Institutional Factors in M&As by Emerging Economies

More and more often in the papers we read about cross-border mergers and acquisitions with a distinction: the bidders come from developing countries, and the targets are in developed countries. At a macro level, one of the biggest differences between the emerging and advanced economies has to do with the structure and level of complexity of institutional mechanisms. Specifically, in developed countries the body of legislation pertaining to corporate governance which serves to protect investors is generally more sophisticated.

Moving across the border into a context characterized by sturdy rules and solid institutions could represent a source of value creation in and of itself for a company located in a developing country. In fact, such an acquisition could contribute to calming the anxiety of investors, and begin a game of “institutional catch-up” in the emerging economy. This kind of cross-border deal could also be a risk diversification strategy. In concrete terms, internationalization in more economically advanced countries could be rewarded on the domestic stock market, generating higher-than-average returns for the acquiring company.

To ascertain the impact of an acquisition in a developed country by a company based in a developing one, conducted by firms located in BRICS (Brazil, Russia, India, China and South Africa). The targets in all these deals were in developed countries (high-income OECD countries and IMF developed economies), and the timeline we considered was January 1997 to March 2012. The reason for choosing BRICS was to obtain a homogeneous sample, in the sense that these nations represent a cohesive block of emerging economies with comparable degrees of economic and financial development, making the transition to capitalism in the early ‘90s.

In our study, we analyzed deals in which the bidder took control of at least 30% of the equity of the target. To evaluate the value creation dynamics linked to the transaction, we looked at the acquiring company’s stock returns and compared them to the return on the market index in an event window five days before and after the deal announcement.

To assess institutional factors that protect investors in the target countries, we used two separate indicators: the anti-self-dealing index (measures that limit the risk that majority shareholders exploit their positions for personal gain) and anti-director rights (which defend investors from possible opportunistic behaviors by company management). We also included a series of control variables denoting the characteristics of the sector, the buyer, the deal, and the cultural distance between the acquirer and the acquired firm.

The average value of the deals in our sample was around 210 million euro, while the median value was just shy of 20.5 million euro, which shows the ample variation from deal to deal. The majority of the target companies were small to medium sized, and most were based in the US, the UK and Australia, while almost three-fourths of the buyers were Indian and South African. This can be explained in part by the fact that there are fewer listed firms in China and Russia. Generally speaking, the aim of the acquisitions we studied was more to shore up core competencies rather than diversify the business. In fact, in most cases the acquiring and acquired companies operated in the same sectors: mainly manufacturing, food and mining, with the exception being Indian companies which were particularly active in the IT and pharma industries. Lastly, over three-fourths of the deals involved payments in cash rather than equity.

Our analysis of stock returns in the days just before and after the deal announcement confirm that the market valuation of the bidder is positive, but this effect is quite limited. Instead, the variables that significantly impact returns are the capitalization of the acquirer (in a negative direction), the listing status of the target company (negative), and the relative deal size compared to the capitalization of the buyer (positive).

On the contrary, no value creation seems to emerge from better standards of governance in destination countries. This is true for both legislation to prevent potential misbehavior by majority shareholders and regulations protecting shareholder rights. Equally irrelevant as far as returns is the cultural distance between the acquirer and the acquired companies.

With acquisitions, when a BRICS buyer does a deal in a developed economy, the more advanced institutional mechanisms in the destination country do not create value in and of themselves. But other studies based on different samples of emerging economies seem to suggest the opposite. So the countries chosen for the sample are what seem to determine whether or not these macro factors actually come into play.

Instead, there’s no doubt of the influence of micro factors on stock returns generated by the deal. These are linked to both specific characteristic of the transaction (relative size of the operation with respect to the capitalization of the buyer) and the companies involved (listing status of the target and market capitalization of the buyer).

Keeping the focus on both micro factors and governance, future research on these kinds of cross-border M&As could explore how other factors impact returns. Some examples are whether there are independent advisors, or what level of protection individual acquiring companies provide for their shareholders.

The role of advisors also calls for further investigation. Specifically, in acquisitions initiated by companies in developing countries, what kind of advisor is involved (in terms of prestige, nationality and fee)? What are the differences with respect to developed countries, and what’s the impact on value creation? The implications of these are questions could be significant and concrete. In fact, in cross-border M&As companies from emerging economies typically bid higher, making it harder to get positive excess returns on the deal.