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Cross-border Mergers and Acquisitions: Anand Shetty, PhD ... ANNUAL... Cross-border Mergers and Acquisitions: The Role of Exchange Rate Movement Anand Shetty, PhD Professor of Finance

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  • Cross-border Mergers and Acquisitions:

    The Role of Exchange Rate Movement

    Anand Shetty, PhD

    Professor of Finance

    School of Business

    Iona College

    715 North Ave.

    New Rochelle, NY, USa 10801

    [email protected]

    John Manley, PhD

    Professor of Finance

    School of Business

    Iona College

    715 North Ave.

    New Rochelle, NY, USA 10801

    [email protected]

    NyoNyo Kyaw

    Associate Professor of Finance

    School of Business

    Iona College

    715 North Ave.

    New Rochelle, NY, USA 10801

    [email protected]

    EFM Classification codes: 610 & 210

    mailto:[email protected] mailto:[email protected] mailto:[email protected]

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    Cross-border Mergers and Acquisitions:

    The Role of Exchange Rate Movement

    This paper investigates the role of exchange rate movement in cross-border mergers

    and acquisitions decisions and their outcomes. Past studies on theoretical and

    empirical relationship between the exchange rate and cross-border investments have

    reported mixed results. We examine this relationship using 2001-2011 cross-border

    mergers and acquisitions by 595 U.S. firms. We look at two measures of exchange

    rate changes – the change in the real exchange rate of the U.S. dollar and exchange

    rate volatility – to assess the impact on merger premium. We do not find a

    significant relationship between the change in the real value of the U.S. dollar and

    merger premium. The relationship between the volatility measure and merger

    premium is, however, positive and significant. Our model also examines the effects

    of bidder specific characteristics such as size, leverage, overseas experience

    overseas experience in addition to the means of acquisition finance and the level of

    economic development in the target country. We find a positive and significant

    effect of the overseas experience and for the choice of MAF (Means of Acquisition

    Financing), as well as a negative insignificant effect of the level of economic


    1. Introduction

    Both domestic and cross-border mergers and acquisitions are motivated by a common goal of

    increasing value for the shareholders, but the wealth effects of cross-border investments are

    affected by a number of factors that are not present in domestic mergers and acquisitions.

    Cultural, geographic, regulatory, and valuation differences, economic development, currency

    movement, degree of market integration, accounting standards, tax laws are some of the factors

    that dominate the wealth effects of cross-border mergers.1

    The traditional models on international capital flows operating under the assumptions of perfect

    capital mobility and perfect capital markets do not provide cost of capital advantage to either the

    domestic or foreign investor in bidding for an asset (Frootand Stein (1991). In the absence of

    1 See Erel et al. 2012 for a detailed discussion of factors.

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    cost of capital advantage, motivations for cross- border investments come from factors ranging

    from imperfections in the production and factor markets (Kindleberger 1969, Caves 1971 and

    Hymer1976), industrial organization, and differences in tax and regulatory policies (Scholes and

    Wolfson 1990). In recent years, the role of exchange rate movement has received substantial

    attention in the foreign direct investment and international merger literature. Observing the trend

    in foreign direct investment (FDI) and currency movement in the late 1970s and 80s, Froot and

    Stein (1991) build a model to explain the link between the FDI flows to exchange rate

    movement. They argue that information asymmetries about an asset’s pay-offs makes it costly

    for an entrepreneur to finance the asset’s acquisition with external sources alone. The more net

    worth the entrepreneur brings to this investment, the lower will be the cost of capital and the

    greater will be the relative advantage in purchasing this asset. When the currency of a country

    appreciates, firms holding most of their wealth in domestic currency denominated assets will

    experience an increase in their relative wealth position, hence the ability to bid aggressively for

    foreign assets. Regressing the foreign direct investments in the U.S. from 1973 to 1988 on the

    real exchange rate of U.S. dollar, they find a significant negative relationship between the FDI in

    the U.S. and the real value of the dollar in support of the connection between FDI and the

    exchange rate movement.2

    Blonigen (1997) also provides empirical evidence in support of an inverse relationship between

    domestic currency value and inward FDI. Blonigen offers a different perspective on the effect of

    2 Scholes and Wolfson (1990) confirm this relationship in their observation

    that the cross-border takeover in the USA slowed down in the early 1980s when

    the dollar was strong and then surged when the dollar weakened in the latter

    half of the 1980s.

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    exchange rate on FDI by separating the price (wealth) effect from the return effect. When

    the domestic currency appreciates, the domestic firm can aggressively bid for a foreign asset

    because of the wealth effect, but there is no guarantee that the investment will generate a higher

    rate of return. When the profits of the acquired firm are translated at the higher valued domestic

    currency, the returns could be adversely affected. If the acquisition involves a firm-specific asset

    which is transferable, it can generate profits in other currencies thus avoiding the return problem.

    Bonigen’s emphasis on firm-specific asset acquisition in FDI is designed to focus on the fact that

    returns on international acquisitions also matter in addition to the price paid for the assets. Other

    FDI studies which used the exchange rate as a regressor with mixed results include Caves

    (1989), Ray (1989) and Martin (1991).

    Since the findings of Foot & Sterns (1991), Blonigen (1997) and others3 that there exists a

    connection between currency movement and cross-border capital flow, many papers studying the

    stockholder benefits from cross-border mergers and acquisitions have introduced exchange rate

    as one of the explanatory variables. In their study comparing the wealth gains to the

    stockholders of U.S. targets from domestic takeovers to the benefits from acquisitions by

    Japanese firms during late 70’s and 1980’s, Harris and Revenscraft (1991) find a strong and

    positive relationship between the strength of the yen and wealth gains to U.S. targets. Cakici et

    al. (1996), report a negative and significant exchange rate effect on bidder’s abnormal return in

    univariate regression and no effect in a multivariate regression for foreign acquisitions in the

    U.S. from 1983 to 1992. Pettaway et al. (1993) find an insignificant positive relationship

    between a strong yen and the wealth gains to stockholders of Japanese acquirers of U.S. assets in

    3 See Klein and Rosengren (1994) and Dewenter (1995)

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    the 1980’s. Kang (1993) finds a positive and significant relationship between Japanese

    bidder gains and appreciation of the yen during Japanese acquisitions of U.S. firms in late 1970’s

    and the 1980’s. HalilKiymaz (2004) reports a positive but not significant effect of exchange rate

    variable on the bidder’s wealth gains in his study covering cross-border acquisitions of U.S.

    financial institutions during 1989-1999 period. Moeller et al. (2005) find no significant effect of

    the strong dollar on the gains to U.S. bidders during 1985-95 period. In a comprehensive study

    of the determinants of cross-border mergers and acquisitions spanning a period from 1990 to

    2007, Erol et al. (2012) observe that currency movement is a major factor determining the

    pattern of cross-border mergers. They find the firms from countries whose currencies have

    appreciated are more likely to acquire firms from countries whose currencies have depreciated.

    Sonenshine et. al. (2014) report that firms pay more for target firms as the exchange rate of the

    home country of the target firm appreciates. They also find that acquirers with high intangible

    asset intensity pay relatively more for targets than those with low intangible asset intensity when

    target firm currency appreciates.

    In this paper, we extend the examination the effects of exchange rate movements on the wealth

    gains in 595 foreign acquisitions of U.S. firms during 2001-11 period. This period has seen a

    significant amount of fluctuation in the value of U.S. dollar. The real trade-weighted U.S. dollar

    index declined to mid and low eighties during the financial crisis period after hovering around

    high nineties during the first half of the sample period. We also examine how gains to the bidder

    are affected by (i) bidder characteristics such as size, leverage and foreign operating experience,

    (ii) the means of acquisition financing, and (iii) the level of econo