Value Creation Differences in Mergers and Acquisitions between Developed and Emerging Markets:

Transcription

1 Value Creation Differences in Mergers and Acquisitions between Developed and Emerging Markets: a Comparison between Europe and Asia Denise Pronk Master Finance Supervisor: dr. R.J. Mehlkopf

2 Value Creation Differences in Mergers and Acquisitions between Developed and Emerging Markets: a Comparison between Europe and Asia Denise Pronk Supervisor: dr. R.J. Mehlkopf Second reader: dr. F. Braggion Date of completion: D. Pronk Tilburg University 2

3 Abstract This paper studies the differences in wealth creation for shareholders of acquiring companies around the announcement day between mergers and acquisitions (M&As) in Western Europe and M&As in Far East and Central Asia in the period Cumulative abnormal returns around the M&A announcement capture information on the expected value of future earnings and the wealth creation for shareholders. In the sample of 201 completed M&A deals no significant abnormal returns are found for shareholders of acquiring companies. The results suggest significant positive abnormal returns of % for M&As in Western Europe. However, this finding is not robust for the alternative regression. For M&As in Asia no significant wealth gains are shown. The value creation in M&As in Europe does not significantly deviate from value creation in M&As in Asia. When distinguishing between cross-border and domestic transactions, the results show no significant differences in abnormal returns for both Western Europe and Asia. D. Pronk Tilburg University 3

4 Table of Content Abstract... 3 Chapter 1: Introduction... 5 Chapter 2: Literature Review Theoretical background The European market of mergers and acquisitions The Asian market of mergers and acquisitions Value creation for shareholders of target and bidder companies Domestic versus cross-border mergers and acquisitions Chapter 3: Research Method Sample selection Methodology Regression model Chapter 4: Results Sample description The wealth gains for shareholders of acquiring companies Value creation for mergers and acquisitions in European and Asian countries Domestic versus cross-border mergers and acquisitions Chapter 5: Conclusion Chapter 6: References D. Pronk Tilburg University 4

5 I. Introduction Worldwide the number of mergers and acquisitions (M&As) has grown intensively over the last twenty years, causing major changes in the organization and control of global economic activity (Faccio & Masulis, 2004). The past century experienced four great waves in M&As (Gugler et al., 2003), which particularly occurred in developed markets (Ma, Pagán & Chu, 2009). Due to the increased globalization of the economy the most recent wave has been composed of an increasing percentage of cross-border M&As (Gugler et al., 2003). In research this trend is motivated by several arguments, such as improvements in information technology, globalization of real and financial markets, increased shareholder pressure and financial deregulation (Altunbaş & Marqués, 2008). Gaughan (2005) states that M&A deals are mainly used by companies throughout the world to pursue their goals and objectives related to strategic growth. In 2000, industrialized countries accounted for 90 percent of the total value of world cross-border M&As (Mody & Negishi, 2000). Academics have developed many theories and hypotheses to cover numerous aspects of M&As, which are mainly based on theoretical and empirical studies derived from U.S. data. However in the past few years, the volume of M&As in emerging countries such as Latin America and Asia has been growing at a rapid pace. An example is the case of Heineken, the world s third largest brewer by sales, who acquired Asia Pacific Breweries (APB) in APB, maker of the popular Tiger brand, has interest in more than twenty breweries in 13 Asian countries (Boxmeer, 2011). By buying out its partner Fraser & Neave, who sold the 39.7% stake it had in APB, the Dutch company increased its presence in the Asian emerging market (Zekaria & Venkat, 2012). Given the relatively recent development in M&As in emerging markets, there is a lack of extensive research on this topic (Ma, 2009). In recent years few academics have addressed this field of study. In their paper, Simões et al. (2012) published the influence of the announcement of M&As on the existence of positive abnormal returns for shares of firms located in the emerging countries Argentina, Brazil and Chile. Another study, performed by Ma, Pagan and Chu (2009), aimed to close the gap in literature by studying the M&A wave in ten emerging markets in East Asia. Their main finding suggests positive cumulative abnormal returns in the three researched event windows (Ma, 2009). In their research on domestic and cross border acquisitions in India, D. Pronk Tilburg University 5

6 Kohli and Mann (2012) suggest that cross-border acquisitions create relatively higher wealth gains compared to domestic acquisitions. One of the aims of this paper is to complement the literature on M&As in emerging markets, specifically in Asia. Furthermore, a comparison is made between M&As in Europe and Asia, to get an overview of the differences between M&As in developed and emerging markets. Although previous studies have extensively discussed the array of this economic activity in the U.S. and Europe (Ma, 2009), academics rarely made a comparison between developed and emerging markets. In addition to the current development of the two markets, regulatory environment, cultural issues, the type of buyer, the type of takeover and abnormal returns could be potential determinants for differences in M&A activity between the markets. In India, the government imposed strict controls and regulations on foreign exchange, constraining the cross-border M&A activity in the country. In 1991, some major changes occurred in the foreign investment policy, as the government relaxed some of its regulations and deregulated several of its industries allowing for economic liberalization in India (Jayesh & Corp, 2013). Since China joined the World Trade Organization in 2001, the conditions and regulations for foreign investors have evolved considerably. However, foreign companies are still confronted with lack of transparency and bureaucracy as well as reluctance to allow foreign participation or even takeovers by foreign companies in key industries (Baker & McKenzie, 2013). Due to the creation of the Monetary Union and the financial globalisation, the volume of cross-border M&As in Europe is extensive (Altunbaş & Marqués, 2008). These contradicting policies towards foreign companies is one of the aspects that can highly influence the M&A activity and performance. Zephyr database is used to identify all completed M&As with the target company located in Western Europe or with the target company located in Far East and Central Asia in the period Daily stock price information is derived from Compustat Global Security Daily. The analysis is based on a sample of 201 M&A deals, 74 M&A deals in Western Europe and 127 M&A deals in Far East and Central Asia. The main results show positive abnormal returns for shareholders of acquiring companies around the announcement day. However, these findings are statistically insignificant. For the subsample Western Europe statistically significant positive wealth gains are found for shareholders of acquiring companies. Nonetheless, this result is not D. Pronk Tilburg University 6

7 robust for the alternative regression. Moreover, the results show insignificant negative abnormal returns for the subsample Far East and Central Asia. Additionally, the findings suggest that abnormal returns in M&As in Europe do not significantly deviate from abnormal returns in M&As in Asia. For both subsamples, no statistically significant differences in wealth gains around the announcement day of M&As are found between cross-border transactions and domestic transactions. The paper proceeds as follows. The next section provides the current state of literature on M&A activity in general. In this section motives for managers to decide on M&As and the disadvantages of M&As are provided. Second, the specific characteristics of M&A activity in Europe are discussed. Additionally, this section describes literature on the European market and legal requirements. Subsequently, these aspects are analysed for the Asian market as well. Third, previous empirical literature on abnormal returns for shareholders of target and bidder companies as well as on domestic and cross-border M&As are provided, formulating the hypotheses to be studied. Section three describes the methodology used to determine the cumulative abnormal returns from M&A announcements and differences between the two markets. After that, section four presents the main data, followed by the overall findings. In the fifth and last section, the final conclusion is presented. D. Pronk Tilburg University 7

8 2.1 Theoretical background II. Literature Review The market of M&As has experienced five great waves in the past century (Martynova & Renneboog). Corporate M&A strategies have evolved in response to environmental changes as well as to changes in individual industries. The early waves were characterized by companies seeking to alter their competitive position within their country, while later waves were influenced by globalization, the importance of shareholder value as determining factor and the increased importance of cross-border M&As (Sudarsanam, 2010). In 2008, M&A activity accounted for US $707 billion, which mainly originated from developed countries. However, in the past decade the growth of purchases from emerging countries has increased significantly as well (Jongwanich, Brooks & Kohpaiboon, 2013). M&As are important strategic decisions that significantly change the structure and organization of the combined companies (Huyghebaert & Luypaert, 2012). There is extensive literature on rationales for M&A activity by companies. In their paper, Cummins and Weiss (2004) indicate four potential reasons for M&As. Firstly, economies of scale are often used by firms to justify M&As. Through the increased scale of its production, the combined company can benefit from cost reductions (Sudarsanam, 2010). Secondly, merging companies profit from the joint use of inputs such as managerial expertise, technologies, customer lists and research and development, i.e. economies of scope. The third rationale given for M&A deals is the creation of internal capital markets. However, this reason would apply mainly to cross-border M&As. Lastly, substantial evidence exists that managers act in their own interest rather than in maximizing shareholder value when deciding on M&As. Monopoly power, job security, perquisite consumption and their own net income are rationales for M&A activity by managers (Cummins & Weiss, 2004). In addition to the reasons provided by Cummins and Weiss, other potential rationales are efficiency gains, brand names, vertical integration and increased competitive position (Chari, Ouimet & Tesar, 2004; Zademach & Rodríguez-Pose, 2009). These motives can result in potential efficiency gains and better performance for acquirer and target companies. However, M&A deals do not always create value for the acquiring and target companies D. Pronk Tilburg University 8

9 involved. Cummins & Weiss (2004) argue that post-merger integration problems can cause friction costs which offset any benefit that may be realized by M&As. Companies can face difficulties with the integration of different business cultures (Campa and Hernando, 2004) or with the workforce of the merging firms. Especially M&A deals motivated by efficiency considerations may result in redundancy and wage cuts for personnel (Sudarsanam, 2010). In addition, M&As fail to create value for companies when managers act in their own interest rather than that they maximize firm value. Non-value maximizing motives may result in managers engaging in questionable projects and abandoning profitable M&A deals to preserve their job security (Cummins & Weiss, 2004). Previous literature generally states that M&As create significant wealth gains for shareholders of target companies around the announcement day (Campa & Hernando, 2004). Target companies can profit from better governance practices of the acquiring company (Danbolt & Maciver, 2012). In their study on the characteristics of target and acquiring companies, Liu & Qiu (2013) find that acquiring companies are larger in size, have higher profitability, have more advanced technology and have higher productivity. Target companies can benefit from these characteristics, resulting in higher wealth gains for their shareholders around the announcement day. In M&A deals, target firms may extract a higher bid premium, resulting in more wealth gains for shareholders of target firms, but in less value creation for shareholders of acquiring firms (Danbolt & Maciver, 2012). On the contrary, research is less conclusive on value creation for shareholders of acquiring companies (Campa & Hernando, 2004). Wealth gains for shareholders of acquiring companies can be influenced by the institutional character of the target country. Complex trade policies, government intervention and asymmetric information result in less value creation for acquiring companies (Wiegerinck & Von Eije, 2007). However, acquiring firms engaging in M&A deals can create value due to synergies like economies of scale and increased market power (Liu & Qiu, 2013). In addition, M&A transactions can give acquiring companies access to new product markets and new capital markets, which could be beneficial to shareholders of bidder firms (Donohoe, 2006). The wealth effects for shareholders of acquiring firms are likely to depend on several characteristics of target and acquiring companies, as well as on numerous takeover characteristics (Martynova & Renneboog, 2011). D. Pronk Tilburg University 9

10 2.2 The European market of mergers and acquisitions During the last decade Europe has become a more important player in the market of cross-border M&As (Wiegerinck & Von Eije, 2007). The integration of national economies, the introduction of the Euro, the deregulation of a large number of economic sectors and financial markets and the privatization of companies all influenced European corporations to become active participants in the M&A market (Campa & Hernando, 2004; Wiegerinck & Von Eije, 2007). In 2000, the volume of M&A activity in the European Union accounted for US $1.53 billion (Campa & Hernando, 2004). The growth of M&A activity stagnated in 2007 due to the worldwide economic crisis (Martynova & Renneboog, 2001). Nowadays, M&A deals in Europe are remarkable in terms of their size and geographical dispersion and M&A activity by European companies has become similar to that of US companies with regard to volume (Moschieri & Campa, 2013). A fundamental step in the development of M&A activity in the European Union was the introduction of the Euro (Moschieri & Campa, 2013). A single currency increases the attractiveness of corporate restructuring as well as it protects domestic markets from a more competitive environment (Campa & Hernando, 2004). Furthermore, new sources of funding became available for companies (Moschieri & Campa, 2013). Due to the introduction of the Euro, M&A activity in Europe is now characterized by an increased use of cash as a form of payment (Moschieri & Campa, 2009). In their study on the European market of M&As, Moschieri & Campa (2009) find an increased importance of cross-border M&As, a process of industry consolidation and larger use of private equity in Europe. In addition, their analysis shows a more important role of the European Commission in fostering standardization and increased transparency in the M&A market. The European Commission has the authority to examine proposed M&As to prevent harmful effects on competition (European Commission, 2014). M&As fall under European Commission s jurisdiction if i) the combined worldwide turnover of all companies involved is more than 5 billion, ii) the aggregate turnover of each of at least two of the merging parties in 250 million or more, or iii) each of the companies involved achieves more than two-third of its total EU turnover within one and the same member state (Dinc & Erel, 2013; Sudarsanam, 2010). Proposed M&As D. Pronk Tilburg University 10

11 for which this community dimension is not present, will be subject to national competition authorities (European Commission, 2014) Even when M&As satisfy the community dimension, Dinc & Erel (2013) suggest national authorities can still take appropriate measures to oppose M&As such as providing finance to domestic firms, find a more friendly acquirer or take measures to protect public interests. According to Moschieri & Campa (2013) large differences exists in takeover regulations and structural and technical barriers between member states in the European Union. In their study, Zhang & Bulcke (2014) investigate the pre- and postestablishment obstacles of foreign direct investment in Europe for Chinese companies. They state that within Europe member states still have policy and regulatory divergences and diversities. In line with these findings, Campa & Hernando (2004) argue that takeover regulations differ widely among member states. 2.3 The Asian market of mergers and acquisitions M&A activity in Asia, an emerging economy, differs from M&A deals in developed parts of the world, such as Europe and the US, in several important ways. Due to the more concentrated ownership structure of Asian companies, agency problems are less likely to occur in those countries. Besides that, emerging countries are characterized by a poor regulatory environment and weak enforcement of existing laws, whereas developed economies often have advanced legal systems with strong shareholder protection. Furthermore, cultural and governance dissimilarities can result in major differences in the organizational structure of firms (Ma et al., 2009). In the last decade, Asia has experienced an intensive economic growth and a substantial rise in M&A activity (Mody & Negishi, 2000; Sudarsanam, 2010). The booming development of the Chinese economy and that of other Asian countries has increased the attractiveness of M&A deals in those countries for companies all over the world (Wiegerinck & Von Eije, 2007). Another reason for the growth in M&A activity in Asia was the Asian financial crisis in the period Many East-Asian companies were dealing with high levels of debt, interest payments and were driven into illiquidity (Mody & Negishi, 2000). Many companies in financial distress were forced to accept M&As by foreign companies in order to survive (Jayesh & Corp, 2013; Mody & Negishi, 2000). As an attempt to improve the economic situation the Chinese government became more open to foreign investors (Wiegerinck & Von Eije, 2007). Likewise, the Korean and Thai D. Pronk Tilburg University 11

12 governments introduced several policy reforms to attract cross-border M&As and to facilitate reallocation of assets (Mody, Negishi, 2000). In the last years, the legal framework of M&As in China has been adjusting rapidly to new developments in the M&A market. Although M&A regulations are becoming more favourable for companies, there are still contradictions and legislative gaps (Devonshire-Ellis et al., 2011). In the 2011 Foreign Investment Catalog, the Chinese government encouraged M&A deals in more industries than it did in previous years. However, acquiring companies continue to face many difficulties when engaging in M&As in China. Foreign investment is still prohibited in many industries and the Chinese currency is not freely convertible in foreign exchange markets (Baker & McKenzie, 2013). Most M&A activity in Japan was focused on domestic deals and M&As were perceived as negative to the Japanese culture. In 2003, the Japanese government adjusted many M&A regulations to facilitate corporate restructuring and private equity investments. The Industrial Revitalization Act was introduced to alter restrictions on M&A activity for firms with high levels of debt. In addition, antitrust restrictions on M&A deals were reduced and legal barriers were minimized. Although Japan seems more open to M&A activity, the Japanese taxation laws for M&As are considered to be very complex due to special rules introduced in Furthermore, M&A activity in the old-fashioned manufacturing and service industries is still confronted with traditional values of the Japanese culture (Tang & Metwalli, 2006). In 1991, India experienced major changes in government policy with the introduction of the New Industrial Policy allowing for economic liberalization in the country. Historically, the Indian regulatory system was characterized by a bar on free trade, strict controls and regulations on foreign trade and stringent control of the flow of funds. By introducing the New Industrial Policy, the Indian government relaxed several controls and regulations on foreign trade resulting in the development of new markets and rapid growth of service sectors. This process combined with the deregulation of several industries significantly increased the M&A activity in India (Jayesh & Corp, 2013). The regulatory system in Indonesia differs from that of other Asian countries and is continuously changing. M&A regulations require careful consideration as they are often unclear and amendments to existing laws and new laws are likely to be added on short notice (Baker & McKenzie, 2013). D. Pronk Tilburg University 12

13 2.4 Value creation for shareholders of target and bidder companies The value creation and shareholder wealth gains of M&As are usually measured by the abnormal shareholder returns around the day of announcement (Huyghebaert & Luypaert, 2012). The shareholder returns around the announcement of M&As reveal information about potential future synergies and the distribution of wealth among stakeholders (Campa & Hernando, 2004). Extensive literature on value creation for shareholders of the bidder firm, as well as shareholders of the target firm is found in numerous studies from the US and Europe (Sudarsanam, 2010). Most studies unanimously agree that M&As create significantly positive returns for shareholders of target firms. In their study on abnormal shareholder returns around the announcement date of M&As involving firms in the European Union, Campa and Hernando (2004) state that target firm s shareholders on average receive cumulative abnormal returns of 9%. Goergen and Renneboog (2004) and Martynova & Renneboog (2009) provide evidence consistent with this study, as they report large positive abnormal returns for target firms in intra-european M&As of 9% and 9.13%, respectively. Huyghebaert & Luypaert (2012) investigate abnormal returns of M&As in Europe during the period Their results show statistically significant abnormal returns of 20.45% for shareholders of target firms. Besides large body of research on the wealth effects of M&As in Europe, several studies have investigated abnormal returns for target firm shareholders in emerging markets. Goddard et al. (2012) analyse 132 bank M&As in seven Asian and five Latin American countries between They find positive and significant abnormal returns for shareholders of target firms. In their study, Simões et al. (2012) provide evidence on abnormal returns of M&As in three Latin-American countries: Argentina, Brazil and Chile. The results suggest positive abnormal returns for shareholders of target companies in all three countries. However, previous literature on abnormal returns for the shareholders of acquiring firms is less conclusive (Campa & Hernando, 2004). As explained, M&A deals can result in lower wealth gains due to complex regulatory systems and information asymmetry between the companies involved. On the contrary, synergy effects and access to new markets can create significant value for shareholders of acquiring companies around the announcement day in M&As. Moeller et al. (2004) examine abnormal returns of 12,023 M&As by public firms. The equally-weighted abnormal announcement return of bidder companies is 1.1%. Goergen & Renneboog (2004) D. Pronk Tilburg University 13

14 show positive and statistically significant bidder returns of 0.7%. Their results are consistent with the results of Martynova & Renneboog (2009), who find positive abnormal returns of 0.53%. The study of Ma et al. (2009) provides evidence on abnormal returns to shareholders of acquiring companies of 1,477 M&As in ten emerging Asian markets. Their findings show positive reactions around the announcement date of M&As. Campa & Hernando (2004) show that bidder s cumulative abnormal returns are zero on average for a sample of 262 European M&As. In their paper, Goddard et al. (2012) report that bidder s shareholders tend not to lose value at the announcement date of M&As as well. No significant abnormal returns for acquirer s shareholders are found by Wiegerinck & Von Eije (2007), who analysed European M&As in Asia. Given these conflicting findings, this study will focus on abnormal returns for bidder firm s shareholders. In previous studies, evidence on abnormal returns for acquirer s shareholders seems evenly distributed. Several researchers find significant positive abnormal returns for acquirer s shareholders. However, other academics report no value creation for acquiring firms or even negative abnormal returns for shareholders. Therefore, it is examined whether M&A deals create significant positive abnormal returns around the day of announcement for shareholders of acquiring firms. Thus, hypothesis one states: H1: M&As create significant positive abnormal returns for acquiring company shareholders around the announcement day. In their studies, Goergen & Renneboog (2004) and Martynova & Renneboog (2009) show positive abnormal returns around the announcement day for acquiring firm shareholders in Europe of 0.7% and 0.53%, respectively. Conversely, Campa & Hernando (2004) report no wealth effects for shareholders of European bidder firms. In previous literature on the value creation for bidder firm shareholders in M&As in Asian countries, Ma et al. (2009) find positive abnormal returns, Goddard et al. (2011) report no value loss around the announcement day, whereas Wiegerinck & Von Eije (2007) show no significant abnormal returns. Given the relatively higher economic growth of the Asian markets, it could be expected that M&As in Asia create higher wealth gains than M&As in Europe. The stock price of acquiring companies can be considered as the present value of all future cash flows created. Due to the fast development of the Asian economies, higher future cash flows and therefore larger abnormal returns around the D. Pronk Tilburg University 14

15 announcement day can be expected. However, previous studies show larger abnormal returns around the announcement day for M&As in Europe. This could be explained by the opposing government regulations for M&A activity in many Asian countries. The complex regulatory environment increases asymmetric information and acquiring companies face difficulties with strict taxation laws and controls and unknown amendments to regulations. The M&A regulatory system in European countries has been more developed and therefore lower abnormal returns for M&A deals in Asia countries could be expected. Consequently, the abnormal returns for acquiring firm shareholders around the announcement day could be higher or lower for M&As in European countries than for M&As in Asian countries. The following hypothesis is defined: H2: Abnormal announcement returns for acquiring company s shareholders created in M&A deals in European countries deviate from abnormal returns created in M&As in Asian countries. 2.5 Domestic versus cross-border mergers and acquisitions Due to increased globalisation and deregulation of industries the level of cross-border M&As has substantially increased throughout the world (Danbolt & Maciver, 2012). Most research suggests that cross-border M&As create significant wealth gains for shareholders of acquiring firms as these, besides the general benefits of M&As, allow bidder firms to take advantage of several market imperfections (Kohli & Mann, 2011). Motives for acquirers engaging in international M&As are differences in tax systems, imperfect capital markets (Wiegerinck & Von Eije, 2007) and strategic natural resources. Acquiring companies have easier access to the target country s natural resources such as crude oil or coal and therefore are able to secure the supply of raw materials (Jongwanich et al., 2013). In addition, reasons for acquirers to invest in foreign companies are international diversification, access to new markets (Danbolt & Maciver, 2012) and imperfections in factor and product markets (Donohoe, 2006). Despite these advantages, not all studies unanimously agree that cross-border M&As are more beneficial than domestic ones (Kohli & Mann, 2011). Danbolt & Maciver (2012) argue that benefits of international diversification are mainly resulting in higher target abnormal returns and not in better performance for acquirers. Companies involved in cross-border M&As could face difficulties with cultural integration, labour mobility and differences in business cultures (Campa D. Pronk Tilburg University 15

16 & Hernando, 2004). Moreover, cross-border M&As can be less advantageous than domestic M&As due to an increased level of competition (Moeller & Schlingemann, 2005), increased organizational complexity (Bertrand & Betschinger, 2012), agency problems and asymmetric information (Wiegerinck & Von Eije, 2007). When acquiring companies are not fully informed, they are more likely to overpay for foreign targets and overestimate synergies (Bertrand & Betschinger, 2012). Furthermore, differences in takeover legislation and regulations can explain differences in wealth effects between domestic and cross-border M&As (Goergen & Renneboog, 2004). In their paper on domestic and cross-border announcement returns of 4000 M&As in the United Kingdom, Conn et al. (2005) find that cross-border M&As result in lower abnormal returns for shareholders of acquiring companies around the announcement day than domestic M&As. Goergen and Renneboog (2004) state that domestic M&As result in higher wealth effects for bidder companies than cross-border M&As. Lower announcement returns for acquirers in crossborder M&As are found by Moeller & Schlingemann (2005) and Campa & Hernando (2004) as well. On the contrary, Danbolt & Maciver (2012) show that both target and bidder firms create higher wealth gains in cross-border M&As than in domestic ones. They report a difference in abnormal returns between cross-border M&As and domestic M&As of 1.5%. In their study on M&As in India, Kohli & Mann (2011) find that acquiring firm s shareholders gain more in crossborder M&As than in domestic ones as well. Previous literature does not consistently state that cross-border M&As create higher wealth gains for acquirer s shareholders than domestic M&As. Besides the general advantages of M&As, firms engaging in cross-border M&As can among other things benefit from international diversification, product and market imperfections and differences in taxation laws. However, cross-border M&A activity can increase the level of competition, increase organizational complexity and acquiring firms can face problems regarding cultural integration. Empirical studies on the differences in wealth gains between cross-border M&As and domestic M&As are not conclusive either. Whereas Danbolt & Maciver (2012) and Kohli & Mann (2011) find larger abnormal returns around the announcement day for cross-border M&A, Goergen & Renneboog (2004) and Moeller & Schlingemann (2005) report higher wealth gains for shareholders of the acquiring firms in domestic M&A deals. Therefore, the following hypotheses are developed: D. Pronk Tilburg University 16

17 H3: Abnormal returns for acquirer s shareholders around the announcement day in cross-border M&As in Europe deviate from abnormal returns for acquirer s shareholder in domestic M&As in Europe. H4: Abnormal returns for acquirer s shareholders around the announcement day in cross-border M&As in Asia deviate from abnormal returns for shareholders of acquiring companies in domestic M&As in Asia. D. Pronk Tilburg University 17

18 III. Research Method 3.1 Sample selection The data on M&A deals are collected from Zephyr database of Bureau van Dijk. Zephyr provides information on M&A deals around the world including detailed financial company information and is used to find announcement days and other bid characteristics. From the database, M&A transactions in two different regions in the world are derived. To capture M&A deals in developed markets, the sample contains M&As of which the target company is located in Western Europe. In addition, the sample includes all M&A deals of which the target firm is situated in Far East or Central Asia, representing M&A activity in emerging markets. In both regions the largest 250 M&A deals according to deal value are selected. This study focuses on European and Asian M&A deals announced in the period The beginning of the sample period was selected to include all deals after the Asian Financial Crisis. From many Asian companies were facing financial distress, which resulted in the Asian governments altering their M&A regulations and thus causing a rapid increase in M&A activity. To be included in the sample, M&A deals must meet the following additional criteria: (1) The M&A transaction must be completed. (2) Both the acquirer company and target company must be publicly listed on the stock market. (3) To focus on changes in control, the acquirer held less than 50% of the target s shares prior to the deal announcement and holds more than 50% of the shares in the target company after the M&A deal. If information on the percentage of shares held by the acquirer prior to the announcement is unknown, M&A deals with an acquisition of 50% or more of the shares in the target company are included as well. (4) The acquiring company has daily stock price data available. Furthermore, M&A deals including the same target company and the same acquirer company announced in the same year are eliminated from the sample in order to accurately estimate the market model parameters. The information on daily stock price data for both European and Asian M&A deals is derived from Compustat Global Security Daily available via Wharton Research Data Services (WRDS). Compustat Global contains fundamental and market information on all non-u.s. and non- Canadian active publicly held companies. For stock price data of M&A deals with an acquiring company from the U.S. or Canada, Compustat North America Security Daily is used. The data description covers 360 M&A transactions by publicly traded acquirers, 171 European D. Pronk Tilburg University 18

19 M&A deals and 189 Asian M&A deals. Of these transactions, stock price data were available for acquiring companies of 285 M&As, 131 acquirers in European M&A deals and 154 acquirers in Asian M&A transactions. 3.2 Methodology To calculate the wealth effects for shareholders of acquiring companies abnormal returns around the announcement day of M&A deals are used. Abnormal returns capture the expectation of the markets regarding the effects of M&A deals. The most common way to value abnormal returns for the shareholders of acquiring companies is the use of the traditional event study methodology. Huyghebaert and Luypaert (2013) state that the most important advantage of this method is that all future M&A gains are discounted. The event study analyses stock prices, which reflect the expectation of markets regarding the value of future earnings of companies. An event study estimates wealth effects by calculating the difference between the normal returns and the actual returns in the event window. The event window includes the announcement day and several days surrounding this event. Following prior literature, this study estimates abnormal returns over a three-day event window (-1, 0, 1), in which the announcement day equals day 0. Small event windows are more accurate, since the possibility of price effects from other market events is ruled out (Ma et al., 2009). One day prior to the announcement day is included in the event window to capture the market reaction to potential information leakages before the official announcement of M&As. One day after the announcement of an M&A deal is added to the event window because it will capture price effects in case the announcement occurs after the stock market trading hours. To estimate abnormal returns for shareholders of acquiring firms a benchmark return needs to be determined, the normal return. In previous studies, several methodologies are used to generate the normal return. The two most common approaches are the capital asset pricing model (CAPM) and the market model. CAPM assumes that the expected return of a certain asset is a linear function of its covariance with the market return of a security (Ma et al., 2009). CAPM explains the relationship between risk and the expected return on a firm s stock. Campa & Hernando (2004) and Goergen & Renneboog (2004) have used this method to determine normal returns. The limitation of this method is that it requires the risk-free return to estimate the benchmark return. In their paper, Ma et al. (2009) state that it is difficult to obtain risk-free interest rates in D. Pronk Tilburg University 19

20 most Asian markets due to the underdeveloped securities markets. The market model assumes a stable linear relation between the expected return of a security and the market return for the estimation period. Although CAPM is a reliable methodology to calculate the benchmark returns, the market model is the most widely used event study model. Among others, Ma et al. (2009), Wiegerinck & Von Eije (2007), Donohoe (2006) and Danbolt & Maciver (2012) have used this approach to estimate the normal returns. However, critiques state this model can include possible measurement problems and problems of missing variable bias. These possible limitations have only a small, but probably no significant impact on the estimated abnormal returns since this study is focusing on short-term announcement effects of M&As. Taking into consideration that this paper is focusing on M&A deals in Western Europe and Far East and Central Asia, difficulties with obtaining the risk-free rates for Asian target companies in CAPM are likely to arise. Therefore, in this study the market model will be used to estimate benchmark returns. The market model uses the undermentioned equation to measure the benchmark returns in the estimation window: Rit = αi + βi(rmt) + εit (1) Rit is the actual or realised return to security i on day t and Rmt is the actual market return on day t. The market return is estimated by the variation in the parameters α and β. The α coefficient represents the intercept term for the market model regression. β is the slope of the market model regression and captures the risk of security i with respect to the actual market. The parameters are estimated by running the market model over an estimation period of 200 trading days. Observations are used from 230 trading days to 30 trading days prior to the official announcement date of the M&A deal. An estimation period of 200 trading days to estimate benchmark returns is applied by Donohoe (2006) and by Wiegerinck & Von Eije (2007) as well. As an index proxy for the market returns, the STOXX Global 1800 Index will be used. The STOXX Global 1800 index contains 1800 European, Asian/Pacific and American stocks. Previous studies mainly used regional indexes such as the MSCI Europe or the S&P500. D. Pronk Tilburg University 20

21 However, since this study is focusing on Western Europe and Far East and Central Asia, a global index will be used. The regression coefficients α and β are calculated over the estimation period using an Ordinary Least Squares (OLS) regression. The difference between the actual return and the predicted benchmark return, i.e. the daily abnormal return is computed for each day in the event window using the following equation: ARit = Rit (αi + βirmt) (2) ARit is the abnormal return of security i at the event day t, Rit is the actual return of security i at the event day t and αi + βirmt is the expected return at the event day t. The abnormal returns are measured for the event window, 1 day prior to the announcement date, on the announcement day and 1 day after the announcement date of an M&A deal. The daily abnormal returns are accumulated over the event window to calculate the cumulative abnormal return (CAR) for each acquiring company. The CARs are averaged over the event window to obtain cumulative average abnormal returns (CAAR). In this study, it is tested whether CAARs for shareholders of acquiring companies are positive and significant, whether CAARs of M&A deals in Europe deviate from CAARS of M&A deals in Asia and if CAARS in domestic M&A deals differ from CAARS created in cross-border M&A deals. The last hypothesis is tested for both European and Asian M&As. 3.3 Regression model A regression analysis is conducted to identify the potential sources of value creation around the announcement day for shareholders of acquiring companies in M&A deals. The basic model specification is as follows: CARi = αi + β1relatedi + β2companysizei + β3ebitda/totalassetsi + β4relsizei where CARi is the cumulative average abnormal return for shareholders of the acquiring company i in the three-day event window. This study controls for a number of variables D. Pronk Tilburg University 21

22 including industry-relatedness, company size, EBITDA/total assets and relative size. These variables have been highlighted in previous literature as likely to affect abnormal returns around the day of announcement. Previous research generally suggests that shareholders of acquiring companies gain significantly more in industry-related M&A deals than in diversification M&A deals (Campa & Hernando, 2004; Feito-Ruiz & Menéndez-Requejo, 2011). Focus strategies generate more value than diversification strategies due to the exploitation of strategic synergies (Campa & Hernando, 2004). In addition, managers are likely to overestimate future performance in diversification M&As, which leads to less value creation for shareholders of acquiring companies (Feito-Ruiz & Menéndez-Requejo, 2011). Therefore, this study introduces a dummy variable to control for industry-relatedness. The dummy RELATED takes the value of 1 for those M&A deals of which the acquiring and target company operate in the same industry and takes the value of 0 if they operate in different primary industries. Acquiring and target companies are defined to operate in the same industry if the main line of business of both companies contains the same two-digit SIC codes. A positive relation between industry relatedness and abnormal returns for shareholders of acquiring companies is expected. Next, this study controls for the size of the acquiring company which is used as a proxy for a company s resources and capabilities. Resources and capabilities include among other things knowledge and ties to business partners which could increase the company s performance. Large companies tend to benefit from more available resources and larger scope and scale economies (Bertrand & Betschinger, 2011). On the contrary, large companies usually have greater separation between ownership and control, leading to greater managerial interest in M&A deals. This may result in managers engaging in questionable deals which may reduce the wealth gains for shareholders of the acquiring firms (Feito-Ruiz & Menéndez-Requejo, 2011). Moreover, large firms have increased organizational complexity compared to small firms and are more likely to overpay in M&A deals (Bertrand & Betschinger, 2011). Based on previous studies, it is expected that company size is negatively related to abnormal returns. COMPANY SIZE is measured by the log transformation of the total assets of the acquiring company at the end of the second quartile prior to the quartile in which the M&A deal is announced. As an indicator of a company s financial performance, earnings before interest, taxes, depreciation and amortization (EBITDA) is added as control variable. The firm s EBITDA is D. Pronk Tilburg University 22

23 calculated as a ratio to the company s total assets. To avoid comparability problems across companies due to different applications of accounting methods EBITDA rather than EBIT is chosen as a measure of financial performance. In their study on M&As by European companies, Feito-Ruiz & Menéndez-Requejo (2011) suggest that higher cash flow will result in less value creation for shareholders of acquiring companies. Cash flow is defined as EBITDA over the total assets of the acquiring firm. In addition, Huyghebaert & Luypaert (2012) report a negative relation between EBITDA to total assets and abnormal returns for shareholders of acquiring companies. However, this result is not significant. Nevertheless, it is expected that a high EBITDA/total assets results in less value creation for shareholders of acquiring companies. The variable EBITDA/TOTALASSETS is measured at the financial year ending prior to the year of the announcement of the M&A deal. Numerous studies on the wealth gains for shareholders of acquiring and target companies around the announcement day have used relative size as a control variable. RELSIZE is measured by the proportion of the total assets of the target company relative to the total assets of the acquiring company. The total assets for both companies are measured at the end of the second quartile prior to the quartile of the M&A announcement. It is expected that relative size is negatively related to the abnormal returns for shareholders of acquiring companies on the announcement day. Larger combined firms require a more complex corporate structure to operate effectively. In addition, the integration of a relatively large target company after the M&A deal may be a difficult process. Hence, relatively large target companies will decrease the abnormal returns for shareholders of acquiring firms. To test the second hypothesis, assuming that abnormal returns for shareholders of acquiring companies created in M&As in European countries deviate from abnormal returns created in M&As in Asian countries, the control variable EUROPE will be added to the basic regression model. EUROPE is a dummy variable which takes the value of 1 if the target company is located in Western Europe and takes the value of 0 if the target company is situated in Far East or Central Asia. The dummy variable CROSSBORDER will be added to the basic regression model to test the third and fourth hypothesis, assuming that abnormal returns for shareholders of acquiring companies created in cross-border M&As deviate from abnormal returns for shareholders of acquiring companies created in domestic M&As for both Western Europe and Far East and D. Pronk Tilburg University 23

24 Central Asia. The dummy variable takes the value of 1 if the M&A is a cross-border transaction and takes the value of 0 if the M&A is a domestic transaction. The hypotheses will be tested using a sample of 201 M&A deals, 74 European M&As and 127 Asian M&A deals. D. Pronk Tilburg University 24

25 IV. Results 4.1 Sample description Table 1 reports summary statistics for 201 M&A deals announced in the period per country of the acquiring company and target company. The Table shows that Japan is the most frequent acquiring country in the total sample. Of the 201 M&As in the sample, Japan was the acquirer country in 43 transactions. China, France, Germany, India and the Republic of Korea account for a large proportion of the M&A deals as well with 16, 13, 10, 13 and 12 M&A transactions respectively. For M&A deals with the target company located in Western Europe, French acquirers represent the largest group, followed at some distance by Germany and Italy. Japan is the most frequent acquirer for M&A deals with the target company situated in Far East and Central Asia. Other large acquiring countries are China, India and the Republic of Korea. In addition, Table 1 provides details regarding the country of the target company. In the sample of 201 M&A deals, companies in Japan are most frequently acquired. Additionally, Table 1 shows that a large majority of the M&A deals involve targets from China, France, Germany, Indonesia, India and the Republic of Korea. These countries are similar to the largest acquiring countries in the sample, except for Indonesia. France, Germany, Turkey and Sweden are the most frequent target countries in M&A deals with the target firm located in Western Europe. For M&As with the target company situated in Far East and Central Asia, firms located in Japan account for the largest proportion of target companies, followed by China and India. Table 2 provides descriptive statistics on M&A deals classified per year of announcement. In the total sample of 201 M&A deals, most M&As were announced in The number of deals does not increase continuously through time. The number of M&A deals announced increases until 2007, but slightly falls thereafter. However, the amount of M&A deals announced after 2007 remains larger than the number of announcements in the period For M&A deals with the target company located in Western Europe, the number of announcements appears to be significantly larger in 2011 and This could be explained by a slight recovery from the worldwide financial crisis which started in The number of M&A transactions with the target company situated in Far East or Central Asia has been growing intensively since In 2007 the number of M&A announcements reached a peak. D. Pronk Tilburg University 25