1. IntroductionThe’Global Financial Crisis’, originated in the U.S. is treated as one of the mostdevastating economic downturns. In history, the United States of America have experiencedseveral financial crises, such as the Great Depression in the 1930s or theDot-com bubble in during 2000-2002 (McGowan, 1971). Generally speaking, a financialcrisis may take different forms in different lifecycle stages, ranging frombanking- and currency crises up to speculative bubbles or even sovereigndefault, leading to negative spillover effects. In terms of negativeexternalities, also known as contagions, the diversification of financialinstitutions plays a vital role for the magnitude of systemic crises.
Banks mayreduce their idiosyncratic risk by diversifying into global assets, yet itinvolves a cost (Wagner, 2010). By adjusting for the similarity ofinternational institutions the systematic risk increases, as well. Within the1990s the correlation between domestic stock prices and those of foreignfinancial institutions rose by over 30 percent, increasing the effects ofcontagions (de Nicolo & Kwast, 2002).Previousresearch argued about the impact of a financial crises on macroeconomicfactors, such as the national trade balance, unemployment and gross domesticproduct (GDP) rates or interest rates. Taking the government bond yield forexample into account shows the governments perception of the future economicexpectations. Low interest rates indicate a positive anticipation about thefuture, hence offering affordable debt and stimulating investments. Incontrast, the impact of a financial crisis on mergers and acquisitions is farmore complex since, besides previous stated market factors, further corporatefactors and conditions influence the probability to engage in M&A deals.Patterns of merger waves are not fully in line with economic booms, as rationalexecutives attempt to take advantage of mispriced securities benefiting fromarbitrary deals (Harford, 2005).
Some papers have tried to explain thefrequency of deals with reference to the neoclassical- and behavioral modelwhich are discussed in this paper. Thisbachelor thesis investigates to what extend the ‘Global Financial Crisis’affected the M&A returns in the U.S., as well as the frequency of closingdomestic- and cross border deals in absolute terms. The paper examines the USdollar values of M&A transactions from 1997 until 2016, incorporating the’Dot-com Bubble’ and the ‘Global Financial Crisis’, yet focusing on the latter.
In order to analyze the relation between market fluctuations and the correspondingeffect on M&A deals, three different U.S. market portfolios are used torepresent the U.S market. To assure a significant correlation with a reliableportfolio representing the market, the Fama- French three-factor model is usedto regress its coefficients against the market indices. Furthermore, theinfluence of exchange rate fluctuations analyses the corporates likelihood toengage in deals.Thepaper is structured as follows.
Firstly, the literature review gives a clearexplanation of existing knowledge about M&As and the Global FinancialCrisis and further explains their relationship to establish the hypothesis.Secondly, the methodology is discussed, including the collected data for theresearch. Thirdly, the results of the test are analyzed and interpreted.Finally, the discussion and future outlook of the topic are given and aconclusion on the findings of the paper is derived.2. Literature Review2.1.
M&A in generalMergers & Acquisitions play a vital role intoday’s world of corporate finance, strategic dealing, globalization and management.First one must distinguish a merger from an acquisition. While a merger occursas one corporation is combined and vanishes into another, also known as a conglomerationor consolidation, a corporate acquisition is the transfer of equity, henceownership, by which assets or stocks are purchased by a new buyer (Reed, Lajoux& Nesvold, 2007). An acquisition may also be unfriendly known as a hostiletakeover, meaning the target company does not want to be taken over. Referringto the motivation of engaging in M transactions, synergies are ofimportance which relate to cost leadership or differentiation. Several benefitsarise, such as reaching economies of scale and scope, obtaining access to newtechnology, reducing staff and optimizing the human resources or even accessingnew markets.
Especially nowadays globalization has forced entities to enter newgeographies to sustain globally competitive. Synergies are seen as a medium forbridging the gap between financial and strategic perspectives (Larsson , 1999). There are mainly five types of mergers which differin terms of transaction style, economic purpose and relationship. The mostcommon one is the conglomerate where the parties are active in unrelatedbusiness activities.
Pure conglomerates mostly have no product or service incommon, while mixed ones have a relation to a certain extent and aiming for aproduct/ or market extension or even penetration. The horizontal- and verticalmerger are also well known nowadays. The former refers to entities in the sameindustry often gaining through the merger more market power, sometimesachieving monopolistic characteristics. The latter is used to optimize a supplychain, hence colluding up- or downstream and therefore decreasing thebargaining power of other suppliers or buyers.
Horizontal colluding may alsolead to the formation of cartels, indicating these rather form in countrieswith les government intervention. Nations with governmental antitrust policiesinduced rather make use of vertical instead of horizontal expanding of MNE’s(Schleifer & Vishny, 1991). The market extension merger regards twopartners dealing with the same product or service but in different markets.Increasing the client base and getting access to a larger market is here themain purpose. In contrast, the product extension merger deals with twocompanies having different products, though operating in the same market.
2.2. Merger WavesThe commonly seen economic cycles are related to thehistorically merger waves, having the first one occurred in the ending of thenineteenth century.
Merger waves occur in combination with the known bullmarkets, which are identified by constantly rising financial welfare,increasing stock prices, an aggressive investor behavior and a general recoveryfrom recessions (L. Gonzalez et al., 2005). Merger Waves may last severalyears, even a decade, while in economic history there have officially beenseven waves recorded. The first one, also known as the “Great Merger Movement”in the US was based on horizontal mergers with the aim of the majority of firmsto establish monopolistic markets. The second wave was rather described byvertical mergers with the few larger companies being more efficiency orientedthan, leading to an oligopolistic competition.
In the 1950’s, entities wereseeking more for expansion and the diversification of products and services viamergers, mainly to reduce the systematic risk. In comparison, the rather recentwave of the early twenty first century is dominated by the abundant liquidity,and the risen importance of globalization and private equity. Furthermore,Leveraged Buyout’s once were made use of to finance larger stakes of ownershipby partly financing a target with debt issuance, next to the invested equity.The determinants of this wave lie in the availability of excess liquidity whichis in line with the neoclassical model (Alexandridis, Mavrovitis & Travlos,2012).
2.3. Risk of M&A’sThe most well-known risk within a company is theagency theory which states that the principle hires his agent to manage a businessunit, though the agent will engage in projects which are in his self-interest.In terms of M transactions, “agency theory of overvalued equity predictsthat the overvalued firms are likely to engage in income increasing earningsmanagement in order to meet the unrealistic performance expectationsincorporated in the stock prices” (Kothari, Loutskina & Nikolaev, 2006). Inparticular, undervalued stock, hence potential ownership stake, may seem quiteattractive for management when it comes to thoughts of a possible market orgeographic expansion. The term ’empire building’ may also be appointed to amanager’s behavior if differences of opinions between executives and the boardof directors, which represent the investors, arise in combination with ashortcoming of observability of corporate actions (Dominguez-Martinez, Swank& Visser, 2006). Despite the fact of the downsides from the lemons model,there are prospects to mitigate the adverse selection of takeovers and projectsof acquirers.
By engaging in an initial public offering (IPO) the informationasymmetries can be reduced and a firm may feature more transparency, henceIPO’s intense effects on the efficiency of M deals (Reuer , 2006). Furthermore, the compensation scheme of managers can beadjusted, for example, instead of receiving bonuses a manager could be partlyremunerated with own call options, motivating the agent to engage in alliancesor deals which increase the stock price. 2.4. Review of Empirical Research based onTheoretical Models Generally speaking, there are two views of Mtransactions, the behavioral and the neoclassical one. The behavioral view isconcerned with market valuations and imperfect markets and information.Acquirers or vendors with an overvalued stock price take advantage of potentialtargets with undervalued stock prices and purchase an ownership stake withtheir inexpensive equity (Schleifer & Vishny, 1991).
In a perfect marketthe systematic-, as well as the idiosyncratic information would be reflectedimmediately in a company’s stock price. The time series analysis within thetwentieth century indicates a strong correlation of stock prices differencesand M&A transactions (Golbe & White, 1988). During a financial crisis, thestock market tends to fall rapidly and often may not reflect the corporatesreal stock value, generating an incentive to engage in deals in times of adownturn in the economy, hence, the behavioral economy partly supports anincrease in M&A deals during a crisis.
The neoclassical model relates M&A transactionsto macroeconomic and industry shocks, such as regulatory influences, economicshocks and technological improvements (Harford, 2005). Regulatory preferenceswith microeconomic preferences may be, for example, corporate- or income taxadvantages and further governmental legal support. Other incentives for directinvestments may be lower labor costs, less auditing of annual reports, or thediminution of importance of shareholder meetings, giving the management morecontrol. These Foreign direct investments (FDI) or acquisitions have beenincreasing in volumes and transactions since the 1980’s in the emergingeconomies, hence decreasing the amount of domestic U.
S. deals. Especially in apost- crisis period the undervaluation of target companies in developingcountries lead to “Fire- sale FDI’s” (Stoddard & Noy, 2015). Economicshocks, on the other hand, refer to a possibility for restructuring corporateand financial assets, giving the acquirer local advantages. Nevertheless,compared to FDI’s, according to the neoclassical model the magnitude of dealsshould have been decreasing in the U.
S. during the financial crisis in 2007,especially to transactions involving larger capital for investments. This isdue to the fact that nominal interest rates rise in times of financialinstability, hence the cost of capital of companies for discounting projectedinvestments. Due to a low rate of liquidity or even solvency of financialinstitutions, long- and short-term debt issuance decreased by almost 50 percentto large corporates (Ivashina & Scharfstein, 2009). In a study of Zhan & Ozawa (2001) cross- borderM&As were analyzed during the Asian crisis of 1997 and it was found thatregional take-over targets in the manufacturing sector would have had a highprobability of bankruptcy if the national government regimes would not have hadbeen adjusted to attract foreign acquisitions from industrialized.Asmentioned all above, there is a confirmation how several papers conclude variously,regarding the impact of some recessions on M&A activities in bothindustrialized- and emerging economies. By reasoning of the continuous debateof how an economic recession affects M&A deals, the Dow Jones IndustrialAverage Index, Standard & Poor’s Index, as well as the NASDAQ Index areused to examine the following propositions.
H1a: A financial crisis has a positiveeffect on the total value of monthly domestic M deals.H1b: A financial crisis has a negativeeffect on the total value of monthly domestic M deals. H2a: A financial crisis has a positiveeffect on the total number of monthly domestic M deals.H1b: A financial crisis has a negativeeffect on the total number of monthly domestic M deals. Apartfrom taking the ‘Global Financial Crisis’ into account, the impact of aspecified currency crisis is analyzed to explain the relationship betweenspecific components of a crisis with M deals.
Whether the nominalexchange rate is experiencing a depreciation or appreciation affects theattractiveness of potential target firms. H3a: A currency crisis has a positiveeffect on the total value of monthly domestic M deals. H3b: A currency crisis has a negativeeffect on the total value of monthly domestic M deals. 3. Methodology 3.1. Analysis of underlying Market Models This paper examines the influence of a sharpdownturn of the economy on an executives’ incentive to engage in a takeover inthe United States.
The two contrasting views, neoclassical and behavioral,which advocate different reasoning for mergers & acquisitions in the literaturereview, are derived from economic theories of capital structure. Since largeacquisitions are often accompanied by debt issuance, the possibility externalfinancing is of importance for acquirers.Costs of financial distress and the advantage oftax shields are the main opponents in the ‘Tradeoff Model’, hence entities arecontinuously adjusting their capital structure to the optimal debt ratio(Shyam-Sunder & Myers, 1999). Ismail & Eldomiaty (2004) show that severaldeterminants are to be included for evaluating the optimal capital structure,e.g. sales growth, expense ratio or the market – book ratio. A financial crisisdecreases the liquidity of financial services, lowers the credit ratings offirms and increases the cost of debt.
Consequently, according to the tradeoffmodel takeovers should decrease in crises, which can be related to theneoclassical model. Contrary, the ‘Market Timing Theory’, also known as the’Window of Opportunities’, comprises the existence of information asymmetriesbetween the market participants where the equilibrium of priced securities canbe altered (Merton, 1981). This study on taking opportunities in the market,supports the arbitrary behavioral model of benefiting from undervalued, listedstock in times of a crisis. 3.2. Selection of M&A Data Toexamine the fluctuation of takeovers, data was extracted from the ‘Institutefor Mergers, Acquisitions and alliances’ (IMAA) database.
The time seriesincorporates the number of deals, as well as the absolute value in US dollar. Toserve a reliable interval including economic recessions and recoveries, theoutput ranges from 1997 until 2016 on a monthly basis, absorbing the effects ofthe dot-com bubble and the global financial crisis. Figure 1 illustrates therelationship between economic cycles and the absolute yearly values of M&Adeals and the corresponding amount, nevertheless the data is extracted on amonthly basis to increase the sample size, hence it’s reliability.