Determinants of Cross-Border Merger & Acquisition Performance of Chinese Enterprises Abstract:Using a unique data set on the cross-border merger and acquisition activities of the public companies listed at China's stock exchanges, we show that pre-acquisition performance and proportion of the state shares have a positive impact on performance of acquiring companies Keywords: Cross-border mergers and acquisitions; Chinese enterprises; International-alization
In the past thirty years China has experienced a rapid economic growth. In that period, a large number of Chinese enterprises have grown up and gained compositeness, a few have even ventured abroad to search for new sources of growth. One way of international expansion is to acquire existing businesses abroad, so called cross-border mergers and acquisitions (M&A). Although the number was low and the scales were small in the recent past, the trend is clearly picking up. It warrants a close look at this phenomenon to gain a better understanding on this matter.
Cross-border M&A refers to a corporate action of purchasing the shares or assets of another company in a foreign country. Obviously, cross border M&A is a transaction of control rights between companies in two or more countries. Although the goals of cross-border M&A are often said to be creating value for the shareholders of acquiring companies, the results are far apart from the stated objective. Systematic studies show a considerable number of cross-border mergers and acquisitions end up in failure. In addition to differences in market environments between home and host countries, the competitive and comparative advantages of the acquiring companies are considered more important. Those advantages include corporate governance, top management term competence, learning ability, among others. Therefore, it s necessary to take a look at the firm specific factors that influence the performance of cross-boarder M&A. The main purpose of this study is to identify the factors that influence the outcomes of cross-border M&A made by Chinese firms in recent years, particularly, economic performance of the acquiring firms.
The scale of cross-border mergers and acquisitions by Chinese firms has increased steadily in recent years. According to the United Nation Conference on Trade and Development, cross-border mergers and acquisitions by Chinese firms totaled US$ 8.139 billion in the period of 1988 to 2003, most of which occurred after 1997. While the average amount each year was only $ 216 million between 1988 and 2003, it reached the level of $ 1.647 billion in2003. There are a few well publicized cases: Shanghai Electric Group purchased a Japanese printing machine manufacturer in 2002, TCL acquired Schneider in Germany in 2003 and Lenovo purchased PC business of IBM in2004. All these cases show Chinese enterprises have entered an era of cross-border mergers and acquisitions.
The economic performance of acquiring firms differs as a result of such corporate action. Some of the differences may relate to the motives of the international expansion. For example, some companies do it because of competitive pressure at home market, while others seek resources such as raw materials and technologies, and probably a few are even encouraged by government policy measures. Despite the variety in their motives, many companies underestimate difficulties and integration risks in cross-border M&A and don’t have a clear idea about success factors that contribute to the difference in performance. Therefore it is imperative to have a good understanding of the relationship between performance of Chinese overseas mergers and acquisitions and determinant factors.
Although the issue is clearly important, many serious academic studies are hard to find. A systematic search through the website of the China National Knowledge Infrastructure that lists all academic journals published in China give us nearly one thousand articles on cross-boarder M&A. Most are merely reviews of existing theories, descriptions of current situations or simple case
Our study attempts to analyze systematically economic performance and its determinants of cross border M&A made by Chinese companies in recent years. In addition to contribute to cross-border M&A literature, we also hope that the findings can provide useful guidance to outward foreign direct investment by Chinese enterprises in the future.
Cross-border M&A is not new. What this paper intends to contribute is to explain the firm level factors and performance of overseas M&A by Chinese enterprises. Because the M&A performance are influenced by multiple factors, we adopt a multiple theoretical perspectives, specifically, organization learning perspective and agency theory.
As we discussed early, we have not yet found a well developed database on the cross-border M&A, therefore we develop on our own a database covering 165 M&A cases by searching through various data sources including company websites, annual reports, newspapers, and the internet.
The paper is organized as follows. The features of cross-border M&A activities of Chinese firms are discussed inspection 2. After a short literature review, a number of hypotheses are developed based on a number of theoretical perspectives. Section 4 discusses the methodology and results are reported in section 5 before the concluding remarks.
2. Features of Cross-border M&A by Chinese Companies
Cross-border M&A by Chinese companies began in the 1980s, with most of the target companies located in the US, Canada and Hong Kong. The firms involved were basically large state-owned enterprises, such as CITIC, SINOCHEM, Capital Steel and China Resources. For example, Beijing Capital Steel Group purchased 70% shares of an American engineering company MASTA for US .4 millions in July 1988. In the 1990s, more and more Chinese companies start engaging acquisitions overseas. In addition to the state-owned enterprises, privately and collectively owned enterprises also joint the game. After entering into the 21 century, Chinese firms become more aggressive in cross-border mergers and acquisitions, several large cases occurred, such as the purchase of Korean company Sang Yong Motor Company by Shanghai Automotive Industry Corporation and the purchase of PC business of IBM by Lenovo.
Anecdotal observations show a few tendencies: 1) volume and sum of transactions increase over time. Figure.1shows amounts of money involved in that cross-border mergers and acquisitions of Chinese enterprises. Although the amounts of money involved vary over the years, but the trend is going up. 2) The purchasing method extended from cash offer into various kinds of payments, such as leveraged acquisitions and swap of equity shares. For example, TCL used the methods of asset injection and shares swap in its acquisition of Thompson of France. 3) Although the state-owned corporations dominate in big cross-border M&A deals, collectedly owned and private enterprises also become active in recent years. 4) The industries covered extended from domestically monopolized industries such as energy, chemicals to manufacturing industry in general.
3. Literature Review
There is a vast literature on both domestic and cross-border mergers and acquisitions, mostly based on the experiences from developed countries. There are a few Chinese scholars have studied mergers and acquisitions casein domestic markets. For example, Feng and Wu (2001), using accounting data and factor analysis, formulate an overall evaluation function of corporate performance. They do not find significant change in firm performance in the year of M&A, but the performance improves in the year after and falls back in the third year. Zhu and Wang (2002) analyze improvement of return on equity (ROE) and returns on assets (ROA) for both acquirer and target companies in 67 mergers and acquisitions cases in 1998. Zhang (2003), using event study method and accounting an alytical method, analyzes the mergers, acquisitions and reorganizations of Chinese publicly listed companies. He found that mergers, acquisitions and reorganizations add value to the target company, b ut had a negative influence upon shareholders’ income and financial performance in the acquiring company. Jia (2003) reports a reverse U shape relationship exists between performance of acquiring companies and their previous acquisition experience. We do not find empirical study on cross-border mergers and acquisitions of Chinese companies. In the following section,we are going to develop a few hypotheses based on the prevailing theories on possible factors that influence the performance of cross-border M&A cases.
The outcomes of cross-border M&A depends at least on 2 broad factors. First of all, it depends on external environment, such as economic growth and degree of competition at home country, changes of political and cultural environment of host country and so on. Secondly, it depends on
resources and capability of the acquiring company.It is the latter that we are going to focus on. A few
hypotheses therefore are developed to reflect the relations between acquiring firm characteristics and performance of cross-border M&A.
4.1 Pre-Acquisitions Performance of Acquiring Firms
Allocation of control rights and possible synergy are often used to explain pre-acquisition performance and acquisition behavior. They are also used to explain post-acquisition performance for both acquiring and target firms.Weston et al. (1990) proposes that synergy effect is one of the main sources in which acquisition adds value, which means economic efficiency can improve after mergers of firms with different management capabilities. A relatively efficient bidder purchases a less efficient target firm and increases the value of the merged firm through improving target firm’s effectiveness.
From target firm perspective, market for corporate control theory argues that it is the difference between a company’s market value and its actual value that determines whether a firm will be acquired. Moreover, the difference of management efficiency between the acquiring firm and the target firm determines the target company's post-acquisition performance. From the acquiring firm s viewpoint, market for corporate control theory predicts that pre-acquisition performance of the acquitting firm is positively related to its acquisition performance.For example, Lang et al. (1989) found that in tender offers, Tobin Q value of acquiring firms and shareholders’interests are positively related. Servaes (1991) found both acquirer’s and acquired company’s shareholders gainsare positively associated with the Tobin Q value of the acquirer. In these studies, Tobin s Q, defined as the market value of a company divided by its replacement cost, is used as an indicator of a company s pre-acquisition performance and management capacity. Hereby we develop the following hypothesis:
Hypothesis 1: Pre-acquisition performance of Chinese company (the acquirer) and its cross-border acquisition performance are positively related.
4.2 Free Cash Flow
Agency theory describes that the relationship between shareholders and managers as a principal-agent relationship. The principal and agent have different and often conflict interests. A manager considers his own interest first when making decisions that may not at the best of interest of shareholders. Jensen & Meckling (1983)define a firm as a nexus of contracts, contending that agency cost is unavoidable in public companies.
One kind of agency costs is associated with the magnitude of free cash flow that refers to the amount of cash leftin the company after covering the need of all investment projects with positive net present value. Large amounts of free cash flow can cause higher agency cost when corporate governance of acquiring company is imperfect. When a company has a large free cash flow but no or just a little debt, shareholders and managers may face a serious conflict in interests regarding dividend policy. In order to maximize their interests, managers prefer not distributing the free cash as dividend payout and to keep free cash flow within the company. Therefore they can use that cash not only for their personal private benefits or over-investment, but also for compensation of possible losses in the future(Jensen, 1986). If there is no good control system in place to ensure efficiency in operations, free cash flow may lead to high agency cost. Under that circumstance, acquisition cannot be a sound decision. On the other hand, free cash flow is redistributable financial resource thus