Morningstar ratings and fund performance blake morey
100015335_EC4302
1. 1
SCHOOL OF ECONOMICS AND FINANCE
EC4302
RESEARCH PROJECT
Session 2013-14
Project Title What affects target premium
distribution of cross-border M&A?
Evidence from Deals of US Targets
Student I.D.
100015335
Date of Submission
Tuesday April 15th
, 2014
Project Supervisor
Professor Leonidas Barbopoulos
Word Count
9,969
I, 100015335, received particular assistance in the writing of this work in respect
of matters of grammar, style, vocabulary, spelling or punctuation. The assistance
was provided by a fellow Student and a member of the Academic Staff.
2. 2
Acknowledgements
I would like to thank my father for inspiring this project. My friends and family have
been instrumental to my success, and I am very grateful for their support and advice.
I would also like to express my deepest gratitude to Professor Barbopoulos, without
whom this would not have been possible. Thank you for motivating me, and providing
me with invaluable guidance and patience.
!
3. 3
Abstract
The financial activity of M&A has provided a substantial area of study for economists.
The nature of M&A is constantly adapting to evolving market environments and financial
trends. Through the use of MNE and synergy theories, this study has facilitated the
understanding of how cross-border acquisitions affect target premium distribution.
Specifically, the study focuses on target cash reserves and growth opportunity, using free
cash flow theory and Tobin’s Q theory, to understand the variance of premiums paid in
takeovers of US targets. The study uses a sample of 21,370 deals of US firms from 1986
to 2011 compiled from the US Securities and Exchange Commission. Events study is
employed to calculate target cumulative abnormal returns over a short event period of
five days. This study seeks to isolate which bidder and target characteristics have an
impact on the target premium paid for US deals between 1986 and 2011. This study finds
that cross-border acquirers pay 11.46% higher premiums for US targets. For the entire
sample, targets with higher cash reserves receive, on average, a 2 % higher premium.
Analysis of target market-to-book ratio and market valuation strongly evidence the third
hypothesis that targets with fewer growth opportunities, thus a lower Tobin’s Q-ratio,
earn higher premiums by acquirers of 3.95%.
5. 5
1. Introduction
On September 1st
2008, Shionogi & Co., a publicly listed Japanese
pharmaceutical company, announced the takeover of the US firm Sciele Pharma inc.
Shionogi, based out of Osaka, made a cash tender offer of $1.4 billion to purchase the
publicly listed American pharmaceutical company. The president of the Japanese
acquirer, Isao Teshirogi, explained that the firm hoped to increase its earning by
enhancing its presence in the US. As a result of this takeover, the merged company
expected to improve productivity growth by capitalizing on the domestic pipelines for
research and development and the sales network in the US.1
This provides but one
example of recent successful cross-border acquisitions of American firms, and has helped
motivate the subject of this paper. In relevance to the Sciele merger, the healthcare
industry, high tech, and general services sector tend to hold higher cash reserves to be
used for short-term R&D, which, as this study argues, could be possibly explanation of
higher target premium offered. This study is devoted to gain a holistic understanding of
the optimal target and bidder conditions driving US target premiums.
Since the early 1980’s, there have been three waves of “merger mania”,
characterized by a boom of cross-border takeovers (see Sudarsanam 2010). The United
States economy, in particular, has undergone a surge of foreign direct investments. The
recent prevalence of cross-border acquisitions has provided a confounding issue for
financial economists who seek to discover how and why mergers happen. The
motivations for cross-border takeovers are different and the characteristics of both target
1
This particular takeover is associated with high takeover premium of around 60 to 70
percent. In this case, the target exhibited a higher Q-ratio relative to other firms in the
US. Such characteristics set the ground to examine which factors determine target
premium.
6. 6
and bidders have varying impacts on the premium distribution relative to domestic
acquisitions.
Harris and Ravenscraft (1991) pioneered the first M&A research regarding the
role of foreign acquisition in the US and the various influences of target and bidder
characteristics on target premium distribution. Their research set the stage for others to
enhance the understanding of cross-border acquisitions [see Moeller and Schlingeman
(2004); Goergen and Rennenboog (2004); Kang (2003)]. In an extensive review study,
Eckbo (2011) compiled various studies and approaches regarding different types of
takeovers, target and shareholder wealth gains, motivations, and reasons for unsuccessful
versus successful mergers. Sudarsanam (2010) and DePamphilis (2012) both delineate
the context and motivations of recent M&A activity. Indeed, M&A activity has inspired a
substantial amount of research, which this study hopes to improve upon.
By applying a rational bidding approach founded in synergy and MNE theory,
this paper aims to identify if cross border takeovers generate differences in target
premiums. M&A literature reveals a heavy influence of target cash reserves and a target’s
Tobin-Q ratio on target premium distribution. Prior research has shown that targets with
high levels of cash reserves receive higher premiums, and that targets with fewer growth
opportunities, a lower Q, earn lower target premiums. Additionally, in the OLS
regression, other target and bidder characteristics are tested against the independent
variable of target premium to gain a more holistic view of target premium distribution.
The study uses a sample of 21,370 deals of US target firms, whose premiums
have been calculated as 5-day cumulative abnormal returns using the modified market
model. The main findings of the study reveals that cross-border acquirers pay higher
7. 7
premiums for US firms than do domestic acquirers, corroborating previous studies such
as Harris and Ravenscraft (1991). As stipulated in Jensen’s (1986) free cash flow theory,
the results reveal that US firms with higher levels of cash reserves receive higher
premiums of around 2 percent. Also, the results report that US targets with lower Tobin’s
Q ratios earn four percent higher CAR, which was anticipated given prior research.
Furthermore, the above results are highly sensitive to (i) method of payment [cash deals
are associated with lower premium] (ii) listing status [private bidders are associated with
lower premiums] (iii) industry diversification [takeovers within the same macro-industry
generate lower premium] (iv) size of target [lower target market valuations lead to higher
premiums].
There are certain ramifications of the analysis due to the assumptions of events
study methodology. Additionally, the limited literature on the impact of target debt-to-
equity ratio on target premium confines this study from making any definite conclusions.
The second section will outline supporting prior M&A literature to develop the
three hypotheses. The study applies a collation of different M&A theory and approaches
in an effort to understand M&A motivations and target premium variations. The section
is followed by a description of the data compiled from the US SEC and methodology
employed. After, the univariate and regression analysis results are presented and
interpreted. The study concludes with a discussion of the issues and future implications of
the research.
8. 8
2. Motivations for Mergers and Acquisitions
A broad scope of M&A literature has been dedicated to identifying the
motivations for takeovers. The waves of M&A beginning in the 1980’s prompted by
globalization, technological improvements, and regulatory change have been
predominately motivated by increased efficiency, market power, and value enhancement.
This study investigates the three predominant approaches to understanding M&A
motivations: synergy, agency problems, and hubris.
The synergy theory simply states that firms choose to merge in order to increase their
production and maximize their shareholder value. Financial (informational) synergy
theory stipulates that firms merge to reduce transaction or bankruptcy costs, through the
creation of internal capital markets. On the other hand, operational synergies enhance
value through economies of scale and scope. As Rossi and Volpin (2004) aptly explain,
“Corporate assets should be channeled toward their best possible use… Mergers and
acquisitions help [this] by reallocating control over companies.” Firms can spread the
fixed costs of production, such as the depreciation of technology and equipment, by
merging with other to increase marginal production and profit. Economies of scope
dictate that firms will merge to share resources in order to increase production efficiency.
Bertrand and Zitouna (2008), contrary to theory, found that mergers and acquisitions
increased the productivity of French targets firms, but did not enhance their profit in the
long run. Ravenscraft and Scherer (1989) report that highly profitable pre-merger
acquired firms experienced a decline their profitability when analyzing takeovers from
1975-1977.
9. 9
Agency problems between management and shareholders of firms can induce
managers to seek investments for personal benefits rather than shareholder value
maximization. M&A may provide a medium through which managers increase their
power. Managers may sacrifice the shareholders’ best interests in pursuit of managerial
empire-building. In a similar vein, hubris may induce careless and wasteful investments.
Owners overconfident in their abilities may overvalue certain investments leading to
hazardous decision-making. Agency problems and hubris can be both complicated and
mitigated by the presence of excess cash reserves, as discussed further in section 3.2.
Scholars have analyzed the reasons behind mergers and acquisitions to find that
synergies are the primary driving force for takeovers [see Ismaili (2005); Goergen and
Rennenborg (2004)]. Consistent with those results, this paper uses a rational bidding
approach: the driving force behind these takeovers is to create synergies to maximize
shareholder value.
10. 10
3. What affects premium?
M&A research has long been concerned with the distribution of premium and the
effects of takeovers for target shareholders. With the emergence of various forms of
takeovers in the past few decades, M&A literature has evolved and improved to better
understand how target characteristics, market environments, and acquirers impact the
target shareholder wealth gains. The current preponderance of cross-border acquisitions
in the U.S. has prompted the interest in takeover premiums. This study selects to analyze
how cross-border takeover premiums differ from domestic premiums and why, focusing
on target cash reserves and target q-ratios.
M&A literature has been dedicated to understanding how the following relevant
factors affecting premium distributions:
i) Geographical location
ii) Cash Reserves
iii) Tobin’s Q-ratio
iv) Method of Payment
v) Acquirer’s listing status (Public, private, or subsidiary)
vi) Industry
These variables are considered when investigating the principle effects of cash reserves,
Tobin’s Q-ratio and geography on target abnormal returns.
11. 11
3.1. Cross-border Acquisitions: Motivations and Premium Distribution
The surge of cross-border acquisitions in the US has proved a compelling area of
research for economists. These cross-border acquisitions constitute a significant part of
the United States’ Foreign Direct Investment, and have led to an overall boost in its FDI
position. Moeller and Schlingemann (2004) attributes this in part to the US investment
opportunities presented due to market integration. Due to this increase in FDI, There is a
growing body of literature exploring the purpose for cross-border acquisition versus
domestic acquisitions. Cross-border takeovers allow for the restructuring of industry, or
as a pathway into foreign markets (Betrand 2006) In accordance with this notion,
Multinational Enterprise Theory suggests that international corporations benefit from
higher productivity and profit. Harris and Ravenscraft’s (1991) paper The Role of
Acquisitions in Foreign Direct Investment employs share price data to compare the
returns from cross-border and domestic takeovers in the US stock market. The study
pinpoints three reasons for the boom in cross-border takeovers, outlined below.
Managers may be motivated to pursue transnational takeovers because of the
imperfections and costs in product markets. Harris (1991) stresses that this is true
especially in research and development industries, because the market is often inefficient
in the transfer of technological information. The patents and licensing of specialized
skills can create barriers to entry, which creates a need for multinational operations to be
able to share technology. In accordance to the synergy theory, large multinational firms
can find the ability to spread the fixed costs of R&D over a number of national markets
advantageous. International enterprises might prefer to seek cross-border acquisitions in
12. 12
order to internalize actions that would otherwise be costly through the market
mechanism.
Government and regulatory policies can incentivize firms to pursue foreign
takeovers. A country’s tariff and trade policies can be prohibitive to a firm’s
manufacturing capabilities, which in turn spur the firm on to purchase producing power
in a different country to avoid importing restrictions. The market for capital control in
different markets can make cross-border acquisitions seem more attractive because of
beneficial trade and tax policies. For example, changes in US tax laws, such as the 1981
Economic Recovery Tax that included accelerated depreciation schedules obtained upon
asset acquisition, created tax motivations for US takeovers by foreign firms.
Lastly, many economists argue that imperfections and information
asymmetries in capital markets induce cross-border acquisitions. Investments firms
may find it very costly to purchase an asset solely with externally obtained funds if there
are information asymmetries about the asset’s return (or payoff). Exchange rates can
prove advantageous to foreign acquisitions if the foreign buyer’s currency is stronger
than the US dollar. Doukas (2007) confirms that foreign direct investments are
promulgated by the existence of market imperfections across different nations. Indeed,
the market for capital control can promulgate the entrance of foreign firms due to
favorable exchange rate policies. However, Bertrand (2006) cautions that cross border
acquisitions may be hindered by these information asymmetries when trying to
implement organizational or managerial changes.
Cross-border literature highlights additional factors motivating FDIs. Moeller and
Schlingemann (2004) conclude that by participating in cross-border acquisitions,
13. 13
acquirers increase their global product diversification, possibly increasing their bidder
returns compared to domestic acquisitions. Harris and Ravenscraft (1991) specify that
certain domestic assets may be more valuable to a foreign acquirer than to a domestic
one. Indeed, foreign bidder can gain valuable assets such as technology and gain
advantage of local government policies, as well as different forms of risk management.
MNE theory dictates that firms enter into FDIs to internalize costly international
transactions, thereby benefiting from market imperfections and creating financial
synergies. However, if global diversification is value decreasing, or the exchange rate
proves unfavorable to the foreign bidder, cross-border M&A can result in lower gains
compared to domestic M&A. Foreign companies can face difficulties in setting up a
domestic distribution channel when producing abroad There is also the additional
problem of cultural, political, and economic difference leading to asymmetric information
for the bidder.
Harris and Ravenscraft (1991) found in their analysis that foreign buyers pay a
significantly higher premium for US firms than US buyers, and takeover wealth gains are
substantially higher in foreign acquisitions compared to domestic takeovers [see also
Kang (2003); Rossi and Volpin (2004); Danbolt and Maciver (2012)]. Doukas (2007) and
Harford (1999) theorize that cross-border takeover pay higher premiums due to the cash-
rich nature of foreign firms. Indeed, Moeller and Schlingemann (2004) argue that foreign
corporations tend to use cash bids since they do not usually have equity traded in the US
stock markets resulting in higher premiums. Conversely, Goergen and Rennenborg’s
(2004) findings indicate that European targets subject to domestic takeovers receive
higher premiums than those involved in cross border acquisitions. Due to the rich amount
14. 14
of literature supporting the notion that foreign firms pay higher for domestic targets, the
first hypothesis states that the expected effect of cross border takeovers should be
positive for US target firms:
3.1.1 H1: Cross-border acquisition targets receive higher premiums than domestic
acquisitions.
3.2 Cash Reserves and Free Cash Flow Theory
This paper focuses on the effect of increasing cash reserves on premium
distributions in both foreign and domestic mergers. In the past decades, US firms have
been increasing their cash reserves and corporate liquidity, instead of opting for
traditional credit lines. Firms can choose to continually hold their cash essentially
generated internally and use this as general insurance, as a reserve for funding M&A or
research and development investments, or as a form of debt creation. The predominant
idea within M&A literature is those firms that hold high cash reserves tend to pay higher
premiums, signaling a bidder’s high valuation of the target’s equity.
Many economists have examined the recent rise in excess cash reserves,
especially for US firms. Sufi (2009) came to the conclusion that having higher cash
reserves could lead to positive investments. Servaes and Lins (1999) outline the theory
differentiating the use of credit lines or cash reserves by firms. Firms tend to hold lines of
credit as a hedge for future investments when the market is booming, while holding lines
of cash ensures that current investments will be funded during bad times. Managers will
15. 15
choose to hold larger reserves of cash when they anticipate future cash flow downfalls. In
this sense, cash reserves tend to act as a general insurance, while higher credit lines
usually indicate that managers believe their firm’s equity is undervalued. Furthermore,
Servaes (1991) finds that information asymmetry between managers and capital markets
makes liquidity (both as cash or credit) valuable as a form of financial flexibility. The
main difference between cash and credit is that cash is unconditional liquidity, and excess
cash is always available. Harford (1999) stipulates that managers can avoid the costs of
external financing in an imperfect information environment with the presence of cash
reserves. However, excess cash reserves can cause agency problems, when controlling
shareholders or managers use the cash for their own private benefit. The existence of
credit lines can mitigate these problems by necessitating the presence of banks, lessening
managerial discretion.
Jensen’s seminal 1986 work Agency Costs of Free Cash Flow, Corporate Finance
and Takeover discusses the repercussion associated with excessive cash holdings. His
theory posits that firms with substantial free cash flows, that is cash holding in excess of
what is required to fund projects and investments, have a tendency to accept investment
projects with negative net present values. This is because managers would prefer to
finance or invest in projects rather than to payout the excess cash to shareholders because
this would in fact reduce the manager’s power. Jensen’s free cash flow theory pivots on
the idea of agency problems between managers and shareholders. Managers will be
tempted to take more risk resulting in possible value-destroying investment decisions
rather than succumbing to the demand of shareholders. Jensen (1986) emphasizes the
importance and benefits of debt in reducing the agency problems for free cash flow
16. 16
theory. Debt creation can act as a control function by reducing the amount of cash at the
manager’s discretion. Instead of investing in low value projects, debt acts as an implicit
contract that managers will have to pay out future cash flows by forcing them to pour out
cash to their investors. This form of control is most effective for firms that generate large
cash flows but have very little growth opportunities, or lower Q ratios, because these
firms face the most pressure to spend excess cash in inefficient investments. Furthermore,
free cash flow theory explains how mergers and acquisitions can highlight and resolve
agency problems between managers and shareholders. The theory implies that managers,
due in part to hubris, will prefer to undertake low-value generating projects, which
includes takeovers, rather than pay cash out to shareholders. Acquisitions financed by
cash instead of stock or credit tend to generate net value for the managers even if the
merger produces inefficient returns. Harford (1999) reaffirms Jensen’s theory that firms
with higher cash reserves tend to make poor acquisitions of targets that tend to have low
market-to-book value. Goergen and Renneboog (2004) found that targets with higher
cash reserves receive higher premiums in European mergers and acquisitions. They
conclude that this is because targets with larger cash reserves may be able to help fund
part of the actual merger.
Jensen’s theory has motivated the second hypotheses regarding takeovers. The
theory implies that acquirers will focus on two types of targets: those that have done
poorly prior to the merger, or those who have generated excess cash holdings which they
refuse to pay out to shareholders. The level cash reserves can be a good indicator of
17. 17
managerial efficiency and a firm’s investment strategy, thus target firms with higher
levels of free cash reserves will receive higher premiums. Thus:
3.2.1 H2: Targets with higher cash reserves receive higher premiums, on average,
than those with lower cash reserves.
The impact of cash reserves has become increasingly relevant with the 4th
wave of
mergers beginning in the 1980s, characterized in part by the emergence of leveraged
buyouts. LBOs involve bidders acquiring whole corporations financed heavily with cash,
in the form of debt. As a result of the LBO, a publicly listed target becomes private and
bidders enjoy higher returns over a short window of time. (Sudarsanam, 2010, p.268).
However, these LBOs are contingent on the appropriate accumulation of cash required to
raise debt capital. (Sudarsanam, 2010, p. 280) The free cash flow is in turn used to payout
debt instead of wasted on value-squandering investments by managers, alleviating agency
problems between owners and shareholders. Schlingemann’s (2004) conclusions on
bidder gains confirm Jensen’s idea of debt as a method of monitoring managerial
discretion. Although M&A studies have emphasized the importance of debt for bidders,
this paper examines how target debt-to-equity ratios affect a target’s cumulative
abnormal returns. A high debt-to-equity ratio indicates that the firm is potentially
inefficient, if the cost of the debt outweighs the gains of the firm’s profit and investments.
Firms rationally decide to generate debt to fund assets if they are confident that the
returns will cover the costs of debt. Consequently, firm with more growth opportunity
could effectively have a lower debt-to-equity ratio, and have a stronger position in the
18. 18
market. This study treats a high debt-to-equity ratio as a signal that the firm is
“unhealthy”, and has been unsuccessful in enhancing its market value. If this is the case,
acquired firms with higher debt-to-equity ratios should receive lower premiums given the
H2.
3.3 Tobin’s Q Ratio and Growth Opportunities
Similar to cash reserves, Tobin’s Q-ratio, which measures the ratio of the firm’s
market value to its replacement value, proves to be an efficient valuation of a target’s
growth opportunities. Doukas (2007) points out that value-maximizing firms have higher
Q-ratios, while firms who poorly manage cash reserves have lower q ratios. When the
average Q-ratio is less than unity, the manager is overinvesting without any positive
returns. When the average Q-ratio is above unity, the firms are undertaking value-
maximizing projects. Thus, bidder’s abnormal return is inversely related to the cash flow
of low q ratio target firms. Lang et al. (1989) reveal that takeovers that increase the value
of the merged firm occur between bidders with higher Q-ratios relative to the one of the
acquired target firms, consistent with Jensen’s free cash flow theory [see also
Servaes(1999)]. The increased combined value of the target and bidder resources lead to
higher takeover wealth gains. Acquisitions force firms with excess cash reserves who
might otherwise invest in unprofitable investments to use the cash reserves to benefit
both the target and bidder shareholders. Inversely, when a target is being courted publicly
by a low Q bidder, the premium calculated on the deal will be low because the market
will react poorly to the merger. The acquirer has announced that it has little growth
opportunity thus its equity is less valuable than previously perceived. Furthermore, Lang
19. 19
et al. (1989) found that bidding firms acquiring targets with higher Q-ratios than the
acquirer are unlikely to make value-increasing changes in the firm’s operations. This has
motivated the third hypothesis.
3.3.1 H3: Targets with a lower Q ratio than the corresponding bidder receive higher
premiums, on average, than those with a higher Q ratio.
Doukas (1995) finds that higher Q-ratio firms gain significant positive abnormal
returns when the target firm is located abroad rather than at the site of existing operations.
If higher Q firms gain more from foreign acquisitions due to better international use of
target resources, cross-border acquisition targets are expected to receive higher
premiums.
Lang (1989) found that bidders make low market valuations of lower Q ratio
firms due in part to the correlation of managerial performance and low Q-ratio. A lower
market value would indicate that the firm either has poor management, and overall less
growth opportunities, therefore a lower ratio. Additionally, Goergen and Rennenboog
(2004) highlight that market-to-book ratio proves to be a crucial variable acting as a
proxy of growth opportunity, a determinant of Tobin’s q. They find that targets with
higher market-to-book values receive higher premiums. Harford (1991) The ratio equals
the market valuation to the actual book valuation of the firm. A higher market-to-book
ratio signifies greater expected future gains due to higher growth opportunities, therefore
the value is positively related to Tobin’s Q-ratio. The market expects that bidders will
overvalue the target’s equity if the target has higher market-to-book value, thus paying a
20. 20
higher premium. Contrary to Goergen’s (2004) view, Fama and French (1992) found
significantly higher positive abnormal returns for US targets with high book-to-market
ratios compared to those with low book-to-market ratios. 2
This study expects firms with
lower market-to-book ratios to receive higher premiums as this variable acts as a proxy of
lower Q-ratio.
3.4. Method of Payment
M&A studies reveal that takeovers are financed through cash, stock, or a mix as a
form of payment for a variety of reasons. A cash (stock) offer implies that the bidder has
a higher (lower) valuation of the acquiring firm. If bidders expect to capitalize on higher
synergy gains, they choose to make all-cash offers as the expected operational
efficiencies will produce gains outweighing this payment. . On the other hander, bidding
firms will offer stock as payment to reduce valuation risk, indicating uncertainty of the
ability to generate synergy (Barbopoulos and Sudsarnam 2012). In line with this
argument, Caves and Slusky (1991) finds that mergers financed by cash have higher post-
acquisition operating performances than those made with all-stock offers. Consistent with
free cash flow theory, Yook (2003) concludes that cash bidder groups with free cash flow
received significantly higher returns than cash bidder groups without free cash flow.
2
Book-to-market is the inverse ratio of market-to-book. Fama and French’s (1992)
findings can thus be interpreted as firms with low market-to-book ratios receiving higher
abnormal returns.
21. 21
Furthermore, firms may prefer to make cash payments, in the form of debt, to “dilute the
private benefits of control in the merged firm”, thus mitigating agency problems (Eckbo,
p.168, 2010). Goergen and Rennenborg (2004) confirm in their study the strong evidence
linking method of payment to target abnormal firms.
Both Moeller (2004) and Harris and Ravenscraft (1991) conclude that bidding firms
prefer to use cash relative to equity as a form of payment in cross-border acquisitions.
Moeller (2004) highlights that although equity would reduce the information asymmetries
between the bidder and target firms, targets do not want to accept foreign equity, forcing
the bidder to pay using cash [see also Vishny and Shleifer (2003)]. In line with this
argument, “bidders may seek to use equity to offset the greater uncertainty connected
with the information problems associated with acquiring abroad.” (Conn, et al. 2003, p.
6). When public bidders pay for private targets, bidders face a valuation risk due to
information asymmetry when employing all-cash bids, which can lead them to overpay
the target (see Barbopoulos 2012). However, this paper examines the opposite, public or
private bidders acquiring public bidders, so the cost of information asymmetry should be
low. Thus, it is expected that all-cash payments impact target abnormal returns positively
(lead to higher premiums). Fuller et al. (2002) finds that higher-valued bidders choose
cash as payment [see also Eckbo (2011)].
3.5. Listing Status
Economic theory suggests that acquisitions of public targets made by public firms
should generate higher premiums because of the shared synergies resulting from the
merger. Conversely, operating synergies in an acquisition of public firms made by
private acquirers are more uncertain, therefore bidding premiums are expected to be
22. 22
lower. Moreover, Bargeron et al. (2008) offers an additional argument explaining higher
premium paid by public firms relative to private bidders. When announcing an offer,
public firms reveal more information to the market about their overall strategy, thus
failure could jeopardize their independence resulting in higher premiums. Schwert (1996)
support Bargeron’s findings that target shareholders earn higher premiums from public
relative to private acquirers.
3.6. Industry
M&A literature predicts that mergers within the same industry tend to create
value, while mergers with a firm outside the industry will create negative returns. I
consider this in my study and create a dummy variable for takeovers between firms in the
same industry and for different industries. Yook’s (2003) study indicates that being in the
same industry did not affect the operating performing synergies for mergers made with
cash offers. However, industry diversification does generate wealth gains for non-
conglomerate takeovers funded by stock offers, confirming Kaplan and Weisbach’s
(1992) findings. Morck, Shleifer and Vishny (1990) theorize that takeovers within the
same industry are more likely to succeed than diversifying takeovers.
3.7. Other Variables affecting Premium
Rossi and Volpin (2004) found targets within countries that have higher
shareholder protection receive higher premiums by foreign acquirers. In the case of
foreign takeovers, Kang (1993) concludes that Japanese mergers and acquisitions of US
target firms created positive abnormal returns for both bidder and target firms, dependent
23. 23
on bidder-characteristic and exchange rate movement [see also Harris (1999)]. Doukas
(1995) also concluded that foreign firms acquiring corporation in low-tax jurisdiction
countries generate positive shareholder wealth gains. Caves and Slusky (1991) find that
the presence of rival bidders can impact the premium paid by acquirers. Many studies
suggest that the mood of the bid impacts target abnormal returns. Sudsarnam (2001)
explains that tender offers tend to generate higher target wealth gains than hostile
takeovers. It is important to keep in mind that the results of the tests may be limited by
the exclusion of these factors.
24. 24
4. Data
The data used consists of 21,370 cross-border and domestic takeovers of US
targets compiled from the Securities Data Corporation’s (SDC) U.S. Mergers and
Acquisitions (M&A) Database. The sample spans across 35 years from January 6th
, 1986
to December 19th
, 2011. To be included, takeovers require the following characteristics:
i) The targets are all publicly listed in the US.
ii) The bidders are public firms, private firms, or subsidiaries.
iii) The deal value exceeds one millions US dollars or more.
iv) The data for market-to-book ratio is generated through Datastream.
v) Takeovers are funded using all-cash offers, all-stock offers, or mixed
offers.
The sample specifies both acquirer and target industry as well as macro and micro
industry. The data includes the following industries: (i) consumer products and services,
(ii) consumer staples, (iii) energy and power, (iv) financials, (v) healthcare, (vi) high
technology, (v) industrials, (vi) materials, (vii) media and entertainment, (viii) real estate,
(ix) retail, and (x) telecommunications.
In addition to testing the sample in its entirety, cross-border and domestic
acquisitions are also tested independently in order to observe which factors affect the
different forms of takeovers. The data is subsequently classified into three different
categories when conducting univariate and multivariate regressions. The “high” group
consists of the deals with the 30% highest values of the given variable, the “mid” consists
25. 25
of the 40%, and the low group has the lowest values of the given variable. The
classifications of the high and low values are of equal size to generate more accurate
results for comparison.
The target characteristics are summarized in Tables II below according to the variables of
interest (cash reserves, debt-to-equity, market-to-book). Table III reports the yearly mean,
median and number of observations for all targets.
(Insert Table II and III)
26. 26
5. Methodology
In line with previous studies [Fuller (2004), Barbopoulos (2012)], this paper
employs traditional events study as the foundation for the methodology. Events study
allows for the analysis of effect on share price caused by firm-specific events. The
premium is measured as the sum of abnormal returns in a 5-day window using Brown
and Warner’s (1985) Modified Market Model:
ARi,t = ri, t – rm, t ; CARi =
€
ARi,t
t =i
T
∑
The parameters ri and rm indicate the return on firm i and the value-weighted market
index return, respectively.
Event studies operate under three main assumptions:
i) Market Efficiency
ii) Market Anticipation of the Event
iii) Confounding Effects
Applying these assumptions, the cumulative abnormal returns in this study are calculated
using a short-term events window of 5 days (-2, 2), with t= 0 being the announcement
date. Brown and Warner (1985) acknowledge the limitations that variance estimation,
non-sychronous trading, and non-normality may have on their long-term results.
However, they do not find any anomalies on average in their results when testing a
shorter events window.
5.1.Specific Approach
In order to test for the impact of foreign investments, cash reserves and Tobin’s Q for
target premiums, this study applies both univariate and multivariate analysis. Univariate
analysis isolates the specific impact on the proxies tested and the corresponding statistical
27. 27
significance. Using OLS estimation, the cross-effects of the dependent variables on target
cumulative abnormal returns are calculated by multivariate regression.
5.2. Variables
M&A studies suggest that market-to-book ratio and market valuation act as strong
proxies for Tobin’s q ratio, or a target firm’s growth opportunities. This study also
focuses on debt-to-equity as an indicator of a target’s growth opportunity. The debt to
equity measure signals the ratio of debt to stockholder equity a firm uses to fund its
assets. A higher debt to equity ratio indicates a higher accumulation of debt by the firm as
a financial mechanism. Included is a description table of the variables used in the uni-
and multivariate regressions. (Insert Table I)
28. 28
6. The Univariate Analysis
Table IV report the five-day summation of target cumulative abnormal returns for
the three main proxies of interest: cash reserves, debt to equity, and market to book ratio.
The results are classified by type of acquirer and distribution level of the premium
dependent on our variables (high, mid, or low). The t-value for each result is also
tabulated to indicate statistical significance. Overall, the significant differential of
domestic minus cross-border acquisitions reveals that foreign firms pay 11.46 percent
higher target premiums than do domestic acquisitions. This is consistent with the
literature on cross-border acquisitions premiums [see Harris and Ravenscraft (1991)].
(Insert Table IV)
6.1. Target Cash Reserves
For all deals, target firms with high cash reserves receive a 1.92 percent higher
spremium than firms with low cash reserves, statistically significant at the one percent
level. This result stems from domestic acquisitions. The differential between high and
low cash reserves for cross-border acquisitions reveals that foreign acquirers pay a
marginally significant higher premium of 3.41 percent. This result makes economic sense
if both cross-border targets are expected to earn higher premiums as are targets with
higher cash reserves. Targets with high cash reserves only benefit from a 1.64 percent
increase in premiums from domestic bidders compared to those with low levels of cash
reserves.
The univariate analysis confirms past studies on cash reserve level on premium.
An interesting result is that different levels of cash reserves have a more statistically
29. 29
significant impact for premiums received by targets in domestic acquisitions than for
targets in cross-border acquisitions. The boom of cash reserves for US firms coupled with
the rise of cross-border acquisitions created expectations of higher statistical significant
results for targets with different levels of cash reserves acquired by foreign firms, which
were not found.
6.2. Target Debt-to-Equity Ratio
The statistically significant result of -7.69 percent reveals that cross-border
acquirers pay, on average, nearly ten percent higher premiums to targets with lower debt-
to-equity ratios. The results imply an inverse relationship between target debt-to-equity
ratios and premiums received. For the entire sample, targets with low debt-to-equity
receive on average a significant 1.68 percent higher premium than those with high debt-
to-equity ratios. Therefore, targets with less debt accumulation are valued more highly by
acquiring firm. The findings indicate that debt-to-equity and cash reserves have opposite
impacts on premium. Cash reserves have a positive relationship with 5-day target
premium distribution, while debt-to-equity evidences a negative one. Debt-to-equity can
act as a proxy for the target firm’s health; a large accumulation of debt over a long period
of time could indicate a series of bad investment decisions due possiblies to managerial
inefficiencies or structural issues. A long-term high level of debt to equity could signal a
firm’s failure to optimize the firm’s market value. Therefore, bidders will put a lower
valuation of these firms’ equity, reflected in the target premium. Indeed, the univariate
analysis shows a substantial difference between premiums of low and high debt-to-equity
for cross-border takeovers.
30. 30
A secondary approach considers free cash flow theory. Jensen’s theory suggesting
that acquirers seek firms that have accrued excess cash reserves and little debt helps
substantiate the argument that unhealthy targets, firms with high debt relative to cash,
receive lower premiums.3
However, the lack of empirical evidence linking debt-to-equity
ratio and free cash flow prevents this paper from establishing a reliable relationship
between the two variables.
6.3. Target Market-to-Book Ratio
The differential between high and low market to book values indicates a negative
statistically significant 3.95 percent for the entire sample. Thus, this suggests an inverse
relationship between target market-to-book ratios and premiums: targets with low
market-to-book ratios receive a four percent higher premium than targets with high
market-to-book ratios. The statistically insignificant difference value between target high
and low market-to-book ratios for premiums offered by foreign acquirers implies that
different levels of market-to-book do not affect premium distribution for cross-border
targets. Analysis the inverse relationship between market-to-book and target premiums
derives from domestic acquisitions. Consistent with Fama and French (1992)’s findings,
these results support the hypothesis that targets with lower Q-ratios, or lower growth
opportunities, receive higher premiums. However, these findings do not corroborate
Goergen and Rennenboog (2004) results.
3
It must be kept in mind that debt is a tricky financial tool. Debt can be both a positive
and negative mechanism depending on other factors within the firm’s structure and the
market environment. This study does not attempt to argue the general benefits of debt for
target premium distribution.
31. 31
It appears that, compared to the univariate findings for target debt-to-equity ratio,
this target characteristic has no significant impact on premiums offered by foreign firms.
This begs the question of whether US firms depend more on the target market-to-book
ratio when valuing target’s equity, and whether foreign firms select target debt-to-equity
ratio as a more efficient valuation index.
Overall, the univariate findings support the three hypotheses. Between 1986 and
2011, cross-border acquirers pay an average 11.46 percent higher premium to US targets
than domestic acquirers. Targets with high cash reserves receive a 2 percent higher
premium relative to targets with low cash reserves. Finally, the analysis of target market-
to-book ratio reveals that targets with less growth opportunities, and a lower Tobin’s Q-
ratio, earn higher premiums of approximately 4 percent.
32. 32
7. Regression Analysis
After conducting univariate tests on impact of the proxies of interest, this study
conducts tests on the linear and cross-effects of the variables influencing premium
distribution for all deals and specifically for cross-border acquisitions. Table V reports
the values and p-values for all 12 models. The multivariate findings reaffirm the
conclusions from the univariate analysis. The coefficient for the foreign dummy variable
evidences that foreign acquirers of US target firms have a significant and positive impact
on target premiums, consistent with Harris and Ravenscraft’s (1991) findings.
(Insert Table V)
7.1. Diversification of Industry
The coefficient denoting the diversification of target and bidder industry proves to
be positive and significant at the one percent confidence level for every model. In
accordance with Morck, Shleifer and Vishny (1990)’s study of US acquisitions, this
finding illustrates strong evidence that acquirers in different macro-industries than that of
targets pay higher premiums than those in the same industry. A possible explanation is
that firms looking to increase diversification expect post-merger operating, and are
therefore willing to pay higher relative premiums. Firms seeking to diversify their
production can benefit from the existent resources of the acquired firm, internalizing
production costs.
7.2. Method of Payment
Models 1 through 3 test the cross-effects of the three different modes of payment
(cash, stock, and mixed) on the 5-day target premiums. The coefficient for dummy
33. 33
variables foreign, cash and the cross-effect of cash and foreign buyers are statistically
significant at the one percent confidence level. Cross-border acquirers offering all-cash
bids have a strong positive effect on premium distribution. This corroborates M&A
studies that foreign acquirers paying with cash overvalue the target’s equity. Arguably,
factors such as tax policy, transaction costs, and exchange rate can drive up target
premium for cross-border acquirers using cash. As previously noted, targets may be
unwilling to accept foreign equity, forcing the bidder firm to finance the takeover with
cash.
However, for all models, the coefficient for the cash dummy is negative, implying
lower target premiums associated with all-cash offers. An argument explaining this result
could be related to the listing status of the target and bidder firms. Bargeron et al. (2008)
confirm that private firms must make cash offers, as they do not have publicly traded
equity to finance the acquisition. Assuming market efficiency, private acquirers, who face
less agency problems than public firms, can assess the value of the synergy more
accurately and do not risk misevaluating the target equity price. According to Myers and
Maljuf’s (1984) asymmetric information theory, bidders prefer to pay cash to convey
favorable information to the market and to maintain their control benefits. On the other
hand, bidders financing the takeover with equity offer higher premiums to targets.
Moeller et al. (2004) find an association between higher shareholder abnormal returns for
public firms making all-stock offers, affirming that public acquirers will more likely offer
equity as payment for public targets. Since the merger of two public firms creates higher
operational wealth gains, the high premium reflects the enhanced valuation of the newly
compounded firm [see Kaplan and Weisbach (1992)]. Following the literature, another
34. 34
argument is often made that the bidders selects to pay with equity in an effort to offset the
information asymmetries at a cost of higher premium.
7.3. Bidder Listing Status
Models 4 through 6 reveal a strong correlation between target premiums and
foreign acquirer listing status. The models indicate that publicly listed foreign acquirers
have a significant positive effect on target premium, as evidenced by the coefficient for
the cross-effect of publicly listed foreign acquirers. This supports synergy theory and
M&A studies that public firms pay higher premiums due to higher operating synergies. In
line with this, private foreign bidding firms have a significant negative effect on 5-day
US target premiums. A possible explanation could be that private acquirers benefit from
acquiring public targets due to the lack of information asymmetry and thus can avoid
over-paying for the target. Private firms will less likely overvalue a public firm’s equity,
and can create a more valid assessment of the market valuation of the merger assets.
Public targets may also be willing to accept lower premiums from private bidders
because of the benefits in post-merging operations [see Bargeron et al. (2008)].
Following the acquisition from a private firm, the target’s listing status will change from
public to private leading to higher wealth gains because of the competitive advantage
provided by being private.
7.4. Target Market Valuation
The coefficient for market valuation is negative and statistically significant at the
one percent confidence level for all models. The strong value demonstrates that market
35. 35
valuation is inversely related to target premium. This provides enough evidence to
deduce that targets with higher market valuation receive lower premiums consistent with
the hypothesis that targets with lower Q-ratios receive higher premiums [see Doukas
(2007)]. Jensen’s theory suggests that acquirers expect higher synergies when acquiring
firms with lower Q-ratios, for which market valuation is a proxy. The targets with lower
Q-ratios have resources still desirable and valuable to the acquirer in increasing market
performance. Theory stipulates that targets with lower Q-ratios have, on their own, few
growth opportunities possibly because of agency problems and managerial issues.
7.5. Target Cash Reserves
Throughout the models, the coefficient expressing the impact of cash reserves on
target premium distribution for the entire sample proves to be significant and positive.4
Thus, the presence of cash reserves does have a strong positive correlation with target
premium, validating the H2.
The coefficient for low levels of target cash reserves evidences a strong negative
value on target premium. Therefore, targets with lower cash reserves receive lower
premiums. According to free cash flow theory, bidders prefer targets with higher cash
reserves, conveyed in premium offered.
However, the cross-effect for both high and low cash reserves and foreign
acquirers indicates that there is no impact on different levels of cash reserves specific to
foreign acquisitions in this sample. This was expected given the prior univariate tests.
The significant coefficient of the cash reserves variable, which is steady in all twelve
4
The only exception is for model 4: the foreign coefficient is statistically insignificant.
36. 36
models, does substantiate the claim that cash reserves have a positive relationship with
target premium.
7.6. Target Debt-to-Equity Ratio
The coefficient for the debt-to-equity variable shows an extremely weak value
relative to the other proxies. Economically, this suggests target debt-to-equity ratio
presents a nearly non-existent impact target premium distribution. However, the dummy
variable for high debt-to-equity exhibits a negative significant value, relative to the
positive coefficient for the low debt-to-equity ratio. Thus, debt-to-equity levels have an
inverse impact on target premium: targets with higher debt-to-equity receive lower
premiums. These results further corroborate the notion that debt-to-equity can act as a
mechanism of target valuation. Bidders should have a lower valuation for targets with
more debt-to-equity. A high ratio suggests an inefficient ability of a firm to maximize
value as well as an extreme and detrimental accretion of debt, possibly as a ramification
of poor investment strategy or inherent managerial problems.
Furthermore, the cross-effect of targets with high debt-to-equity ratio in cross-
border acquisitions signals a statistically significant negative impact on premiums offered
for these firms. The coefficient of the cross-effect describing targets with low debt-to-
equity subject to foreign acquisitions implies a strong positive effect on target premiums.
This confirms univariate analysis implying an inverse relationship between debt-to-equity
ratios and target premiums. The results indicate a strong effect for the dependence of
target debt-to-equity ratio and foreign acquirers on target premium. This correlation has
not been examined in the past literature. This study suggests that an argument could be
37. 37
made that foreign firms tend to prefer debt-to-equity as a tangible indicator of target
valuation. Due to information asymmetry associated with capital markets, foreign firms
may choose debt-to-equity ratio as a more unbiased proxy for estimating synergy.
However, the researchers of this study have not come across that argument in the
literature.
7.7. Target Market-to-Book Ratio
The models exhibit a strong negative coefficient for target market-to-book ratios,
signaling an inverse relationship between target premium distribution and target market-
to-book ratios. The linear effects of the high and low market-to-book ratios further
support this relationship. Consistent with the literature, the multivariate regressions
confirm that targets valued with lower market-to-book, a proxy of Tobin’s Q-ratio,
receive higher premiums than those with high market-to-book. Effectively, this shows
that firms with weak growth opportunities act as optimal targets for bidding firms
because it presents an opportunity for the bidder to improve the merged firm’s production
using the combined resources thereby enhancing value and internalizing transaction
costs.
However, models 11 and 12 show no significant impact from the cross-effects of
market-to-book ratios and foreign acquirers on target premiums, also exhibited in the
univariate results. It is possible that target premium distribution is absorbed more by
other target and bidder characteristics not specified within these models.
38. 38
8. Limitations of the Analysis
For a comprehensive understanding of the results, it is important to address the
restrictions of the applications of market efficiency and rational bidding approach.
Efficient market hypothesis stipulates that the premium paid in acquisitions reflects the
true market price of target as it is being valued during the negotiations. In reality,
Sudsarnam (2001) argues that stickiness in the stock market means that actual equity
prices take time to be reflected. A shorter time event window could prevent the market
from digesting the full implications of the merger, and cause misevaluation of the target’s
equity by the bidder. Furthermore, this study assumes that firms enter mergers for
rational and altruistic purposes of maximizing shareholder value. However, firm owners
could initiate value-destroying takeovers to increase their managerial control, skewing
the results. Unfortunately, it would prove impossible to verify the motivation for each
deal in the sample.
Gaps in the research prevent this study to confidently hypothesize about the
effects of target debt-to-equity ratios on target premiums. Since the 1980s, M&A
literature has emphasized the importance of this characteristic for bidder firms as a proxy
for leverage but few studies have been conducted studying the ramifications of the ratio
as a target characteristic. However, univariate and regression analysis prove that
premiums paid by foreign firms depends significantly on the level of target debt-to-
equity. Future M&A literature should examine this ratio more closely as a target
characteristic.
The statistical insignificance of cross-effects prevents the study from confirming
the effects of certain target characteristics specific to foreign acquisitions. This study
39. 39
cannot confidently confirm the impact of target cash reserves for cross border
acquisitions, or that of target market-to-book ratio for cross-border acquisitions. In
seeking to further improve this research, it would be favorable to create additional
proxies for a regression model particular to cross-border acquisition. Doing so might
allow for a more comprehensive understanding of the effects of different characteristics
for premiums paid by foreign acquirers. Specifically, it would be compelling to examine
why, according to the univariate analysis, target firm’s debt-to-equity ratio affected target
distribution more for foreign acquisitions than domestic takeovers. Market-to-book
valuation could be measured differently depending It could be that this is specific to the
United States, or determinant of trends in all cross-border M&A.
Harris and Ravenscraft (1991) find a heavy concentration of cross-border
acquisitions in research & development industries, such as tech and pharmaceuticals.
These industries don’t necessarily accrue many physical assets, and will therefore have
higher market-to-book ratios. Thus, the emphasis of R&D for cross border acquisitions
indicates a positive relationship between foreign acquirers and low market to book ratios.
A more industry-specified model could have revealed a stronger effect of target market-
to-book ratios in cross-border acquisitions for target premium distribution. Since this
paper does not focus on deals within each specific industry, takeovers within R&D
intensive industries may only constitute a small portion of the entire sample.
The inclusion of other proxies to control for the nature of the takeover, relative
size of the target, and even bidder characteristics could have provided a more specified
model for target premiums. Variables crucial to cross-border acquisitions are different
from domestic acquisitions. Exchange rate and tax laws differing between bidding and
40. 40
target countries can cause fluctuations in the premiums, as well as the effects of the
cultural and political environment of both countries. Proxies accounting for these
differences could have potentially altered the results of the regressions for cross-border
acquisitions. However, the consistency of the results in the twelve regression models and
the concordance of the univariate and multivariate findings authenticate the three
hypotheses laid out in this study.
41. 41
9. Conclusion
Using Brown and Warner’s 1985 modified market model, both the univariate and
multivariate analysis provide ample evidence supporting the three hypotheses set out in
this paper. Furthermore, the results present strong evidence that cash reserves, debt-to-
equity ratio of US targets, method of payment for the premium, Tobin’s Q-ratio, the
listing status of the bidder, and the geographical placement of the bidder all have
substantial effects on target premium distribution in the recent waves of “merger mania”.
Jensen’s free cash flow theory, synergy theory, and MNE approach establish a solid
foundation for the interpretation of the results.
Consistent with prior M&A research, the study finds that US target firms subject
to cross-border takeovers receive 11.46 percent higher premium relative to domestic
mergers. Target premium distribution depends positively on cash reserves, supporting
Jensen (1986) and Harford (1999). Furthermore, publicly listed foreign firms pay higher
premiums as well as foreign acquirers funding the merger with all-cash offers. As
stipulated by Doukas (1995) and other studies relating M&A to Tobin’s Q-theory, targets
characterized with few growth opportunities, indicated by market-to-book and target
market valuation, acquire higher premiums from bidding firms.
For further consideration, the relationship between the three main variables of the
univariate analysis could provide another layer in understanding M&A premium
distribution. Free cash flow already identifies a connection between Tobin’s Q and cash
reserves. Firms with high cash reserves and low growth opportunities, evidenced by a
low Q-ratio, will more likely conduct poor investments that damage the firm’s market
valuation. Jensen (1986) argues that these firms act as optimal targets for acquirers who
42. 42
can then benefit from the target’s resources and apply organizational changes to enhance
the merger’s production value. However, no assumptions can be made about the
relationship between Tobin’s Q-ratio and target debt-to-equity ratio, or cash reserves and
debt-to-equity ratio. Although similar effects on target premiums are observed for
Tobin’s Q and debt-to-equity, no definite conclusions can be derived about the
dependence between debt-to-equity and growth opportunities. This is also true for cash
reserves and debt-to-equity ratio. These relationships could be difficult to establish due to
the multiple roles of debt to firms. Debt accumulation can act as a beneficial leverage
measure, providing a form of managerial monitoring. On the other hand, too much debt
can be a preliminary indicator of a failing firm. This duplicity makes it impossible to
form a cohesive opinion on what should be the optimal amount of debt for firms.
There is still a great absence of M&A literature corroborating target
characteristics of cross-border acquisitions with target premiums. Only recently have
economists focused M&A research on target wealth gains for cross-border acquisitions;
most studies examine the effects on bidder gains. With the emergence of globalization
coupled with the evolving nature of takeover motivations, M&A remains an indubitably
attractive field of research for financial economists.
43. 43
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47. 47
Table I
Variable Description
Table below outlines the variables used in the univariate and regression analysis. Dummy
variables are used to test linear and cross effects in the regression models. The groups classified
as “high” consist of top 30% of values, and as “low” of the bottom 30% of values.
tcarm2p2PREMIUM Target Premium
Dependent on
Foreign = 1 if acquirer is a foreign firm [= 0 otherwise]
Cash Reserves Target cash reserves
D/E Target debt-to-equity ratio
M/B Target market-to-book ratio
Market value (log) Log of target’s market valuation (in million USD)
Diversifying = 1 if acquirer and target are in different industries [= 0 otherwise]
Cash = 1 if financed using all-cash payment [= 0 otherwise]
Stock = 1 if financed using all-stock payment [= 0 otherwise]
Mixed = 1 if financed using a mix of stock and cash [= 0 otherwise]
Cash_CBA = 1 if a foreign bidder paid all-cash offer [= 0 otherwise]
Stock_CBA = 1 if a foreign bidder paid all-stock offer [= 0 otherwise]
Mix_CBA = 1 if a foreign bidder paid a mix offer [= 0 otherwise]
Public = 1 if acquirer is publicly-listed [= 0 otherwise]
Private = 1 if acquirer is private [= 0 otherwise]
Sub = 1 if acquirer is a subsidiary [= 0 otherwise]
Pub_CBA = 1 if foreign acquirer is public [= 0 otherwise]
Priv_CBA = 1 if foreign acquirer is private [= 0 otherwise]
Sub_CBA = 1 if foreign acquirer is a subsidiary [= 0 otherwise]
D_HCR = 1 if target has high level of cash reserves [= 0 otherwise]
D_LCR = 1 if target has low level of cash reserves[= 0 otherwise]
HCR_CBA = 1 if target with high level of cash reserves acquired by a foreign firm
[= 0 otherwise]
LCR_CBA = 1 if target with low level of cash reserves acquired by a foreign firm
[= 0 otherwise]
D_HDE = 1 if target has a high debt-to-equity ratio [= 0 otherwise]
D_LDE = 1 if target has a low debt-to-equity ratio [= 0 otherwise]
HDE_CBA = 1 if target with high debt-to-equity ratio acquired by a foreign firm
[= 0 otherwise]
LDE_CBA = 1 if target with low debt-to-equity ratio acquired by a foreign firm
[= 0 otherwise]
D_HMB = 1 if target has a high market-to-book ratio [= 0 otherwise]
D_LMB = 1 if target has a low market-to-book ratio [= 0 otherwise]
HMB_CBA = 1 if target with high market-to-book ratio acquired by a foreign firm
[= 0 otherwise]
LMB_CBA = 1 if target with low market-to-book ratio acquired by a foreign firm
[= 0 otherwise]
48. 48
Table II
Mean and Median of Target Characteristics
Panel A, B, C, and D summarize the values of the four proxies of target characteristics according
to domicile of acquirer, industry, payment, and bidder listing status. Industry classification is
done according 4-digit SIC code. Same industry classifies deals with the same 2-digit code, while
different industries have different 2-digit SIC codes. The cash reserves value is calculated as cash
and equivalence (short term liabilities) divided by total assets.
Panel A: Target Cash Reserves
N Mean Median
All 21,370 0.147 0.058
Foreign 701 0.201 0.099Domicile of Acquirer
Domestic 20,669 0.145 0.057
Same 18,133 0.143 0.055
Industry
Diversifying 3237 0.169 0.074
Cash 18,989 0.147 0.060
Stock 1072 0.181 0.061Payment
Mixed 1309 0.114 0.039
Private 2547 0.144 0.059
Public 18,099 0.147 0.058Bidder Listing Status
Subsidiary 724 0.168 0.066
Panel B: Target Debt-to-Equity Ratio
N Mean Median
All 21,370 146.095 44.88
Foreign 701 120.306 40.70Domicile of Acquirer
Domestic 20,669 146.969 45.01
Same 18,133 144.075 44.66
Industry
Diversifying 3237 157.410 46.80
Cash 18,989 142.837 42.97
Stock 1072 139.318 51.49Payment
Mixed 1309 198.905 83.92
Private 2547 194.721 56.51
Public 18,099 138.821 43.23Bidding Listing Status
Subsidiary 724 156.868 52.68
49. 49
Table II Cont.
Panel C: Target Market-to-Book Ratio
N Mean Median
All 21,370 3.137 1.75
Foreign 701 3.922 1.71Domicile of Acquirer
Domestic 20,669 3.105 1.75
Same 18,133 3.124 1.77
Industry
Diversifying 3237 3.176 1.61
Cash 18,989 3.038 1.74
Stock 1072 4.181 1.84Payment
Mixed 1309 3.553 1.71
Private 2547 3.013 1.46
Public 18,099 3.157 1.79Bidder Listing Status
Subsidiary 724 2.918 1.53
Panel D: Target Market Value (USD millions)
N Mean Median
All 21,370 3570.892 315.50
Foreign 701 1463.789 192.09Domicile of Acquirer
Domestic 20,669 3642.355 320.20
Same 18,133 4070.006 380.76
Industry
Diversifying 3237 774.959 141.33
Cash 18,989 3790.839 330.09
Stock 1072 1765.397 196.29Payment
Mixed 1309 1858.838 254.54
Private 2547 751.329 125.05
Public 18,099 4080.513 388.92Bidding Listing Status
Subsidiary 724 750.166 150.56
50. 50
Table III
Mean and Median of Target Characteristics by Year
Panel A tabulates the values for target cash reserves by year. Panel B reveals the yearly mean and
median values for target debt-to-equity ratio. Panel C and D show the values for yearly mean and
median for the proxies of Tobin’s Q-ratio, target market-to-book ratio and target market
valuation.
Panel A: Target Cash Reserves
N Mean Median
1986 235 0.090 0.051
1987 348 0.117 0.065
1988 409 0.102 0.063
1989 638 0.091 0.052
1990 684 0.109 0.053
1991 306 0.096 0.054
1992 404 0.139 0.060
1993 430 0.123 0.068
1994 762 0.123 0.056
1995 945 0.113 0.049
1996 1293 0.122 0.046
1997 1184 0.134 0.044
1998 1859 0.136 0.046
1999 1658 0.118 0.035
2000 1132 0.148 0.041
2001 849 0.197 0.055
2002 594 0.188 0.058
2003 648 0.154 0.053
2004 707 0.161 0.056
2005 821 0.173 0.084
2006 879 0.149 0.066
2007 1205 0.155 0.066
2008 1197 0.210 0.118
2009 546 0.198 0.104
2010 716 0.201 0.126
2011 921 0.191 0.112
Total 21,370 0.144 0.056
52. 52
Table III cont.
The number of observations, mean and median of target market-to-book ratio by year:
Panel C: Target Market-to-Book Ratio
N Mean Median
1986 235 2.301 1.69
1987 348 2.646 1.68
1988 409 1.880 1.46
1989 638 2.411 1.65
1990 684 1.786 1.31
1991 306 1.875 1.38
1992 404 2.283 1.66
1993 430 3.796 1.82
1994 762 2.268 1.56
1995 945 2.495 1.65
1996 1293 2.580 1.71
1997 1184 6.082 1.98
1998 1859 2.883 1.83
1999 1658 2.989 1.60
2000 1132 3.562 1.47
2001 849 2.455 1.57
2002 594 2.371 1.54
2003 648 3.072 1.62
2004 707 4.332 2.05
2005 821 3.742 2.12
2006 879 3.791 2.16
2007 1205 3.292 2.12
2008 1197 3.372 1.79
2009 546 3.495 1.28
2010 716 2.915 1.70
2011 921 3.131 1.87
Total 21,370 2.992 1.67
53. 53
Table III cont.
Panel D reports the average distribution of target market valuation in USD millions by year.
Panel D: Target Market Value (USD millions)
N Mean Median
1986 235 1592.455 440.41
1987 348 2400.580 252.98
1988 409 1555.487 248.30
1989 638 1743.330 294.89
1990 684 928.5072 214.61
1991 306 1615.494 198.12
1992 404 1887.403 272.72
1993 430 2055.794 333.98
1994 762 1828.405 283.35
1995 945 1893.157 218.83
1996 1293 2476.328 254.24
1997 1184 2803.019 282.31
1998 1859 2141.915 206.23
1999 1658 1934.741 200.15
2000 1132 2964.627 199.71
2001 849 3998.777 131.22
2002 594 3925.170 143.47
2003 648 3434.416 194.07
2004 707 6389.309 546.20
2005 821 6557.333 879.12
2006 879 7155.391 876.40
2007 1205 7669.996 926.02
2008 1197 4118.797 375.88
2009 546 3855.616 218.24
2010 716 5462.259 745.60
2011 921 6510.669 1327.10
Total 21,370 3419.191 263.48
54. 54
Table IV
Target Premium Distribution: Univariate Results
US target premium for the sample is given by the summation of the target abnormal returns. The
modified market model is used to estimate the target returns:
ARi,t = ri, t – rm, t ; CARi =
€
ARi,t
t =i
T
∑
Table IV shows the percentage premium for the high and mid groupings of target cash reserves,
target debt-to-equity ratio, and target market-to-book ratio.
Results show the mean T-value from the two-sided t-test is reported for all values. Table reports
the results for the differential of the high values minus the low values for all, domestic and
foreign takeovers. The differential for domestic acquisitions minus foreign acquisitions for all
deals, deals in the high group, and deals in the low group.
Panel A: Target Cash Reserves
All Domestic Foreign Domestic - Foreign
Mean 6.12%a 5.75%a 17.20%a DIFF: -11.46%a
T-val 66.02 63.06 22.34 -14.78All
N 21,370 20669 701
Mean 7.34%a 6.79%a 19.64%a DIFF: -12.85%a
T-val 37.92 35.85 12.80 -8.31High
N 6411 6201 211
Mean 5.41%a 5.16%a 16.24%a DIFF: -11.08%a
T-val 34.91 33.49 12.63 -8.55Low
N 6411 6201 211
Differential 1.92%a 1.64%a 3.41%c
HML
T-val 7.77 6.71 1.7
! ! ! ! ! !
Panel B: Target Debt-to-Equity Ratio
All Domestic Foreign Domestic - Foreign
Mean 6.12%a 5.75%a 17.20%a DIFF: -11.47%a
T-val 66.02 63.06 22.34 -14.78All
N 21,370 20,669 701
Mean 5.74%a 5.47%a 13.94%a DIFF: -8.47%a
T-val 36.36 35.04 10.72 -6.47High
N 6411 6201 211
Mean 7.42%a 6.89%a 21.62%a DIFF: -14.73%a
T-val 38.68 36.80 13.60 -9.2Low
N 6411 6201 211 !!
Differential -1.68%a -1.42%a -7.69%a !! !!
HML
T-val -6.75 -5.83 -3.74 !! !!
55. 55
Table IV cont.
! ! ! ! ! ! !
Panel C: Target Market-to-Book Ratio
All Domestic Foreign Domestic - Foreign
Mean 6.12%a 5.75%a 17.20%a DIFF: -11.46%a
T-val 66.02 63.06 22.34 -14.78All
N 21,370 20,669 701
Mean 4.61%a 4.19%a 16.36%a DIFF: -12.16%a
T-val 30.08 28.08 12.56 -9.28High
N 6411 6201 211
Mean 8.57%a 8.21%a 18.87%a DIFF: -10.66%a
T-val 43.11 41.88 11.53 -6.47Low
N 6411 6201 211
Differential -3.95%a -4.02%a -2.51%
HML
T-val -15.75 -16.3 -1.2
a Denotes significance at the 1% level
b Denotes significance at the 5% level
c Denotes significance at the 10% level
56. 56
Table V
Regression Analysis of Premiums
Table V reports the values and p-values for the OLS regression analysis of dependent variables
on target premium distribution. Models 1 through 3 examine the linear and cross-effects of
method of payment and foreign acquisitions. The value for the constant is tabulated for each
model. Dummies labeled as “High” have the top 30% of values, and “Low” have the bottom
30%.
Panel A
Model 1 Model 2 Model 3 Model 4 Model 5
Dependent on:
Coef. 0.027a 0.084a 0.093a 0.011 0.088a
Foreign
P-Val 0.005 0 0 0.169 0
Coef. 0.043a 0.038a 0.045a 0.043a 0.041a
Cash Reserves
P-Val 0.001 0.001 0.001 0.001 0.001
Coef. 1.08E-06b 1.12E-06b 1.06E-06b 1.07E-06b 1.11E-06b
D/E
P-Val 0.022 0.018 0.026 0.023 0.018
Coef. -0.001b -0.001c -0.001c -0.001b -0.001b
M/B
P-Val 0.035 0.053 0.078 0.032 0.040
Coef. -0.012a -0.012a -0.012a -0.012a -0.012a
Market Val. (log)
P-Val 0.001 0.001 0.001 0.001 0.001
Coef. 0.046a 0.055a 0.049a 0.038a 0.062a
Diversifying
P-Val 0.001 0.001 0.001 0.001 0.001
Coef. -0.089a -0.084a -0.08a
Cash
P-Val 0.001 0.001 0.001
Coef. 0.065a
Cash_CBA
P-Val 0.001
Coef. 0.082a
Stock
P-Val 0.001
Coef. -0.021
Stock_CBA
P-Val 0.205
Coef. 0.083a
Mixed
P-Val 0.001
Coef. -0.087a
Mix_CBA
P-Val 0.001
Coef. -0.016a
Public
P-Val 0.001
Coef. 0.098a
Pub_CBA
P-Val 0.001
Coef. -0.024a
Private
P-Val 0.001
Coef. -0.085a
Priv_CBA
P-Val 0.001
Coef. 0.193a 0.110a 0.111a 0.204a 0.188a
cons
P-Val 0.001 0.001 0.001 0.001 0.001
N 21,368 21,368 21,368 21,368 21,368
R2
0.139 0.118 0.121 0.142 0.143
Adj. R2
0.139 0.118 0.12 0.142 0.142
