International Research Conference on Corporate Governance in Emerging Markets FinancingMotivated Tak

1
International Research Conference on
Corporate Governance in Emerging Markets
Financing-Motivated Takeovers The Case of
China

• Julan Du, Oliver M. Rui,
• and Sonia M.L. Wong

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Takeovers under Financial Repression

• Recent literature shows that corporate behaviors
  are not only affected by firm, industry and
  market factors but also by country institutional
  factors.
• One of the salient characteristics of financial
  systems in developing and emerging markets is the
  existence of various forms of financial
  repression regimes, in which governments impose a
  set of qualitative and quantitative
  administrative restrictions and controls on the
  operation of financial markets and international
  capital flow (McKinnon 1973 Shaw 1973 Roubini
  and Sala-i-Martin, 1999, Battilossi, 2003).

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Takeovers under Financial Repression

• Under financial repression, access to external
  finance in an economy is regulated by the
  government. As a result, different types of
  economic agents have different abilities to
  obtain external finance, and thus face different
  capital costs, with those having better access to
  finance facing lower costs.
• The difference in capital costs implies the
  existence of economic rents, which would lead to
  various rent-seeking activities on the part of
  companies and induce corporate behaviors that
  would differ dramatically from those in a
  liberalized financial system.

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Takeovers under Financial Repression

• This paper makes a first attempt to study how
  financial repression in China has nurtured
  takeovers in which acquirers major objective is
  to circumvent administrative restrictions on
  access to external finance so as to obtain low
  cost capital. This is a rent-seeking behavior in
  the market for corporate control induced by the
  central governments monopolistic control over
  financial intermediation in the transitional
  economy.

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Takeovers under Financial Repression

• Chinas financial market has been developed in a
  state-dominated financial system with strong
  financial repression, in which the governments at
  various levels control the allocation of
  financial resources in both the banking sector
  and the securities market.
• In the banking sector, the state-owned banks
  extend the majority of bank loans to the favored
  state-owned enterprises (SOEs) but not private
  enterprises.
• In the stock market, the government controls the
  amount of capital that can be raised from IPOs
  and rations the valuable listing opportunities to
  a few favored SOEs.

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Takeovers under Financial Repression

• The quantitative restrictions on public listing
  and the privilege of post-acquisition financing
  create a unique incentive for non-listed
  enterprises to acquire the control rights of
  listed companies, a desire particularly strong
  for private enterprises. Once they become
  controlling shareholders, acquirers can enjoy the
  privilege of getting access to both the capital
  market and banking sector to raise external
  finance.
• The targeted companies of such financing-motivated
  acquisitions would witness extensive
  fund-raising activities in post-acquisition
  stage.

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Hypothesis 1

• Hypothesis 1 Acquisition target companies are
  more highly motivated to conduct post-acquisition
  financing activities than non-acquired companies
  with similar firm characteristics
  privately-acquired companies exhibit a stronger
  tendency to conduct post-acquisition financing
  activities than state-acquired companies do.

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Uncertain Efficiency Implication

• Ambiguous efficiency implication
• Efficiency improving help the fund-lacking
  acquiring investors to fulfill their good
  investment projects
• Reflected in the increase of firm value of both
  the acquiring and the target companies or the
  combined value of the acquiring and target
  companies though one of them decreases

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Uncertain Efficiency Implication

• Efficiency-deteriorating under weak legal
  institutions, deficient investor protection,
  inadequate stock market regulation, and poor
  corporate governance, the managers of the
  acquiring firm may well misuse or use
  inefficiently the funds raised through the public
  equity market
• Particularly true if the managers of the
  acquiring companies do not have good investment
  projects in hand and simply raise external
  finance after acquisition to conduct
  empire-building or tunneling

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Focus on Targets Performance

• No way to analyze the effects of acquisitions on
  overall efficiency as acquirers are mostly
  non-listed companies
• Focus on targets operational performance and
  stock market reaction to acquisitions
• The post-acquisition target performance is
  central to the interests of numerous investors in
  the public equity market.
• Their welfare gains or losses are important to
  market regulators and government.

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Performance Improving vs. Deteriorating

• The acquirers could use funds efficiently and
  improve the targets operating performance if
  they have a long term plan
• But they may have a short-term objective under
  Chinas distorted economic and financial system.
• They may rush to raise external finance after
  acquisition by taking advantage of the shell
  value of the acquired company.

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Performance Improving or Deteriorating

• Under weak legal institutions, deficient investor
  protection, inadequate stock market regulation,
  and poor corporate governance, the managers of
  the acquiring firm may well misuse or use
  inefficiently the funds raised through the public
  equity market
• This could lead to worsening corporate
  performance for the target company.

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State vs. Private Acquirers

• State-owned acquirers are expected to have a
  stronger incentive to tunnel rather than invest
  and enhance target performance
• 1. State-owned companies face fewer obstacles to
  the formal financial system than private
  companies, and thus they are less likely to have
  un-funded positive NPV projects than private
  companies

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State vs. Private Acquirers

• 2. The different access to the formal financial
  system also implies that the control rights of
  listed companies are more valuable to private
  companies than to state companies.
• In order to preserve the privilege in fund
  raising, private acquirers tend to be more
  self-restrained in their tunneling activities
  than state acquirers do.

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State vs. Private Acquirers

• 3. State-owned companies enjoy much more
  political protections with central and local
  bureaucrats so that their tunneling activities
  are less likely to face serious negative legal
  consequences.
• 4. State-owned acquirers typically bear much more
  social responsibilities in maintaining excess
  employment and providing welfare safety net for
  employees for the purpose of enhancing social
  stability (Bai et al., 2000).
• Hence, they have stronger motivation to siphon
  financial resources out of the target companies
  to sustain their social obligations.

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Hypothesis 2

• Hypothesis 2 State-acquired companies with
  post-acquisition financing display stronger
  tendency to conduct tunneling than
  privately-acquired companies with
  post-acquisition financing, i.e., more severe
  fund occupation by the state acquirer than the
  private acquirer, and more frequent extreme
  dividend payout.

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Hypothesis 3

• Hypothesis 3 State-acquired target companies and
  state-acquired target companies with
  post-acquisition financing are less likely to
  make positive-NPV investment, i.e., show slower
  growth in long-term investment and cash flow
  generated from investment than privately-acquired
  ones and privately-acquired ones with
  post-acquisition financing do, respectively.

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Data

• Acquisitions from the CSMAR MA and
  restructuring database complemented by own data
  search
• Focus on the acquisitions leading to the change
  of the largest shareholder of the listed company
  in the period 1998 to 2001
• 1998-2001 stock issuance quota system in place
  strict control on public listing and rights
  offerings
• 1998-2001 liberalization of the market for
  corporate control allow non-listed companies to
  acquire listed companies
• 1998-2001 financing-motivated takeovers should
  be most salient.

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Sample

• Two sample groups --- private acquirers and state
  acquirers
• Exclude banks, security companies, trust
  investment companies and other financial firms
  with special financial reporting standards and
  requirements
• 162 acquisitions from 1998 to 2001
• Private acquirer group 94 companies
• State acquirer group 68 companies

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Control Group

• Control group construction the criteria for
  selecting our control groups are year
  correspondence and similarities in firm size,
  industry, and operating performances
• Filter band 20 to 25
• Control group not involved in any change in the
  largest shareholder in the sampling period.

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Comparing Post-acquisition Financing Activities

• Use rights offerings (issues) and corporate debt
  to proxy for financing activities
• Rights offerings account for most of Seasoned
  Equity Offerings (SEOs)
• Rights offerings are the unique channel of fund
  raising for listed companies in the public equity
  market and they constitute the unique strength or
  shell value of listed companies.

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Comparing Post-acquisition SEO Financing
Activities

• Companies with acquisition implement over 30
  more financing activities within three years
  (esp. first year) following the acquisitions than
  control group firms.
• About 54.3 of the privately acquired subgroup
  conduct rights offerings significantly more
  privately acquired firms conduct more frequent
  SEOs than private control group firms, especially
  in the first year following acquisition.

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Comparing Post-acquisition SEO Financing
Activities

• Only 35.3 of the state-acquired subgroup carry
  out rights offerings, not significantly different
  than state control group firms
• Privately acquired subgroup has significantly
  more firms conducting rights offerings than state
  acquired subgroup also more frequent rights
  offerings.

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Comparing Post-acquisition Financing Activities

• Probit model to see how acquisition and
  acquirers ownership identity affect the
  likelihood of financing
• Model 1 fin_t a ßMA ?control_variables
  e,
• Model 2 fin_t a ß1MA ß2(MAPrivate)
  ?control_variables e,

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Post-acquisition Debt Financing

• Acquiring bank debt after acquisition
• State-dominated banking system favors listed
  companies in loan allocation
• Regional governments push regional
  branches/subsidiaries of nationwide state banks
  to extend large amounts of loans to listed
  companies under their jurisdiction

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Post-acquisition Debt Financing

• Year-on-year Growth in Total Debt/Total Assets
• (1) Acquisition target companies gt control group
  companies
• (2) State-acquired group gt state control group
• (3) Privately acquired group gt private control
  group

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New Bank Loans

• To better capture the changes in corporate debt
  holdings, we follow the methodology of Helwege
  and Liang (1996) and Huyghebaert, Qian and Sun
  (2007) to construct a qualitative measure of a
  large increment in debt holdings.
• We define a new bank loan occurring in any year
  in a listed company if the companys ratio of
  total debt to total assets has increased by more
  than 15 over the preceding year.

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New Bank Loans

• Proportion of sample group with new bank loans
• Acquisition companies gt control group companies
• State-acquired group gt state control group
• Privately-acquired group gt private control group

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Comparing Post-acquisition Financing Activities

• Eagerness to conduct SEOs
• Companies with acquisition gt control group
• Privately acquired group gt Private control group
• Privately acquired companies group gt
  state-acquired companies
• Buying into listed companies creates a channel
  for acquirers, especially those private
  enterprises, which are particularly financially
  repressed, to get access to the financing
  opportunities of equity markets.

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Is Acquisition Good News to the Market?

• Conduct event study around the announcement date
  of block share transfers leading to change in the
  largest shareholder
• Event window AR (Abnormal Return) on the
  announcement date, CARs (Cumulative Abnormal
  Returns) on (-1, 1), (-3, 3), (-5, 5), (-10, 10),
  and (-10, 120)

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Is Acquisition Good News to the Market?

• Because it is hard to find the exact date of
  block share transfers announcement for many
  companies, we finally end up with 76 acquisition
  companies with identifiable block share transfer
  announcement dates, among which 34 are state
  acquired companies and 42 are privately acquired
  companies.

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Is Acquisition Good News to the Market?

• The whole sample of acquired target companies
  mostly show positive and often fairly significant
  CARs
• Privately acquired group shows more frequently
  significant positive CARs than the state-acquired
  group
• The magnitude of CARs is often larger for the
  privately-acquired group than for the
  state-acquired group

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Is Acquisition Good News to the Market?

• State-acquired group without SEO shows more
  significant and more frequent positive CARs than
  state-acquired group with SEO
• Privately-acquired group with SEO displays more
  significant and more frequent positive CARs than
  privately-acquired group without SEO

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Is Acquisition Good News to the Market?

• Overall, acquisition/block share transfer is good
  news
• Privately acquired MA targets conducting SEOs is
  good news
• State-acquired targets conducting SEOs is often
  bad news.

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Financing and Corporate Operating Performance

• In computing ROA, we use operating income for
  different periods (0, 1, 2, 3) divided by the
  total assets of the year preceding acquisition
  (-1).
• This could help control for the potential
  increase in total assets after conducting SEOs or
  bank financing

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Financing and Corporate Operating Performance

• For targets without financing, an increase in ROA
  in periods 0, 1, 2, 3, truly means an improvement
  in earnings performance
• For targets with financing, a decrease in ROA in
  periods 0, 1, 2, 3, reinforces the conclusion
  that earnings performance has declined, though an
  increase does not necessarily imply earnings
  improvement

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Financing and Corporate Operating Performance

• Acquisition targets without SEOs, no matter
  privately or state-acquired, show stronger
  earnings growth after acquisition.
• SEOs in year 1 only weakly improve corporate
  earnings for target companies, mainly
  privately-acquired ones, in year 1.
• SEOs even lower earnings for the state-acquired
  companies.

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Financing and Corporate Operating Performance

• Based on the control-firm-adjusted ROA
• In the post-acquisition years,
• Targets with SEOs lt Targets without SEOs
• State-acquired targets with SEOs lt State-acquired
  targets without SEOs

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Financing and Corporate Operating Performance

• Overall, the post-acquisition SEO financing does
  not bring about improvement in the corporate
  earnings performance of the target company
• Private acquirers with financing often show
  improvement in earnings performance
• State targets exhibit particularly strong low
  efficiency in using the funds raised after
  acquisition

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Regression Analysis of Financing vs. Performance

• Sample of acquisition companies and control
  companies
• ROA t- ROA -1 a ß1 Financing µ
• ROA t- ROA -1 a ß1 Acquisition ß2
  Acquisition Financing µ
• ROA t- ROA -1 a ß1 Private_Acquisition ß2
  State_Acquisition ß3 Private_AcquisitionFinanci
  ng ß4 State_Acquisition Financing µ

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Regression Analysis of Financing vs. Performance

• Sample of acquisition companies
• ROA t- ROA -1 a ß1 Financing µ
• ROA t- ROA -1 ß1 Private_AcquisitionFinancing
  ß2 State_Acquisition Financing µ
• Control variables log of sales, province
  dummies, industry dummies, year dummy and
  corporate restructuring variables

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Low Efficiency of Fund Usage

• The post-acquisition SEO financing does not bring
  about improvement in the corporate earnings
  performance of the target company
• State targets exhibit particularly strong low
  efficiency in using the funds raised after
  acquisition

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Tunneling --- Fund Occupation by the Controlling
Shareholder

• We examine the amount of funds occupied by the
  controlling shareholder scaled by the total
  assets of the firm
• MA group gt control group
• Private MA group gt Private control group
• State MA group with SEO gt State MA group
  without SEO
• State MA group with SEO gt State control group
  with SEO
• State MA group with SEOgt Private MA group with
  SEO
• The state-acquired companies with ex post
  financing exhibit a more serious fund occupation
  symptom, and display a higher degree of
  inefficiency in fund use so that their earnings
  performance is particularly disappointing.

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Tunneling --- Extreme Dividend Payout

• Yuan (2004) and Xiao (2005) cash dividend policy
  often displays irregularity and discontinuity,
  and caters to the preference of large
  shareholders in Chinas listed companies.
• It often serves as an instrument of tunneling
• We try to detect those companies that experience
  a decrease in corporate cash flow in a year but
  increase dividend payment in the same year.
• They are suspected to conduct tunneling to move
  corporate earnings out of the company.

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Tunneling --- Extreme Dividend Payout

• State-acquired group with rights offerings has a
  statistically significant higher proportion of
  companies engaged in tunneling than the
  privately-acquired group with rights offerings in
  year 1.
• State-acquired group with post-acquisition new
  bank loans has a statistically significant higher
  proportion of companies conducting tunneling than
  the privately-acquired group with new bank loans.

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Investment Efficiency

• Long-term investment behavior
• Acquisition group companies gt control group
  companies
• Privately-acquired companies gt private control
  group companies
• Privately-acquired companies gt state-acquired
  group companies.
• Privately-acquired group with SEOs gt
  state-acquired group with SEOs
• Privately-acquired group with new bank loans gt
  state-acquired group with new bank loans

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Investment Efficiency

• Growth in net cash flow generated from investment
• State-acquired companies lt state control
  companies
• Privately-acquired companies gt private control
  companies
• State-acquired companies with SEOs lt state
  control companies with SEOs
• State-acquired companies with SEOs lt
  Privately-acquired companies with SEOs
• State-acquired companies with new bank loans lt
  State control companies with new bank loans
• State-acquired companies with new bank loans lt
  privately-acquired companies with new bank loans

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Investment Efficiency

• Overall, state-acquired companies, especially the
  those with ex post rights issuing, have low
  investment efficiency.
• Explanation for the unsatisfactory performance of
  state-acquired companies with SEOs more serious
  tunneling symptoms and lower investment
  efficiency.

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Conclusion

• State-dominated financial system promotes
  financing-motivated mergers and acquisition
• The non-listed companies, especially those
  private ones, make use of acquisition as a means
  to get access to equity market fund raising and
  bank loans

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Conclusion

• They tend to rush to conduct rights offerings or
  bank borrowing immediately after being listed
• The post-acquisition financing do not seem to
  have significantly and consistently improved the
  corporate operational performance of the target
  companies.
• The fund-seeking acquirers, especially the
  state-acquirers, have conducted tunneling and
  made investment in negative-NPV projects.

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Thanks!!!