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Foreign takeover activity in the U.S. and wealth effects for target firm shareholders.

A. Sinan Cebenoyan is an Assistant Professor of Finance at the University of Baltimore, Baltimore, Maryland. George J. Papaioannou is an Associate Professor of Finance at Hofstra University, Hempstead, New York. Nickolaos G. Travlos is an associate Professor of Finance at Boston College, Chestnut Hill, Massachusetts.

The significant increase in acquisitions of U.S. firms by foreign corporations in the 1980s has raised questions of public policy interest and has generated considerable academic interest.(1,2) Although inward foreign direct investment (FDI) studies are replete with theoretical and empirical explanations concerning the concentration patterns and motives of foreign direct investment in the U.S., less attention has been given to the financial consequences of foreign takeovers of U.S. firms. Specific questions of interest in this connection include, whether the market reacts differently to foreign takeover announcements relative to domestic takeovers, and what factors might explain the difference, if any. Answers to such questions are important for the finance literature on corporate control. As a result of inward FDI, foreign firms compete directly with domestic firms for the acquisition of U.S. firms. Consequently, foreign bids affect the terms of competition and, hence, the acquisition premia paid to target firm shareholders. Furthermore, examining the market reaction to acquisition bids by foreign firms can provide evidence of whether cross-border expansion--specifically into the U.S.--entails takeover gains in excess of those that U.S. bidding firms are expected to generate by acquiring other domestic firms.

Only recently, papers by Harris and Ravenscraft |18~, Shaked, Michel and McClain |33~, Marr, Mohta and Spivey |28~, Cakici, Hessel and Tandon |7~, and Conn and Connell |9~ have examined various aspects of the wealth consequences of foreign takeovers of U.S. firms. The major findings of these studies can be summarized by the following conclusions. All of the studies show that the wealth gains (i.e., abnormal returns) to targets in foreign takeovers are positive and significant, thus, in line with the evidence from domestic takeovers. When the wealth gains of targets in foreign and domestic takeovers, respectively, are compared, foreign takeovers are found to generate significantly higher wealth gains (Harris and Ravenscraft |18~, Shaked, Michel and McClain |33~, and Marr, Mohta and Spivey |28~). The gains to foreign acquired targets are found to be affected by whether the foreign bidder has operations in related lines of business (Marr, Mohta and Spivey |28~), by the exchange rate of the dollar versus the home currency of the bidder, and by the number of bids received (Harris and Ravenscraft |18~). Finally, there is no conclusive evidence as to what factors explain the difference in the wealth gains between target firms in foreign and domestic takeovers. Specifically, Harris and Ravenscraft |18~ find that, contrary to industrial organizational theories of FDI, neither the research and development nor the marketing intensity of the U.S. targets appear to be significant factors in this regard. In addition, the tax-related factors yield inconsistent results.

In this paper, we seek to explain differences in excess returns of foreign and domestic takeover bids by considering the intensity of foreign acquisitions in the industries of U.S. target firms. Consistent with the competitive acquisitions market paradigm, we hypothesize that if cross-border expansion via corporate acquisitions produces superior (relative to domestic acquisitions) gains, foreign bidders pass them to target firm shareholders only when the demand of foreign firms for U.S. firms in a particular industry is relatively strong. Accordingly, we find statistically significant evidence that the relative dollar volume of foreign acquisitions in a particular industry affects directly the excess returns earned by the shareholders of target firms in the respective industry.

The rest of the paper is organized as follows. Section I reviews the theory and derives the testable hypothesis; Section II describes the data and methodology; Section III presents and interprets the findings; and finally, Section IV offers a summary and some concluding remarks.

I. Theory and Testable Hypothesis

In a well-functioning market for corporate control, price reaction to announcements of corporate acquisitions depends on the takeover gains generated from transferring control of the target firm's assets to the acquirer. If the market perceives that there are no differences between domestic and foreign acquirers concerning their ability to generate takeover gains, the stock price reaction upon acquisition announcements by either class of acquirers should be similar. We investigate this issue within the context of corporate multinationalism and foreign direct investment theories.

Industrial-organization-based theories of FDI attribute the cross-border expansion of firms to the existence of market imperfections and failures (Hymer |20~, Vernon |35~ and |36~, Kindleberger |24~, Caves |8~, Buckley and Casson |6~, Magee |26~, and Dunning |11~). These theories suggest that direct expansion to foreign markets allows firms to exploit oligopolistic advantages stemming from the possession of specialized resources. Cross-border expansion also allows multinational corporations to internalize the market for their superior managerial and technological resources, and avoid frictions and costs caused by market failure.(3)

Besides the industrial organization theoretic approach, other explanations attribute FDI to foreign exchange rate fluctuations and disparities, relative taxation advantages for foreign and domestic corporate acquirers, and regulatory factors (Froot and Stein |15~, and Scholes and Wolfson |32~). More specifically, these arguments suggest that acquisitions of U.S. firms become more attractive in periods of a cheap dollar, when U.S. taxation favors foreign acquirers relative to domestic firms, and when regulations in the U.S. make it more difficult for U.S. firms to pursue domestic acquisitions. Empirical evidence supports the theoretical predictions that multinationality enhances firm value for industrial organization reasons. In this connection, Errunza and Senbet |12~ report a systematic positive relationship between a firm's degree of international involvement and excess value, where the latter reflects the economic rents associated with multinational operations. Also, Doukas and Travlos |10~ find evidence that the market recognizes the potential of excess takeover gains for U.S. multinationals that expand into new geographical areas and industries. Morck and Yeung |30~ also find that multinational expansion enhances, through internalization, the value of intangible assets like research and development and advertising. These findings suggest that cross-border acquisitions entail superior benefits relative to domestic acquisitions. However, target shareholders do not necessarily reap the excess benefits. Their gains depend on whether foreign bidders share with them the anticipated excess gains. The extent and conditions under which this occurs is an interesting question addressed in this study.

If the market anticipates foreign bidders to generate superior wealth gains compared to domestic bidders, this should be reflected in the target firm's excess returns at the acquisition announcements of the foreign and domestic bidders. However, the potential of foreign firms to generate superior gains through cross-border expansion is not, by itself, sufficient to ensure that foreign bids generate larger acquisition gains for U.S. target firms than domestic bids. For this to happen, it is necessary that competition among foreign bidders for U.S. corporations be sufficiently strong to allow the target firm shareholders to share the excess takeover gains the foreign bidder is expected to produce. In the absence of sufficient competition, the foreign bidder may not be compelled to pass any anticipated excess takeover gains to the target firm.

More specifically, we can think of the total takeover gain as comprised of two components. The first component is the takeover gain that stems from the target firm's contribution to the synergistic benefits; the second component stems from the bidder's contribution to the synergistic benefits. The well-documented positive and significant excess returns earned by targets and the relatively insignificant gains of bidders (see Mandelker |27~, Asquith |3~, and Jensen and Ruback |22~) suggest that, due to competition, target shareholders reap the lion's share of the acquisition gains. Ruback |31~, and Bradley, Desai and Kim |5~ provide more detailed tests and evidence in support of the effects of competition on takeover announcement excess returns. (Berkovitch and Narayanan |4~ provide a theoretical explanation for the relationship between increases in target's share of synergistic gains and the intensity of potential competition.)

If foreign acquirers can indeed produce superior takeover gains, the excess gain will be reflected in the target firm's excess returns only when the degree of competition is so strong as to force the foreign bidder to share the excess economic benefits of the acquisition with the target firm. This leads to the joint hypothesis that (i) differential wealth gains in foreign takeovers signify the advantages of cross-border expansion, and (ii) these differential gains are observed in the excess returns earned by shareholders of foreign takeover targets when competition for foreign acquisitions in the U.S. intensifies. Consequently, the main hypothesis tested in this study is: As the degree of competition for foreign acquisitions increases, U.S. targets acquired by foreign bidders realize greater excess returns than U.S. targets acquired by U.S. (domestic) bidders at the announcement of the acquisition bid.

II. Data and Methodology

A. Sample and Data Description

The sample of U.S. targets acquired by domestic and foreign films respectively satisfy the following criteria:

(i) The takeover announcements refer to completed acquisitions in the period 1978 through 1987. Some announcements were made, however, in 1977.

(ii) The acquisition bid is for at least 50% of the equity of the target. This ensures that effective control of the target's assets passes to the management of the bidder.

(iii) The target firm's stock was traded on the New York Stock Exchange or the American Stock Exchange. This ensures that the stock returns of the targets can be retrieved from the CRSP tapes of the University of Chicago.

(iv) Targets with material news releases (unrelated to takeover activity) around the announcement time are excluded.

A search of the annual rosters of Mergers and Acquisitions and the W. T. Grimm & Co. Mergerstat Review helped identify 149 U.S. firms acquired by U.S. bidders and 89 U.S. firms acquired by foreign bidders that satisfied the above criteria. Due to missing stock returns, the two samples are reduced to 134 targets acquired by domestic firms and 73 targets acquired by foreign firms.

The takeover announcement dates are taken from the Wall Street Journal Index (WSJI) and refer to the first announcement that identifies the ultimately successful bidder (domestic or foreign). On the basis of these announcement dates, we form two groups of targets: (i) those for which these announcements refer also to the initial takeover offer by any bidder; and (ii) those for which the announcement identifying the successful bidder is preceded by takeover offers from other bidders. Mergers and Acquisitions and the WSJI are used to obtain information on the method of payment, i.e., cash, debt, stock exchange, or a combination of the above.
Exhibit 1. Frequency Distribution by Year of Announcement Dates
of Acquisition Bids by 73 Foreign and 134 U.S. Firms for U.S.
Target Firms
 Foreign Bidders U.S. Bidders
Year Frequency % Frequency %
1977 3 4 3 2
1978 10 14 10 8
1979 14 19 22 16
1980 5 7 7 5
1981 1 1 2 1
1982 6 8 9 7
1983 3 4 5 4
1984 6 8 13 10
1985 2 3 31 23
1986 15 21 25 19
1987 8 11 7 5
Total 73 100.0 134 100.0

Exhibit 1 presents the distribution of foreign and domestic acquisitions of U.S. targets across years. In both samples, a few cases refer to 1977 since the announcement occurred the year preceding the acquisition year. The data show that the more active years for foreign acquisitions were 1978 and 1979, in the early period, and 1986 and 1987 in the latter part of the period under study.(4) Domestic acquisitions occurred most frequently in 1979, and then in 1984, 1985 and 1986.

Exhibit 2 presents the breakdown of the two samples by (i) method of payment, and (ii) country of origin of the bidder. It is evident that foreign bids were overwhelmingly made with a cash offer (which usually coincided with a tender offer), whereas domestic bids followed a more balanced use of cash offers and stock exchanges. With respect to country of origin, foreign bids originated mostly from English-speaking countries like Canada and the United Kingdom, followed by other Western European countries. Surprisingly, Japan had only five bids, indicating the nonpreference or reluctance of Japanese firms to expand to the U.S. via the acquisition of entire firms, at least in the 1978-1987 period.
Exhibit 2. Sample Characteristics of Acquisition Bids for U.S.
Firms by 73 Foreign and 134 U.S. Bidders, 1978-1987
 Number of Number of
 Foreign Bidders U.S. Bidders
(i) Method of Payment
Cash 62 62
Common stock exchange 3 19
Cash/stock 2 19
Debt 0 11
Indeterminate 6 23
(ii) Country of Bidder
Australia 3
Belgium 2
Canada 14
Great Britain 25
France 3
Holland 3
Hong Kong 1
Japan 5
Puerto Rico 1
Sweden 4
Switzerland 6
West Germany 6
U.S.A. NA 134

B. Test Methodology

We use the market model to measure the announcement wealth gains of foreign and domestic takeover bids in two ways.(5) For the sample of targets with announcements that identify the ultimate acquirer but are preceded by other takeover rumors, we cumulate abnormal returns over the event window t = -15 to t = 0. This results in a vector of cumulative abnormal returns over 16 days, CAR16. For the sample of targets for which the initial announcement identifies the ultimate acquirer and is not preceded by other takeover news, we take the cumulative returns over the event window t = -1 to t = 0, and form a vector of cumulative abnormal returns, CAR2. The advantage of using the former sample is that it contains a larger number of targets (a total of 207 firms, 73 with foreign and 134 with domestic bids). However, the second (smaller) sample provides the most direct measurement of the market reaction to the initial takeover announcement that also identifies the successful bidder as a foreign or domestic firm. In the tests that follow, we analyze both variables, CAR16 and CAR2; but since we find both samples to uphold the major conclusions of the study, we report results based on cumulative abnormal returns over the narrow window t = -1 to t = 0 (of the smaller sample).

According to the hypothesis of this study, the difference in the cumulative abnormal returns between domestic and foreign takeovers is attributed to the intensity of foreign acquisitions in the respective industries of the targets. Since prior evidence has shown that other factors affect the wealth gains of targets in foreign takeovers, we also investigate the explanatory power of these factors, and test the robustness of our competition variable in the presence of other variables.

In the cross-sectional regressions that follow, we utilize the following independent variables.

The Payment Method (FIN). Abnormal returns may be affected by differences in the payment method employed in foreign and domestic takeover bids. Exhibit 2 shows that 62 of the 73 foreign takeover bids used the cash offer method, whereas only 73 of the 134 domestic takeover bids used cash and debt. Previous studies (Wansley, Lane and Yang |38~, and Huang and Walkling |19~) find that acquisitions financed with cash and/or debt generate higher excess returns for target shareholders than stock-for-stock financed acquisitions.(6) Therefore, to control the payment method effect, we use the variable FIN, which takes a value of 1 or 0 depending on whether the acquisition bid is financed with a stock exchange or a cash/debt offer.

The Tax Regime Variables (TAX81 and TAX86). Scholes and Wolfson |32~ argue that following the 1981 tax reform, domestic takeovers gained a relative tax advantage over foreign takeovers. This bias was, however, removed after the Tax Reform Act of 1986. This analysis predicts that the wealth gains from foreign acquisitions would be negatively affected in the period 1981 to 1986, whereas the tax effect on the wealth gains from foreign and domestic takeovers should be neutral in the post-1986 period.(7) Accordingly, TAX81 is a dummy variable with a value of 1 if the takeover is in the period 1981-1986, and 0 otherwise. Similarly, TAX86 takes the value of 1 for takeovers in the year 1987, and 0 otherwise.

The Foreign Exchange Variable (REX). It is often argued that a cheap dollar makes the purchase of U.S. firms less expensive to foreign bidders and thus enables them to outbid domestic bidders. (Froot and Stein |15~ and Graham and Krugman |17~ offer sophisticated arguments on the role of the foreign exchange value of the dollar on FDI.) Following Harris and Ravenscraft |18~, who find a significant foreign exchange effect on the wealth gains generated by foreign takeovers, we construct a foreign exchange variable as the ratio of the difference between the average exchange rate of the dollar (units of dollars per unit of the currency of the bidder) in the 1978-1987 period and the foreign exchange rate of the dollar in the year of the announcement divided by the average exchange rate of the dollar. Negative (positive) values indicate a cheaper (more expensive) dollar for the foreign bidder.

The Target Firm's Industrial Sector (TECH and SEC). Arpan and Ricks |2~ report that inward FDI in the U.S. has been consistently concentrated in mainly innovation-intensive industries. Kim and Lyn |23~ also show that inward FDI is influenced by such industry characteristics as capital expenditures, industry size (in sales), and intensity in R&D. Following the Arpan and Ricks |2~ findings on the industry concentration of inward FDI in the U.S., we divide our total sample of targets into three groups. The first group consists of targets classified under the two-digit SIC codes 28 (chemicals), 33 (primary metals), 34 (fabricated metals), 35 (machinery), 36 (electrical), and 38 (scientific instruments). We call this the technology industrial sector. All targets classified under other SIC codes indicating extraction and manufacturing operations are grouped into the secondary industrial sector. Finally, targets classified in the service industries form the group of the service sector. In line with the Arpan and Ricks |2~ survey results, the technology group comprises the major part of our sample of foreign takeover targets (43% of the total sample). In the regressions below, the variables TECH and SEC are dummies which capture the impact of industry-specific asset characteristics on the realized excess returns. TECH takes the value of 1 for targets in the technology sector, or 0 otherwise, whereas SEC takes the value of 1 for targets in the secondary sector, or 0 otherwise. The service sector is the default dummy variable imbedded in the intercept of the regression model. The TECH and SEC variables are alternative specifications for corporate resource uniqueness, captured in other studies by research and development and marketing expertise variables, which, however, were not found to be significant.

The Foreign Competition Variable (FCOMP). The degree of competition in foreign takeovers of U.S. firms is measured by using aggregate data that refer to the dollar volume of foreign and domestic acquisitions. Specifically, we collect data on the dollar value of acquisitions per year, and industry and origin of bidder, i.e., for domestic and foreign acquirers. The publication Mergers and Acquisitions for the pertinent years is the source of both sets of data. Since Mergers and Acquisitions began to report this data in 1981, we exclude acquisitions announced in the years 1977 through 1980. The different sample sizes are noted in the exhibits.

We specify the competition variable, FCOMP, as the total dollar value of acquisitions by foreign acquirers in the industry of the respective target in the year of the announcement of the bid divided by the grand total dollar value of all acquisitions by foreign acquirers in all industries in the same year. This ratio signifies the relative importance of the industry to foreign firms that want to expand multinationally, and it, therefore, captures the intensity of foreign takeover activity in the respective industry.

The Multiple Bids Variable (BIDS). The wealth gains of target shareholders can be also affected by the presence of multiple bidders, which is an alternative indication of the competition for the control of a target. Bradley, Desai and Kim |5~ offer empirical evidence in support of the positive role multiple bids play when they are announced. Ruback |31~ notes that absence of bids does not indicate lack of competition, if the initial bid exhausts all potential gains for other bidders. Harris and Ravenscraft |18~ find multiple bids to have a significant positive effect on foreign takeover target abnormal returns, but do not offer evidence on whether multiple bids explain the differences in the abnormal returns of domestic and foreign takeovers. BIDS is used as a dummy with a value of 1 if there is more than one bidder around the takeover announcement time, 0 otherwise.

Nationality of the Bidder (NAT). NAT is a dummy variable that takes the value of 1 for foreign bidders or 0 for domestic bidders.

Interaction Variables. We form several interaction terms by combining various independent variables with the nationality variable (NAT) in order to ascertain whether these variables impact the relationship between the origin of the bidder and the abnormal returns.

III. Empirical Findings

To control problems arising from the heteroscedasticity of the error term in the regressions that follow, we have standardized all observations of all the variables by the standard error of the market model that generated the event time CAR values. As noted above, we report results obtained from the sample of targets where the initial takeover announcement identifies the successful bidder. Accordingly, the dependent variable is CAR2.

First, we report results for the whole sample of acquisitions in the period 1978 to 1987. Exhibit 3 presents regression results for the sample of foreign and domestic takeover targets over this period for all types of methods of payment and for cash bids only. Panel A (all bids) shows that when nationality of bidder (NAT) and method of payment (FIN) are considered separately, both are significant at the ten percent level. In Regression 3, both variables, NAT and FIN are included, and only NAT turns out to be significant at the ten percent level. Since almost all foreign takeovers are cash bids, it is unclear whether nationality or method of payment effects are reflected in the significant coefficient of the variable NAT in Regression 3. To probe this question, we next consider only a sample of foreign and domestic takeovers which used cash. Panel B of Exhibit 3 shows in Regression 1 that nationality is significant, although barely, at the ten percent level. We conclude, therefore, that before controlling for other factors, foreign takeovers seem to produce higher wealth gains for target shareholders than domestic takeovers.

In Regression 4 of Panel A of Exhibit 3, we capture the effects of various factors that have been predicted to affect the wealth gains of targets in foreign versus domestic takeovers. In this model, origin of bidder is insignificant, but the interaction of takeover concentration in the high-technology sector and origin of bidder (TECHNAT) is found to have a significant positive effect on the abnormal returns of targets receiving foreign bids. This finding suggests that foreign takeovers of U.S. firms operating in high-technology fields are expected to produce higher wealth gains than domestic takeovers of targets in the same sector. Other factors, including the number of competing bids, and the tax regime in effect, are not found to provide a statistically significant explanation of the variation of abnormal returns across foreign and domestic bids. Turning to Panel B of Exhibit 3, Regression 2 reveals that besides the interactive variable TECHNAT, the tax reform of 1981 had a negative impact on the wealth gains of foreign acquisitions versus domestic acquisitions. The negative and significant coefficient of TAX81NAT (at the ten percent level) is consistent with the Scholes and Wolfson TABULAR DATA OMITTED |32~ prediction and the Harris and Ravenscraft |18~ finding that the tax reform of 1981 favored domestic relative to foreign acquirers with regard to tax-induced acquisition benefits.

To test the main hypothesis of this study, we use a sample of announcements from 1981 to 1987, the years for which we have data for the variable of foreign competition, FCOMP. Results are reported in Exhibit 4.

Panel A of Exhibit 4 reports results from all bids in this period, whereas Panel B reports results for only cash bids. Regression 1 of Panel A shows that the origin of bidder was not significant for bids in the 1981 to 1987 period. This finding is also supported by the results of the cash-only bids (Regression 1 in Panel B). Regression 2 of Panel A shows that the interaction of foreign takeover activity in the U.S. and the origin of bidder produces higher wealth gains for targets in foreign takeovers. The coefficient of FCOMPNAT (0.857) is positive and significant at the one percent level. This finding is consistent with the prediction of the study that target shareholders capture greater

wealth gains from foreign bidders when the demand of foreign firms for U.S. firms in the industry of the target increases. This finding is also suggestive of the market's expectation that foreign acquisitions can produce greater takeover gains than domestic acquisitions. Hence, multinationality is found to have value in corporate acquisitions. Moreover, the insignificance of the variable FCOMP suggests that the wealth gains from domestic bids are not influenced by the TABULAR DATA OMITTED intensity of foreign demand for U.S. firms. This is further support for the hypothesis that competition results in greater gains for target shareholders when there are bidder-specific takeover gains which would not be passed on to the target shareholders otherwise.

Regression 3 (Panel A) shows that the influence of the variable FCOMPNAT is robust in the presence of other variables (its significance remains at the one percent level). In addition, this regression reveals that targets in high-technology fields capture greater wealth gains when acquired by foreign bidders than domestic bidders. Other variables (with the exception of NAT) are not found to be significant. Interestingly, the nationality variable, NAT is significant but negative. However, as the results of the cash-only bids (Panel B) indicate, the bidder's origin, although still negative, is not significant. The results reported in Panel B (cash-only bids) confirm the robustness of the variable FCOMPNAT. Although the interaction of the technological sector with nationality is positive, it is no longer significant.

The finding that nationality was found to be positive (and significant in some regressions) for acquisitions in the 1978-1987 period, but negative (and significant in some regressions) for takeovers in the 1981-1987 period, prompted us to examine its effect for acquisitions in the 1978 to 1980 period. The regressions of CAR2 on the TABULAR DATA OMITTED variable NAT revealed that nationality was positive and highly significant (at the 2.6% level) in this early period. It is possible, therefore, that developments in the tax code in the U.S. and other factors have contributed to a material decline in the wealth gains produced by foreign takeovers of U.S. firms in the 1980s. Since previous studies have not presented evidence from different time periods, the present results cannot be corroborated. Nonetheless, these findings suggest that the general conclusion of previous studies, that cross-border takeovers produced superior wealth gains for U.S. target shareholders, might not hold for takeovers in the 1980s.

The regressions reported in Exhibit 5 examine the explanatory power of various factors for the abnormal returns of targets in foreign takeovers.

Panel A reports results for the whole period 1978 to 1987. Regression 1 shows that the exchange variable, REX, has a negative coefficient which is significant at the five percent level. This finding suggests that target gains in foreign takeovers are inversely associated with the value of the dollar relative to the value of the currency of the foreign bidder. Therefore, foreign takeovers generated higher gains for targets when the bidder's currency was stronger vis-a-vis the dollar. Harris and Ravenscraft |18~ also report a similar association between the exchange rate of the dollar and the wealth gains of foreign acquisitions of U.S. targets. Regression 2 shows that when we also examine the impact of multiple bids, taxation, and industry concentration, the only significant variable is TECH, which implies that target firms belonging to the high-technology sector realized higher wealth gains. The exchange variable, however, is no longer significant in the presence of these additional factors. Panel B of Exhibit 5 reports results from the 1981-1987 period, and thus, presents evidence on the role of foreign takeover activity. Regressions 1 and 2 show that when the foreign competition variable, FCOMP, is analyzed in conjunction with the exchange rate and the tax variable, respectively, it is positive and significant at the five percent level. Neither of the other two variables is found to be significant. Similarly, when the remaining independent variables are introduced in the model (Regression 3), only FCOMP is found to be positive and significant at the ten percent level. On the other hand, TECH is not found to be significant. These findings corroborate the evidence from the regression results of Exhibit 4 about the positive association between the intensity of foreign takeover activity and the wealth gains to U.S. target shareholders.

IV. Summary and Implications

This study investigates the wealth effects of the announcement of acquisition bids made by foreign bidders to U.S. firms, and the factors that might explain the differences in wealth gains across foreign and domestic takeovers. Utilizing theories of foreign direct investment and corporate multinationality, we argue that cross-border expansion can entail incremental benefits not available in domestic acquisitions. We postulate that these excess takeover gains are reflected in the abnormal returns realized at the announcement time if competition forces foreign bidders to share the incremental acquisition gains with their targets. We measure this competition by the intensity of foreign acquisition activity in U.S. industries, and predict that the abnormal returns of target shareholders are directly related to the foreign takeover activity.

Consistent with the main prediction of the study, we find that the wealth gains realized from foreign bids, relative to those realized from domestic bids, increase with foreign takeover activity in the respective industry of the target. This positive effect persists even after we account for various control variables. We infer from this evidence that cross-border expansion into the U.S. corporate market is expected to generate incremental benefits to foreign bidders, and these benefits are captured by target shareholders when the demand of foreign firms for U.S. corporate acquisitions in the respective industries increases.

In addition, and unlike previous studies, we find that the wealth gains from foreign takeovers are not consistently superior to the wealth gains from domestic takeovers. Specifically, we find evidence that the relative wealth gains of foreign versus domestic takeovers declined in the 1980s. This may be attributed to changes in taxation, regulation and other factors that took place in the 1980s. Our results also offer tentative evidence that target firms in the high-technology sector reaped greater wealth gains relative to other targets when acquired by foreign bidders. This finding may be simply due, however, to the greater concentration of foreign takeover activity in the technological sector, as previous inward FDI research has shown. Although variables like exchange rates, tax regime, and the technology sector were significant in some regressions, foreign takeover competition was found to offer the most dominant and consistent explanation of the difference in wealth gains between foreign and domestic takeovers of U.S. firms.

Several important implications can be drawn from the findings of this study. First, they confirm the results of previous studies that firm- and industry-specific characteristics do not explain foreign takeover wealth gains consistently. This implies, then, that specialized resources at the firm and/or industry level of the target are not recognized as the principal source of differential synergistic gains in foreign and domestic takeovers. Instead, the evidence is more consistent with the findings of Morck and Yeung |30~, that multinationality enhances the value of the specialized resources of the firm. Since a takeover places the assets of the target under the control of the acquirer, an extension of the Morck and Yeung conclusion would suggest that the specialized assets of U.S. targets are expected to increase in value when acquired by a foreign firm. Accordingly, the market recognizes the multinationality of the foreign bidder as a source of excess takeover gains. However, the evidence suggests that these gains are passed to the target only when competition for such cross-border acquisitions arises. A second implication of the findings of this study is that the documented concentration of FDI in certain U.S. industries, especially those characterized by technology intensity, is not associated consistently with a market expectation of greater wealth gains for the shareholders of targets in such industries when acquired by foreign firms. Instead, what matters the most is the relative concentration of the flow of acquisitions by foreign acquirers in an industry about the time of each acquisition.

Overall, the results confirm earlier evidence that competition in the market for corporate control enhances the wealth gains of target shareholders.

1Over the ten years covered by this study, 1978 to 1987, the number and value of acquisitions of U.S. firms by foreign firms increased from 199 and $6.3 billion to 326 and $41.9 billion, respectively (W.T. Grimm & Co. Mergerstat Review |39~, and Mergers and Acquisitions |29~).

2This is evidenced from the multitude of studies on reverse or inward foreign direct investment, as the purchase of U.S. corporate assets has been termed. See Arpan, Flowers and Ricks |1~, and Graham and Krugman |17~ for extensive coverage of theoretical and policy related issues.

3Vernon |36~ has advanced a theory of corporate multinationalism according to which FDI is motivated by interfirm rivalry to preserve oligopolistic advantages. Consistent with this view are the "follow the leader" hypothesis of Knickerbocker |25~ and Flowers |13~, and the "exchange of threats" explanation of Graham |16~. Flowers |13~, Franko |14~ and Magee |26~ have also proposed the "knowledge seeking" hypothesis according to which FDI into the U.S. has been motivated by the need of foreign MNCs to expand their stock of managerial and technical information and know-how in order to achieve and perpetuate oligopolistic advantages.

4This pattern may be suggestive of an FDI surge into the U.S. in periods of a weak dollar. Graham and Krugman |17~ consider this explanation, but question its ability to explain the size variation of FDI in the U.S. over time.

5The announcement wealth effects of takeover bids are estimated using a standard event-study methodology with an estimation period from t = -136 to t = -16 relative to the date of the announcement in the Wall Street Journal, defined as day t = 0.

6Similar findings are reported by Travlos |34~, and Wansley, Lane and Yang |37~ for bidding firms.

7Graham and Krugman |17~ argue that due to the complicated manner in which tax provisions impact on foreign acquirers, the association between FDI to the U.S. and tax changes has not been found to be a significant determinant of the FDI flow into the U.S.


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Title Annotation:Special Issue: Corporate Control
Author:Cebenoyan, A. Sinan; Papaioannou, George J.; Travlos, Nickolaos G.
Publication:Financial Management
Date:Sep 22, 1992
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