that their stocks are undervalued and vice versa. The method of payment may reveal private information of the bidder management about the valuation of the bidder's stock, and thereby it affects stock prices. Moreover, several studies suggest that tender offers are the drivers of profitability for bidders. The evidence shows that when buyers address directly to the target stakeholders avoiding contacts with the management, the returns increase sufficiently. Although all of the factors mentioned above are not exhaustive, it is very important to take them into account while making decisions concerning M&A deals. The studies based on surveys of executives find some interesting insights. It is very important to look at the connections between managers opinions on M&As and the scientific findings. The evidence shows that the returns from the deals appear only in the short-term. The authors of such surveys, however, find that managers tend to be positive about the deals, and only a third of the executives admit that they did not achieve their goals (Bruner R.F., 2001). The clinical studies illustrate several M&A cases and try to give explanations of success or failure. The key problems that are defined are incomplete knowledge of the target, the imposition of inappropriate organizational designs on the target (Kaplan, Mitchell, and Wruck, 1997), managerial objectives that were not consistent with maximizing shareholder wealth, executives overconfidence (Lys and Vincent, 1995), and the use of extremely high debt financing (Wruck, 1991). All of these studies stress the importance of organizational, financial, 7

14 and strategic issues. The geographical issues of M&A deals also impact the stock price reaction. The shareholders returns depend on whether a deal is domestic or cross-border. Almost all studies that cover the geographic focus of a transaction conclude that more shareholder value is created when target and bidder operate in a related geographical region (Houston and Ryngaert, 1997). So, we can see that a lot of academics have developed a series of theories to explain and predict the price reaction from an M&A. Most of the studies, however, were focused on the M&A in a developed market like the USA and European countries. But, if we look at the developing economies, we also observe a growing number of M&A deals. The question remains whether or not the behavior of these transactions is impacted by different variables. The Asian market does not have the legal system, like the USA, to protect the interests of shareholders and the welfare of consumers as well as its weak enforcement of existing laws (La Porta et al., 1999). There are cultural differences between those markets which can lead to a dissimilarity in the organizational structure of firms (Denis and McConnell, 2003; Kwok and Tadesse, 2006). In Asian emerging markets, few studies have analyzed the relationship between M&A deals and value effects. J. Ma, J.A. Pagán and Y. Chu (2009) investigate abnormal returns to shareholders of bidder firms around the day of M&A announcement for ten emerging Asian markets: China, India, Hong Kong, Indonesia, Malaysia, the Philippines, Singapore, South Korea, Taiwan, and Thailand. In the study, they employed several event windows to see if there is a difference in the abnormal returns depending on the selected time period. They, however, found that shareholders returns are mostly positive in all of the event windows. Also, the evidence shows that the returns are smaller when the deals are made between companies in the financial industry. 8

15 Many studies that are focused on the emerging markets of Asia analyze M&As in the financial sector. For instance, M. Vaziri, R. Bhuyan, and I-C. Yang examine the return of 123 banking acquisitions in six of Asia s strongest emerging markets (Hong Kong, China, Taiwan, Singapore, Indonesia, and Malaysia) for the acquiring bank using an event-study methodology. Their hypothesis is that if the cross-sectional average CAR is positive and statistically significant, that will show that the acquisition does create value, and investors perceive that the benefits overcome the costs of the acquisition. The results are mixed. Most of the deals, however, resulted in positive returns to bidders. Moreover, they indicate that cross-border banking acquisitions announcements, during 2002 to 2010 in Asia markets, are found to be associated with negative cumulative abnormal returns for the acquirer after the announcement. Y. Chen and M. Young (2010) reveal an interesting fact in their study of cross-border M&As involving Chinese firms from 2000 to They hypothesize that firms in which the government is the dominant owner are less capable of preventing managerial opportunism, more likely to conduct a cross-border M&A with political motives, and less likely to possess the necessary managerial competence. The conflict of interests between the majority shareholders and minority shareholders results in minority shareholders having a negative reaction to the transaction. The results show that M&A deals, with the government as the largest shareholder, result in negative returns. In this study we extend the existing literature by examining the markets in Asia and South America. We specifically measure what variables impact the returns associated with M&As. It is the first study that examines these cross-sectional models for M&As in Asia and South America. 9

16 HYPOTHESIS AND RESEARCH QUESTIONS The discussions presented above are the main motivations for this thesis, and they are the reasons to conduct the analysis in line with previous academic evidence in the field of M&A. Consequently, this paper will focus on Asian and South American M&A profitability from a quantitative perspective by examining the cumulative abnormal stock returns to shareholders in the period surrounding the deal using the event study methodology in a certain window to see whether the findings of the US and European merger waves are still applicable to the emerging market data from the 2000s. The following research question will be investigated: Do M&A deals in the Asian and South American markets create value for shareholders of bidder and target companies? We also examine the stock price reaction of the bidder and target firm. We test the following two hypotheses: H 0 : M&A announcements by Asian and South American firms will generate positive abnormal returns for target shareholders in the certain event window; H 0 : M&A announcements by Asian and South American firms will generate positive abnormal returns for bidding shareholders in the certain event window. We also examine the variables that impact the size of the abnormal returns. We examine the following questions: What are the effects of different types of payment on the cumulative abnormal return to shareholders of the acquiring and target firm? What are the effects of the size of the deal between the target and the acquirer firms on the cumulative abnormal return to shareholders? 10

17 What are the effects of the target firm or the acquiring firm involved in domestic versus cross-border M&As on the cumulative abnormal return to shareholders? What are the effects of corporate financial figures, such as market capitalization, price to cash flow multiple, interest expense coverage ratio, and dividend per share multiple of the target or the acquiring firm, on the cumulative abnormal return to shareholders? While making an M&A transaction, the companies can pay with cash (cash in exchange for shares), equity (a certain number of the bidder s shares for a target share), or a combination (loan notes, deferred payment, share and equity). The type of payment in M&As has been regarded as an important factor for many reasons. For example, Jensen (1986) examines agency costs of free cash flow and suggests that M&As paid with cash would bring more positive results than those made through the exchange of stocks due to its liquidity and motivation for managers to use resources more efficiently. So, companies with more cash or a high cash flow are more likely to make cash offers. Analyzing 60 bidding firms, Travlos (1987) mentions big differences between cash M&As and stock M&As. Acquirers that use stock as a method of payment had a significant negative influence on the cumulative abnormal return of -1.47% while bidders using cash offers gained an insignificant cumulative abnormal return of 0.24%. Based on the evidence presented above the following hypotheses are formulated: H 1 : Cumulative abnormal returns to target shareholders in M&A deals of all-cash offers are significantly higher than for all-equity offers. H 1 : Cumulative abnormal returns to bidder shareholders in M&A deals of all-cash offers are significantly higher than for all-equity offers. 11

18 The number of companies engaged in merging with or acquiring companies outside of their home country has continued to grow in the 21st century to the extent that it has become the main strategic tool for corporate growth (Delios & Beamish: 2004). Viewed originally and primarily as an activity of the US and European companies, cross-border M&As are now becoming more popular among companies in emerging markets. This leads to the following hypotheses: H 2: Cumulative abnormal returns to target shareholders in cross-border M&A deals are significantly higher than in domestic deals. H 2: Cumulative abnormal returns to bidder shareholders in cross-border M&A deals are significantly higher than in domestic deals. Many previous studies (J.M. Campa, I. Hernando, 2004) stress the importance of corporate financial figures such as market capitalization, interest coverage ratio, price to cash flow multiple, and dividend per share multiple for returns to shareholders. The evidence shows that they have a positive impact on shareholders returns. This may not be the case, however, for companies in emerging markets. The following hypotheses are examined: H 3 : Cumulative abnormal returns to target shareholders in M&A deals of companies with high market capitalization are significantly higher than those of companies with low market capitalization. H 3 : Cumulative abnormal returns to bidder shareholders in M&A deals of companies with high market capitalization are significantly higher than those of companies with low market capitalization. 12

19 H 4 : Cumulative abnormal returns to target shareholders in M&A deals of companies with high price to cash flow ratio are significantly higher than those of companies with low price to cash flow ratio. H 4 : Cumulative abnormal returns to bidder shareholders in M&A deals of companies with high price to cash flow ratio are significantly higher than those of companies with low price to cash flow ratio. H 5 : Cumulative abnormal returns to target shareholders in M&A deals of companies with high interest expense coverage ratio are significantly higher than those of companies with low interest expense coverage ratio. H 5 : Cumulative abnormal returns to bidder shareholders in M&A deals of companies with high interest expense coverage ratio are significantly higher than those of companies with low interest expense coverage ratio. H 6 : Cumulative abnormal returns to target shareholders in M&A deal of companies with high dividend per share multiple are significantly higher than those of companies with low dividend per share multiple. H 6 : Cumulative abnormal returns to bidder shareholders in M&A deal of companies with high dividend per share multiple are significantly higher than those of companies with low dividend per share multiple. And finally, it is also important to look at the relationship between shareholders returns and the size of the deal (the announced total value of the deal). The following hypotheses concerning this relationship are examined: H 7 : Cumulative abnormal returns to target shareholders in M&A deal with higher value are significantly higher than those of companies with less value. 13

20 H 7 : Cumulative abnormal returns to bidder shareholders in M&A deal with higher value are significantly higher than those of companies with less value. DATA DESCRIPTION The data was obtained from Bloomberg M&A Database based on the following criteria: - Either the target or the bidder firm must be from the developing market of Asia or South America; - The period of transactions must be from 2000 to 2011, inclusive; - Both the target and the bidder must be public companies; - The size of the deal must be greater or equal to US$ 100 million; - The transaction must be completed. As the result of these selection criteria, the initial sample includes 71 transactions. Some stocks of the companies, however, were not actively traded, and the daily stock prices were not available, so the final sample is comprised of 64 transactions: 57 observations of target companies and 63 observations of bidder companies. Table 1 presents the composition of the deals by year and by country of either target or acquirer in the developing market of Asia and South America. It is important to mention that Brazil is the most active country concerning M&As in that period. Figure 1 displays the final sample divided by the payment type. Figure 2 shows the composition of the deals separated by geographical issue (whether a deal is domestic or cross-border). 14

21 Table 1. Composition of deals by year and by country of either target or acquirer in the developing market of Asia and South America Market/ Year Total % Argentina Brazil Chile China Colombia India Indonesia Malaysia Mexico Pakistan Peru Philippines South Korea Thailand Taiwan Total Figure 1. Composition of the final sample divided by the Payment Method 10 Payment Method 4 Cash Stock Undisclosed 50 15

22 Figure 2. Composition of the deals separated by Geographical Issue Geographic Issue Cross-border 44% Domestic 56% METHODOLOGY In this paper, I examined the market reaction to M&A deals in the developing market of Asia and South America, using the event study, to test the hypothesis that the M&A deals positively affect the returns to shareholders and, also, to define the drivers of these returns. To implement the event study, it is important to properly identify an event window, which is the time period where the stock prices were most affected by the M&A deal. There are different approaches to this problem. Some authors find that the event window should be only several days before and after the announcement of the deal because all of the investors respond to the news immediately. Others suppose that the deal has a long-lasting effect, and the implementation of the deal can change the reaction, which investors made on the announcement day. So, they include several months in the event window. Finally, considering the studies of 16

23 Campa and Hernando (2004) and Moeller (2005), we indicate that the event window should be from 90 trading days prior to the deal to 30 trading days after it. After establishing the event window, we need to capture the abnormal returns (AR) and cumulative abnormal returns (CAR) to determine any significance created by the M&A deal. In order to do this, I define the actual returns and the expected returns, as an abnormal return is the difference between them. For calculation of the returns, I employed the market model which shows the linear relationship between stock returns and returns on the market portfolio: R it = α i + β i R mt + μ it where t is the time index, t=1,2,3, T; i is the security number, i = 1,2,3, I; R it is the daily return on the security; R mt is the daily return on the market; β i is the volatility of the security in relation to the market (a covariance between R it and R mt divided by a variance of R mt ); α i is expected value of (R i -β i R m ); and μ it is a model error term of security i on day t, with expected value equal to zero. The daily actual return on the security was calculated as: R it = where Pit is the closing price of the security i on day t, and Pit-1 is the closing price of the security i on day t-1. The daily return on the market was calculated as: R mt = where Pmt is the closing market index on day t, and Pmt-1 is the closing market index on day t-1. For the market index, we chose the S&P500, due to the fact that it is the best 17

24 representation of the market fluctuations, and it fits for both the Asian and South American markets. So, I can calculate the abnormal return the following way: AR it = R it (α i + β i R it ) where AR it is the abnormal return for the company i on day t; and R it is the actual return for the company i on day t. Then, the daily abnormal returns are summed over the event window (-90; 30) to get the cumulative abnormal returns (CARs): where CAR i is the cumulative abnormal return for the company i over the event window (T2,T1). Simple Regression Analysis It is necessary to run several simple regressions to find the level of significance of different factors on the cumulative abnormal returns to shareholders. The number of observations for targets and bidders differ due to the availability of the information on variables in the models. The independent variables are the size of the deal, the market capitalization of a company, price to cash flow multiple 2, the interest expanse coverage ratio 3, and the dividend per share multiple. The dummy variables are the type of the payment and the type of the deal. The type of the deal is either cross-border or domestic; TD = 1, if type of the deal is cross-border, TD = 0, if type of the 2 The price to cash flow ratio is a measure of the market's expectations of a firm's future financial health. It is calculated by dividing the current share price by the total cash flow from operations per share found. 3 The interest coverage ratio is used to determine how easily a company can pay interest on outstanding debt. It is calculated by dividing a company's earnings before interest and taxes (EBIT) of one period by the company's interest expenses of the same period. The lower the ratio, the more the company is burdened by debt expense. 18

25 deal is domestic. The type of the payment can be cash, stock, or undisclosed. Table 2 displays key descriptive statistics and characteristics for the various independent variables and for the dependent variable that are used in the model for target companies. Table 2. Descriptive statistics for the dependent and independent variables for target companies Variables Min Max Range Standard Error Mean Independent variables (in million USD) Size of the deal Type of Payment (cash) Type of payment (stock) Market Capitalization Price to Cash Flow Interest expanse coverage Dividend per share Type of the deal (crossborder or domestic) Dependent variable CAR -42% 118% 160% 4% 19% The same process was done for bidding companies. Table 3 presents the results of the descriptive statistics. Table 3. Descriptive statistics for the dependent and independent variables for bidders Variables Low High Range Standard Error Mean Independent variables (in million USD) Size of the deal Type of Payment (cash) Type of payment (stock) Market Capitalization Price to Cash Flow Interest expanse coverage Dividend per share Type of the deal (crossborder or domestic) Dependent variable CAR -42% 143% 184% 5% 16% The following models are used to run the simple regression analysis: 19

26 1. CARt1,t2 = α 0 +β 1 SD; 2. CARt1,t2 = α 0 +β 1 PT_cash + μ i ; 3. CARt1,t2 = α 0 +β 1 PT_stock + μ i ; 4. CARt1,t2 = α 0 +β 1 MC + μ i ; 5. CARt1,t2 = α 0 +β 1 PCF + μ i ; 6. CARt1,t2 = α 0 +β 1 IEC + μ i ; 7. CARt1,t2 = α 0 +β 1 DPS + μ i ; where: CAR t1t2 - cumulative abnormal return from day t1 to day t2; SD size of the deal (in million USD); PT_cash type of the payment (cash, stock or undisclosed); PT = 1, if mode of the payment is cash, PT = 0 otherwise. PT_stock type of payment (cash, stock or undisclosed); PT = 1, if mode of the payment is stock, PT = 0 otherwise. TD type of the deal (cross-border or domestic); TD = 1, if type of the deal is crossborder, TD = 0, if type of the deals is domestic. MC size of market capitalization of the company (in million USD); PCF price to cash flow multiple of the company (in million USD); IEC interest expanse coverage ratio of the company (in million USD); DPS dividend per share multiple of the company; μ i - error terms. 20

27 Multiple regression analysis In order to predict the portion of variance in cumulative abnormal returns, multiple regression analysis was also performed. The following model is used to test which variables would impact the CAR of bidding firms and target firms. The regressions were made separately for bidding and for target firms. The regression for target companies has 56 observations. The regression for bidding companies has 62 observations. Both regressions cover 64 M&A deals. CARt1,t2 = α 0 +β 1 SD+ β 2 PT_cash+ β 3 PT_stock+β 4 MC +β 5 PCF+β 6 IEC+β 7 DPS + μ i where: CAR t1t2 - cumulative abnormal return from day t1 to day t2; SD size of the deal (in million USD); PT_cash type of the payment (cash, stock or undisclosed); PT = 1, if mode of the payment is cash, PT = 0 otherwise. PT_stock type of payment (cash, stock or undisclosed); PT = 1, if mode of the payment is stock, PT = 0 otherwise. TD type of the deal (cross-border or domestic); TD = 1, if type of the deal is crossborder, TD = 0, if type of the deals is domestic. MC size of market capitalization of the company (in million USD); PCF price to cash flow multiple of the company (in million USD); IEC interest expanse coverage ratio of the company (in million USD); DPS dividend per share multiple of the company; μ i - error terms. 21

28 EMPIRICAL RESULTS The regression results of the stock price reaction to M&A deals in Asia and South America during the period are displayed in several parts. The first part of the analysis covers the results of simple regressions for bidding companies; they are presented in Table A1. The second part consists of the results of simple regressions for target companies (Table A2). The third part provides the outcomes of the multiple regressions for bidding companies (Table A3). And finally, the last part discusses the results of the multiple regressions for target companies (Table A4). We find that the shareholders have positive average cumulative abnormal returns of 19.3% in the case of target companies and 0.16% in the case of bidding companies in the event window starting from 90 days prior to the deal and ending 30 days after it. Table A1 reports the results of simple regressions for bidding companies. The individual control variables that were introduced in the section above are used in the model. The evidence shows that the strongest relationship exists between the CAR and the type of payment. If the deal is guaranteed by stock instead of cash or other methods, the CAR of a bidding company increases by 12%. The other significant variables are the type of the deal and the market capitalization. They, however, show an inverse correlation, as we can see from Table A5 about correlation between variables for bidding companies. The CAR to the bidding shareholders is higher when the deal is domestic and the market capitalization of the bidding company is smaller. These facts can be explained partially by the lower cultural risks (in the case of a domestic deal) and by more opportunities for future growth after an M&A (in the case of a small market cap). Also the results show that the size of the deal is not very significant in explaining CAR fluctuations because of small t statistics of and relatively high P-value of

29 Moreover, it was discovered that the price to cash flow multiple and the interest expanse coverage ratio are not correlated with CAR. Regarding the results for target firms, Table A2 shows that target shareholders earn higher CARs more when the type of payment is stock and the deal is domestic. And these factors are even more significant for targets returns than for bidders. If we look at the variable TD (CB) (type of the deal, cross-border), the R square is 0.16 in the model for target companies compared to R 0.04 in the model for bidding companies. In both cases, the correlation coefficient is negative, which means that the CAR and cross-border deals have inverse relationships (Table A7). These results support the notion that investors prefer domestic deals over cross-border. Another significant variable for targets CARs is the market capitalization. It tells us that the smaller the market capitalization of targets the higher CARs they earn. Looking at the variable DPS (Dividend per Share) reported in Table A2, there are no significant impacts on CARs of target shareholders, while for bidders returns it was one of the main drivers, as was already mentioned above. As displayed in Table A2, the other variables are not significant for the CARs of the target firms. Table A3 presents the results of the multiple regressions for bidding companies. The analysis indicates that 28% of the total variation of CAR is explained by this model. The evidence shows that the most significant variables in this regression are the type of payment, the market capitalization, and the type of the deal. They are significant at the 5% level of significance. Table A4 reports the outcomes of the multiple regressions for target companies. As we can see here, the model describes the total variation of CAR for targets better than for bidders, explaining the 30.6% of the total variation. Also, the significant variables are the same as in the 23

30 simple regressions. In general, the results obtained in this study are consistent with the existing literature field. It is more complicated, however, to foresee the returns of shareholders in M&A deals in the developing countries due to more instability in the market and a constantly changing environment. CONCLUSIONS AND IMPLICATIONS Starting from the mid-1980s, many authors have been trying to analyze M&A activity. Many studies have focused on the effect of mergers and acquisitions upon shareholders returns. Almost all of them, however, have been concentrated on the European countries and the US. In this study, we investigate the stock price reaction to shareholders of bidder and target firms around M&A deals in Asia and South America. Using a sample of 64 M&A deals in the developing Asian and South American markets over eleven years from 2000 to 2011, we find that the shareholders have positive average cumulative abnormal returns of 19.3% in the case of target companies and 0.16% in the case of bidding companies in the event window starting from 90 days prior to the deal and ending 30 days after it. These findings are consistent with Mulherin and Boone (2000), and they state that bidders shareholders usually break even upon the M&A deal, while targets shareholders enjoy rather high returns. The results of an event study show that the main driver of the CARs is the type of the deal: whether a deal is domestic or cross-border. The evidence suggests that the deal between the companies in one country ensures more positive returns both for target and bidding shareholders. It indicates that investors consider geographic diversification will have negative consequences to the companies in the future. It can be partially explained by cultural differences. If, for example, the deal is made between European and Asian companies, it will be more difficult to establish 24

31 the common corporate culture, as they have absolutely different approaches to the decision making process and to communication between the different levels of management etc. Also, the outcomes reveal that variables, such as the type of payment, the market capitalization, the size of the deal, and the dividend per share multiple, are statistically significant at the 5% level of significance, so they have a large impact on shareholders returns. It can appear because the investors pay attention to the financial situation of companies. And also, it is easier for bidding companies to acquire a smaller target so that they will probably faster implement all of the changes. Conversely, some companies financial figures, such as price to cash flow multiple and interest expense coverage ratio, are not correlated with the cumulative abnormal returns, so the findings of several studies of European markets (Goergen, Renneboog, 2004) are not the same for the Asian and South American markets. The results on the M&A deals in Asian and South American developing markets have important policy implications. First, while investors enjoy the financial benefits associated with M&A deals, external growth through M&A deals is strongly suggested for managers because they can explain how M&As satisfy the interests of their companies. Second, liquidity is significantly affected by the size of the market. In emerging markets, target firms, especially small companies, cannot be easily liquidated at a reasonable price. Managers of bidding firms should learn how to deal with the liquidity effects and how to benefit from the M&A deal. Also, while preparing M&A transactions, companies should be attentive to their peculiarities and choose the right moment and the right partner for the deal. Using the findings of this study and the previous research, shareholders can better predict the results of their deals and get more returns. There are, however, always some unforeseen circumstances that make every transaction special. 25

32 REFERENCES Alexandridis G., Petmezas D., Travlos N.G., Gains from Mergers and Acquisitions Around the World: New Evidence, Financial Management, Vol. 39, 2010, pp Barkema, H.G. Bell, J.H.J. Pennings, J.M.E., Foreign entry, cultural barriers and learning, Strategic Management Journal, 1996, pp Barkoulasa J.T., Baumb C.F., Chakrabortyc A., Waves and persistence in merger and acquisition activity, Economics Letters, Vol. 70, 2001, pp Cebenoyan A.S., Papaioannou G.J., Travlos N.G., Foreign Takeover Activity in the U.S. and Wealth Effects for Target Firm Shareholders, Financial Management, Vol. 21, 1992, pp Cartwright S., Price F., Managerial preferences in international M&A partners revisited: how are they influenced?, Advances in Mergers & Acquisitions, Vol. 2, 2003, pp Golbe D.L., White L.J., A Time-Series Analysis of Mergers and Acquisitions in the U.S. Economy, the National Bureau of Economic Research, 1988, p Gorgen M., Renneboog L., Shareholders Wealth Effects of European Domestic and Crossborder Takeover Bids, European Financial Management, Vol. 10, 2004, pp Kiymaz H., Baker H.K., Short-Term Performance, Industry Effects, and Motives: Evidence from Large M&As, Quarterly Journal of Finance and Accounting, Vol. 47, 2008, pp Lubatkin M., Merger strategies and stockholder value, Strategic Management Journal, Vol. 8, 1987, pp Moeller S.B., Schlingemann F.P., Stulz R.M., Wealth Destruction on a Massive Scale? A Study of Acquiring-Firm Returns in the Recent Merger Wave, The Journal of Finance, Vol. 60, 2005, pages

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34 APPENDICES Table A1. Simple Regression Results for the CAR for bidding firms (see equations on p. 20) Variable Coefficient P-value R 2 Intercept Size of the deal Intercept PT_CASH Intercept PT_STOCK Intercept MC Intercept PCF Intercept IEC Intercept DPS Intercept TD (CB)

35 Table A2. Simple Regression Results for the CAR for target firms (see the equations on p. 20) Variable Coefficient P-value R 2 Intercept Size of the deal Intercept PT_CASH Intercept PT_STOCK Intercept MC Intercept PCF Intercept IEC Intercept DPS Intercept TD (CB) Table A3. Multiple Regression for the CAR for bidding firms (see the equation on p. 22) Variable Coefficient P-value Intercept Size of the deal PT_CASH PT_STOCK MC PCF IEC DPS TD (CB) R 2 =

36 Table A4. Multiple Regression for the CAR for target firms (see the equation on p. 22) Variable Coefficient P-value Intercept Size of the deal E PT_CASH PT_STOCK MC PCF IEC DPS TD (CB) R 2 = Table A5. Correlation coefficients for bidding companies CAR SD PT_CASH PT_ STOCK MC PCF IEC DPS TD (CB) CAR 1 SD PT_CASH PT_STOCK MC PCF IEC DPS TD (CB)