The Complexities of Cross Border Mergers Finance Essay

The fifty wave of mergers and acquisition took popularity in the stream ofcross border mergers(Wikipedia)In 1998, cross-border acquisitions accounted for around 80% of FDI outflows of united kingdom in the US, on average over the 1984-1995 period, crossborder acquisitions accounted for over 90% of US FDI inflows. Cross border mergers and acquisitions are playing an important role in the growth of international production Although the basic merger or acquisition is the same worldwide, undertaking a cross-border transaction is more complex than those conducted ''in market'' because of the multiple sets of laws, customs, cultures, currencies, and other factors that impact the process.-article 102 For the first time in recent history, in 2007, the value of cross-border deals equaled the value of intraborder M&As (Economist 2007a). Article 100 Cross border m&a are generally initiated by either Capital market school-capital market prospective of mergers and acquisitions looks into revenue that is generated by the bringing together of assets of two companies. They believe that a new investor becomes the owner because he/she can manage the assets in a better way then it was earlier done. These economists highlight concepts such as capital asset pricing model,agency theory, EMH, and a market for corporate control. Strategy school- unlike the capital market school, which is dependent on aspects like impact on the market after post or prior to M&A, this school is interested in knowing the impact on individual entity (e.g.-impact of a merger on both the companies balance sheets, trading, business, revenue etc) Organisational behaviour school- evidence suggest that acquisitions in the last 2 decades have been much surrounded by implementation problems and bad post acquisition performance (vermeulen and barkema 2001). This school takes into account the human behaviour on post merger integration. The ecomomist are more inclined towards finding the impact of cross border M&S on individuals.

YEAR

DEAL

NATURE OF DEAL

1907 Royal Dutch / Shell- Friendly 1930 Unilever Plc /Unilever NV Dual-Headed Structures 1988 GrandMet / Pillsbury HostileDeal 1989 SmithKline Beckman / Beecham ADRand Stapled Stock 1997 BAT/ Zurich Dual-Headed and Demerger 1998 DaimlerBenz/Chrysler Global Share 1999 Vodafone / AirTouch Contested StockDeal 1999 Alcan / Alusuisse / Pechiney 3-WayStockDeal 1999 Vodafone AirTouch /Mannesmann Hostile StockDeal

WHY MERGERS AND ACQUISITIONS

faced with continued pressure to grow profits and with substantial cash on the balance sheet However, in many industries-telecommunications and banking, for example-further national consolidation is constrained in more mature markets by antitrust regulations, forcing companies to look abroad for new targets. In addition, as competitors, suppliers and customers become more global in outlook, many companies are feeling the pressure to expand their geographic presence just to remain competitive. agency theory (Kesner et al., 1994), hubris (Weston and Weaver, 2001; Berkovich and Narayanan, 1993; Roll, 1986; Seth et al., 2000) and empire building (Trautwein, 1990) indicate the existence of more than one motive for M&As. Hitt et al. (2001) also suggested multiple motives for firms to complete CBM&As. Acquiring of foreign targets should benefit the acquirers in many ways. First, it offers better access to product market in the forms of new sources of demand and enhanced possibilities of receiving favourable treatment from consumers and regulators in foreign markets. Second, it leads to relatively stable cash flows owing to reduced exposure to macro-economic risk through geographical diversification as the business cycles of various countries are unlikely to move together. Third, it offers opportunities of using local resources and technology that may help reduce the cost of production. Fourth, the increased access to foreign capital markets helps in lowering the cost of capital of the firm. Finally, multinational firms enjoy more investment opportunities than domestic firms while maintaining the opportunities available in home market. Such enhanced business opportunities suggest that (a) acquisition of a foreign target should increase the value of bidder and (b) the gains CBAs should be higher than the gains from domestic target acquisitions. These should be reflected in both announcement period and long-term performance of acquirers. There are a number of reasons why a corporation will merge with, acquire, or be acquired by another corporation. Sometimes, corporations can produce goods or services more efficiently if they combine their efforts and facilities. These efficiency gains may come simply by virtue of the size of the combined company; it may be cheaper to produce goods on a larger scale. Collaborating or sharing expertise may achieve gains in efficiency, or a company might have underutilized assets the other company can better use. Also, a change in management may make the company more profitable. Other reasons for acquisitions have to do more withA hubrisA and power. The management of an acquiring company may be motivated more by the desire to manage ever-larger companies than by any possible gains in efficiency.

To facilitate faster entry into foreign market

Increase market power

Access to and acquisition of new resources and technology

Diversification

Improved management

Synergy

Managerial motive

- K. Shimizu et al. / Journal of International Management 10 (2004) 307-353

RECENT TRENDS The size of private equity has increased doubling the size of global mergers and acquisitions deals. The new figures show that private equity in cross border mergers and acquisitions is around 31% (2004-2007).new market player including financial corporations and sovereign wealth fund have entered the market. A survey by Accenture group reveals that 20% of the future growth will come from mergers and acquisitions Despite the current tightening of credit and general economic uncertainty, one area of business activity has remained surprisingly robust: M&A. Although many players sat on the sidelines for the first half of 2008, global deal volume during the previous two years surpassed the record-breaking levels set in 2000. Moreover, the need for corporate growth and the availability of financing from new sources are likely to reignite the merger market boom and keep it going for the foreseeable future. The role of private equity has grown dramatically, doubling its share in global M&A deals-accounting for more than 31 percent of transactions in the current M&A wave (2004-2007) compared with the prior M&A wave (1995-2000.) Other new investors, including corporations and sovereign wealth funds from emerging markets, have entered the M&A arena. But the most significant trend has been the growth in the number of cross-border transactions, which now account for almost half of total M&A deal value. While the majority of M&As involve two firms within the same country, over 40% of the M&As that were completed between 1999 and 2000 involved firms headquartered in two different countries (Hitt et al., 2001a,b) Cross-border M&As pose tremendous challenges, in particular, at the postacquisition stage (Child et al., 2001). Recent evidence suggests that they are not highly successful. For instance, a study by KPMG found approximately that only 17% of crossborder acquisitions created shareholder value, while 53% destroyed it (Economist, 1999). Complexities- article 102 foreign target acquisition increases the risk of the acquirer for several reasons. First, acquisition of a foreign target exposes the firm to wider range of transactions and translations risks. These may result in higher volatility in cash flows, earnings and net assets. Second, it exposes the acquirer to political risks such as threat of nationalization by host government, changes in host government's attitude towards foreign investment and amendments in financial regulations such as custom duties, taxes etc. that may affect bidder's cash-flow adversely. Finally, due to differences in legal and cultural factors the agency cost of managing a foreign subsidiary is likely to be higher than running a domestic subsidiary. These factors are likely to push the cost of capital 6 which in turn reduces the value of the bidder. This suggests that, ceteris paribus, bidders of domestic targets, which are not exposed to these risks, should perform better than bidders engaged in CBAs. Therefore, whether CBAs are superior to domestic acquisitions is an empirical issue as it addressed in the paper. The dynamics of cross-border M&As are largely similar to those of domestic M&As. However, due to their international nature, they also involve unique challenges, as countries have different economic, institutional (i.e., regulatory), and cultural structures (Hofstede, 1980; House et al., 2002)

Flowback, Or 'I Don't Want Your Stock'

WhenA foreign investorsA perform a massive sell-off of a company's cross-listed sharesA back to the country of issuanceA as a result of an impending cross-border merger Flowback may be the biggest obstacle to the feasibility of cross-border mergers. Put simply, flowback is the unwillingness of target-company shareholders to hold foreign-domiciled equity of the acquirer. This sentiment is common among indexers and quasi-indexers; if themerged firm will not be indexed in the target's country, there is little incentive for these investors to hold the shares and a large incentive to sell. Many important stock indices, including the S&P 500, no longer admit foreign-domiciled issuers. tax or currency issues-cross border mergers have complex tax structures which makes then deal even more complicated. Althought the government provides tax incentives Despite some harmonised rules, taxation issues are mainly dealt with in national rules, and are not always fully clear or exhaustive to ascertain the tax impact of a cross-border merger or acquisition. This uncertainty on tax arrangements sometimes requires seeking for special agreements or arrangements from the tax authorities on an ad hoc basis, whereas in the case of a domestic deal the process is much more deterministic This uncertainty on tax arrangements sometimes requires seeking for special agreements or arrangements from the tax authorities on an ad hoc basis. The uncertainty on VAT regime applicable to financial products and services may put at risk thebusiness model or envisaged synergies . A group operating across several Member States may wish to centralize support functions to increase operating efficiency. But in many cases the result will include creating a VAT penalty on the inter group supply of services increase operating efficiency. But in many cases the result will include creating a VAT penalty on the inter group supply of services

significant antitrust or non competition issues

which law would be applicable- Take the case ofA Tata Steel's acquisition of UK's Corus, where the initial strains have begun to show through labour issues and could likely result in labour strikes on account of Tata Steel's decision to mothball its Teesside unit in northeastern England.

POLITICS AND ANTITRUST

Politics still plays a role in cross-border M&A-but to varying effect. In some cases, the reluctance of state shareholders to sell to foreign firms has scuttled planned transactions (although the quickening pace of privatization, particularly in Europe, should diminish these concerns). Reluctance to cede jobs and tax revenues to other states is another, potentially more enduring, obstacle. In other cases, political concerns about domestic competition and antitrust may in fact accelerate cross-border consolidation, as companies with fewoptions at home are forced to seek scale abroad. A The cultural complexities. One of the biggest challenges in a cross-border M&A transaction is overcoming cultural and business differences. Understanding the culture, regulatory environment, benefits philosophy, customer expectations, working habits and marketing strategy of a company adds layers of complexity to a deal. Clashes in country and company cultures can easily trump business objectives and derail a deal. Body intensity of M&A activity is significantly higher in countries with better investor protection. International market for corporate control targets firms in countries with weaker corporate governance practices Zechner (2001) and Reese and Weisbach (2002) show that firms from countries with weak legal protection for minority shareholders list abroad more frequently than firms from other countries. Investor protection increases the demand for M&A activity. Mearly pricing and valuation is not a good approach for final decision of whether to acquire or not. Every long term effect of the deal should be taken into concideration.

Legal barriers

Cross border mergers or acquisitions is a complicated transaction which involves numerous participants legal as well as private. A cross border deal (of a large firm or, of a important sector like mining, power, telecom) is actively contemplated by regulators and govt for possible flaws. There are often regulated by laws, local rules and regulatory restrictions.even at times when the bids are actually friendly takeovers acquirers are disadvantages by a potential lack of information and legal restrictions from the govt. countries having rigid legal system which leads to foggy decision ability. The bidder might not be aware of where the bid could fail or be rejected and on what grounds. In some countries the company law allows the companies to adopt defence tactics like poison pill, dual voting to prevent hostile takeovers. These efects discourages companies to take such a costly action

Blocking cross-border mergers

REGULATORY LAW : M&A are regulated by both state and federal laws. State law sets procedures to be followed while approving a merger or a acquisition. It also establishes legal enforceability of these laws so that the acquired company and its shareholders are given a fair compensation. Law does not create any obstacle in the deal unless a question of who has the authority to regulate or govern a deal arises.m

Main body

We find that cross-border M&As are more likely to occur in countries where foreign institutions hold a higher fraction of the local stock market. Previous studies on cross-border M&As focus on country-level governance aspects. Rossi and Volpin (2004) find that targets in cross-border M&A deals are more frequently from countries with weaker investor protection than their acquirers' country, suggesting a convergence in governance standards. Starks and Wei (2004) and Bris and Cabolis (2008) find a higher takeover premium when investor protection in the acquirer's country is stronger than in the target's country.

In view of miller and Whitman, Ragazzi, black & Stulz foreign direct investment (FDI) is the product of such factors as (a) imperfections in the product and factors markets, (b) different taxation, and (c) imperfections in the international financial markets.

Effect of cross border merger and acquisition on share holder wealth

cross-border transactions result in significant wealth destruction for shareholders while domestic transactions result in value generation for shareholders of German acquirers. Legal, economic or cultural obstacles to cross-border transactions, information imperfection and difficulties in post-merger integration due to cultural differences may have contributed to the negative cumulative abnormal returns to shareholders of cross-border transactions. A majority vote of shareholders is generally required to approve a merger La Porta et al. (1997) showed that investors in common-law countries enjoy the highest level of protection, while investors in civil-law countries receive the lowest. Rossi and Volpin (2004) show a strong positive relationship between takeover premiums and investor protection, suggesting that acquirers pay higher premiums when they acquire targets from countries that have better investor protection. Errunza and Senbet (1981, 1984), Kim and Lyn (1986), and Morck and Yeung (1991) report a significantly positive relation between internationalisation and firm value. Bodnar, Tang and Weintrop (2003) corroborate the prior evidence on the positive effects of corporate international diversification on firm value, whereas Christophe (1997) and Denis, Denis and Yost (2002) find evidence that international operations lead to value destruction. Marcelo B. Dos Santos, Vihang R. Errunza and Darius P. Miller* evaluated 136 cross border mergers and acquisitions from the acquirers of foreign target firms between 1990-1999 and find no evidence on average of any statistically significant decrease in the excess value of the U.S. acquiring firms in 2 years surrounding the deal. Also they use similar valuation methodology as in Bodnar, Tang and Weintrop (2003) and Denis, Denis and Yost (2002), which represents a variation of the industry-matched multiplier approach. Their results advice that a cross border acquisition does not result in value destruction. They find that related cross border mergers and acquisition does not lead to value destruction and unrelated cross border merger and acquisition leads to value destruction. Fatemi and Furtado (1988), Markides and Ittner (1994) and Datta and Puia (1995) all of which find either non-significant positive abnormal returns or, in the case of Datta and Puia, negative abnormal returns John Doukas And Nickolaos g. Travolis discuss how firms engaging in international expansion by acquiring foreign corporations with an intension to maximise shareloders wealth. Their results suggest that shareholders of firms not already operating in the target firms country get the best benefit from the acquisition, In terms of non-US countries, Kang (1993) investigates the abnormal returns of Japanese bidders in the US and finds positive abnormal returns to Japanese firms. Corhay and Rad (2000) find weak evidence that cross-border acquisitions are wealth-creating based on a sample of Dutch firms They also find evidence that the benefits from internalisation are greater for firms having less international exposure and making acquisitions outside their main industrial activity. In terms of cross-country comparisons, Eun et al. (1996) have shown that the returns to acquiring firms are likely to vary across countries. Examining Cross-border acquisitions in the US, they show that bidding firms sourced from Japan experienced positive abnormal returns while UK firms experienced considerable negative abnormal returns. Acquiring firms based in Canada experienced mildly positive abnormal returns that were considerably below those experienced by Japanese firms.4 Cakici et al. (1996) also report significantly positive abnormal returns around the event date for acquirers from Japan, Australia, the UK and the Netherlands. These studies suggest that positive abnormal returns are likely to vary depending upon the characteristics of the investing firms, the country of origin, and the country and/or industry in which the acquiring firm is investing in Hidden weaknesses/problems in acquired companies lead to over-optimistic expectations of the acquirer or failure to anticipate difficulties Strong internal/external pressures for swift decision-making encourage a financial focus as opposed to the assessment of crucial operational or cultural issues. Control by very few people with a limited time commitment or continuity throughout the pre- and post integration process. Frequently there is no a formal function/team taking responsibility to systematically control M&A projects. Lack of processes in place to deal with the complex organisational dynamics necessary in pursuing M&A synergies. Merged companies frequently take years to deliver full organisational integration.

SOME MERGERS AND ACQUISITIONS

Failure of General Motors' (GM) AND Daewoo (one of the key players of the automotive industry) joint venture in 1980's was a result of differences in the approach of the managers. Daewoo executives wanted the venture to achieve net growth even thought the venture was running in net losses. But GM Wanted to reduce operations in order to increase the profits. eventually this led to a disagreement which was to be discontinued. This led to a great loss to bothd the companies in terms of investment and valuable time. This is a very good example of a friendly merger which can be unsuccessful due to changes in opinions.

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