The effect of cultural and institutional factors on initiation, completion, and duration of cross-border acquisitions

Highlights

• Culture plays an important role in the initial decision making about the selection of the cross-border targets.

• The completion and time to completion of the deal does not depend on the cultural and institutional factors.

• There is higher probability for acquirers to use Top-tier advisors when targets are in culturally distant countries.

• Top-tier advisor by acquirer increases the probability of deal completion when acquirer and targets are culturally distant.

Abstract

We study the effect of cultural and institutional distances on the probability that a firm from an acquiring country announces an acquisition of a firm in a target country (initiation), the probability that an announced deal is completed (completion), and the average time it takes to complete an acquisition (duration). We find that culture plays a decisive role in deal initiation. Completion and duration of a deal is largely unaffected by the cross country cultural and institutional differences and depends on deal level characteristics. We find a higher probability for acquirers to hire Top-tier advisors when they initiate deals in countries with higher cultural differences. We also find that use of Top-tier advisors by acquirers increases the probability of completion of the deal.

Introduction

In the last few decades cross-border mergers and acquisitions (M&A) have become a considerable part of global economic growth. In the five-year period from 2014 to 2018 cross-border deals worth $19.6 trillion were announced across the world. In 2018 alone, the value of announced cross-border deals exceeded $4.1 trillion.¹ In Fig. 1 we show that the network of cross-border M&A is widespread amongst countries across the world. Because of the high economic significance, cross-border M&A have been an area of active research by academicians. Hymer (1960), in his dissertation that founded the field of international business, noted that there is a “liability of foreignness” when firms expand their operations to other countries. The introduction of the gravity equation to economics by Tinbergen (1962), which analogizes Newton's law of universal gravitation to cross-border flows, has allowed researchers to explore the empirical structure of the costs and benefits of cross-border M&A.

From these foundations, researchers have focused on completed deals to either investigate if the mergers are value creating or to find out the determinants of cross-border M&A.² These determinants may either be firm level factors such as firm size, public status, industry affiliation, and mode of payment, or country level factors such as differences in institutional and cultural characteristics. As pointed out by Karolyi (2016), finance has paid little attention to the role of culture and institutions in financial decision making as compared to other business disciplines. In line with this, Karolyi (2016) encourages researchers to investigate the role of culture and institutions to understand cross-border activities of firms.

In this paper, we study the impact of differences in cultural and institutional factors between an acquirer-target country pair, on initiation, completion and duration of cross-border M&A. We define Initiation as the probability that a company from an acquiring country announces an acquisition of a company in a target country. We define Completion as the probability that an announced deal between an acquirer target country pair is completed, and Duration is the average time it takes to compete an acquisition between an acquirer target country pair. Our empirical results show that cultural distance plays a decisive role in the initiation of M&A. The higher these distances the lower the probability of initiation of cross-border M&A. We find that completion and duration are orthogonal to cultural and institutional factors, but depend largely on deal level characteristics.³

We provide new insights into whether cultural and institutional distances play a role in selecting the target or if they affect the post announcement process for completion of M&A. The consensus in the extant literature is that larger cultural and institutional differences reduce the volume of cross-border M&A (see for example, Ahern et al., 2015; Rossi and Volpin, 2004; and Erel et al., 2012). However, existing literature does not reveal whether the companies announce the deals which subsequently fall through because of cultural differences or they take culture into consideration in selecting the targets and therefore culture does not affect the completion. We separately analyze the effect of managerial due diligence before the announcement and between the announcement and completion of cross-border M&A. We do so by separating the group of companies that complete their M&A process and then make the announcement and those that make the announcement of M&A and then work towards completion of the deal. In the overall cross-border M&A, about 50% of deals are announced post completion whereas the remaining 50% of deals are first announced and then completed. We find that cultural and institutional distances do not affect the completion of the deals that are announced and then completed later.⁴ This finding suggests that cultural and institutional differences do not affect the transactional due diligence for the announced deals.

There are several limitations in the extant literature related to the impact of culture and institutions on cross-border acquisitions. Researchers in general have excluded all deals that were initiated but could not be completed and have restricted their sample to the deals where the acquirer acquires majority stakes in the target firm and the value of the deal is more than $1 million. By excluding such deals, the sample is biased towards larger firms from more developed countries.⁵ Moreover, the percentage of initiated but incomplete deals is non-trivial, and in our country level sample almost a quarter of initiated deals are not completed. Out of the deals that announce their intention for M&A before completing the acquisition, almost 50% of the deals remain incomplete.

In this paper, we alleviate these sample selection issues by considering all of the initiated deals irrespective of their completion status, their size, and the proportion of the stake that the acquirer receives. Moreover, instead of dollar volume, we use number of deals, thus alleviating bias towards bigger companies and companies from the developed world. We measure initiation as the number of deals announced between a country pair as a percentage of total deals announced by the acquirer country. When dollar volume of the deals or the number of deals is used as a dependent variable, then the countries that do a lot of M&A and those with larger size companies get higher weight. In our setting each country gets equal importance irrespective of the dollar volume or the number of deals.⁶ This allows us to gauge the holistic view of differences in culture and institutions on cross-border mergers.

A priori, we expect that cultural and institutional factors should be significant in explaining the initiation of cross-border acquisitions. We argue that managers in acquiring firms already know about the cultural and institutional differences with target countries, and that these differences may lead to possible failures of the deals. Shareholders suffer loss when a deal, which should have been initiated, is not considered and when a deal that is initiated gets abandoned. From the manager's perspective, cross-border M&A are time-consuming and resource intensive, and the challenges can often be exacerbated by distances involving culture and institutions. Hence, they would avoid initiating deals in countries that are culturally and institutionally apart.

It may be argued that if managers do their due diligence before the initiation of a deal and do not initiate a deal that is likely to be abandoned because of cultural and institutional differences between acquirer and target countries, then these factors should not influence the completion and the duration of cross-border acquisitions. It may also be argued that negotiations continue to take place even after the announcement of a deal where the differences in culture and institutions between acquirer and target countries may influence the completion and duration of the deal. Our dataset is almost equally divided between the deals that announce M&A after the completion (i.e. the announcement and effective date is the same for these deals) and those that announce and later complete the deal (i.e. the announcement and effective date is different for these deals). For the second group of companies it is expected that due diligence takes place between the announcement and completion of the deal. The analysis of this subgroup helps us in answering whether cultural and institutional factors affect the decision-making between the announcement and the completion of the deal.

To test our hypotheses, we use a sample of 178,090 cross-border M&A occurring between 1970 and 2016. We use Hofstede cultural dimensions to construct a measure for cultural distances amongst country pairs based on Kogut and Singh (1988). We then use International Country Risk Guide (ICRG) data on government stability, investor profile, internal conflicts, external conflicts, military in politics, democratic accountability, corruption, law and order, and bureaucracy for constructing a measure of institutional distance amongst country pairs.⁷ These ICRG variables are time series data and allow us to capture changes in the institutional variables over time.

For Initiation as a dependent variable, we run regressions using the Poisson pseudo-maximum likelihood methods (PPML). Our overall regressions for initiation have 4225 country pairs. We find a negative and significant coefficient for both cultural and institutional distances indicating that cultural and institutional differences between target and acquirer countries are important determinants in the decision to initiate a cross-border M&A. As our data includes deals of all sizes from all countries across the globe, which is distinct from the large deals from countries with high levels of M&A activity that is generally used in current literature, it may be argued that our results are driven by our distinct sample choice. To alleviate this concern, we do subsample analysis for the group of deals that are less than $1 million and those greater than $1 million. We also separately analyze the acquirers from developed world countries and developing world countries. Our subsample analysis reveals that our results hold for cross-border acquisitions in general and are not driven by any specific subsample of cross-border acquisitions.

To further alleviate the endogeneity and reverse causality concerns, similar to Ahern et al. (2015), we use instrument variable regression where we consider genetic differences across countries as an instrument for national cultural differences. We find that the coefficient on predicted value of culture remains negative and statistically significant, confirming our results that higher cultural distance lowers the initiation probability.

Next, we analyze the 2332 country pairs for completion of cross-border acquisitions.⁸ The fractional logit regression results for completion show no influence of cultural and institutional distances on the completion of cross-border acquisitions. For duration, we exclude the country pairs where none of the initiated deals were completed. Using the remaining 2184 country pairs, we find that duration of cross-border acquisitions is not influenced by cultural and institutional factors. To find out whether cultural and institutional differences play any role in the transactional due diligence, we analyze only those deals that are announced and then later completed (i.e. the announcement and effective date is different for these deals). Our regression results for completion and duration show that coefficients on cultural and institutional variables are not significant, indicating that the cultural and institutional factors may not be part of the due diligence between announcement and completion.

To alleviate the concern for selection bias arising due to the nonrandom nature of completion where only initiated deals can be completed, similar to Ahern et al. (2015) we perform a two-stage Heckman test. In the first stage, we run a probit model with an initiation dummy as a dependent variable and a double taxation treaty as an instrument. We then use country pair probability to calculate the inverse mills ratio (IMR). Our second stage results for completion and duration at the country pair level remains unchanged despite inclusion of IMR.

To enrich our analysis, we study initiation, completion and duration at the deal level also. For initiation we follow an approach similar to Bena and Li (2014) and Bereskin et al. (2018) and for each acquirer of a deal announced in year t, we find up to five matching pseudo target firms with exactly same SIC code as of the actual target firm and with closest deal values as of the actual target firm. Initiation is then measured by a dummy that takes a value of one for the actual acquirer target pair and zero for acquirer and pseudo target pairs. Our deal level analysis for initiation confirms our findings for cultural distance but institutional distance becomes insignificant.⁹ Our findings indicate that initiation of cross border mergers and acquisitions depends primarily on the cultural differences amongst countries. To alleviate the endogeneity and reverse causality concerns, we perform instrument variable regression that confirms our results that higher cultural distance lowers the initiation probability.

For completion and duration our deal level results remain the same as in the country-pair level. Additionally, we find that deal level variables play an important role in the completion and duration of the deal. For the deal level sample, we analyze the subsample where announcement and effective dates are different to confirm if cultural and institutional factors play a role in the transactional decision-making. Similar to our country pair results, we do not find any effect of cultural and institutional variables for this subsample. Next, we do subsample analysis for the group of deals that are less than $1 million and those greater than $1 million and for the acquirers from developed world countries and developing world countries. Again, similar to initiation, our subsample analysis reveals that our results hold for cross-border acquisitions in general and are not driven by a specific subsample of cross-border acquisitions. We find that the probability of completion is higher for cash deals, deals within the same industry, higher value deals, for friendly acquisitions and for the acquirers that are helped by Top-tier advisors.¹⁰

Motivated by the influence of Top-tier advisor for acquirer in completing the deals and the influence of cultural distance in managerial decision making on mergers and acquisitions we investigate if acquirers hire Top-tier advisors depending on the cultural distance i.e. the higher the cultural distance, the higher the probability that acquirer will hire Top-tier advisor. We also investigate if Top-tier advisors are more successful in completing culturally distant deals. Our empirical tests show a higher probability for acquirers to hire Top-tier advisors when deals are in a culturally distant country. We also find a higher probability of deal completion when acquirers hire Top-tier advisors for deals in culturally distant countries..

We perform several additional robustness tests. It may be argued that the effect of cultural and institutional distances on cross-border M&A may be coming from the inclusion of announced but uncompleted deals.¹¹ To alleviate this concern, we include additional control variable that measures the fraction of prior incomplete deals out of the number of deals initiated. Our results stay qualitatively similar to the overall sample.

In this paper, we use the widely used Hofstede measures for computing country level cultural index, but we acknowledge the alternate measure of cultural dimension provided by the World Values Survey (WVS), which has been used by some researchers (see for example Ahern et al., 2015, and Berry et al., 2010). To test whether our measures of culture and institution are adequate proxies, we rerun our regressions using the nine different measures of distances from Berry et al. (2010). Our results using these independently calculated distance measures reconfirm our earlier results.

Finally, we provide an additional test using the WVS data for domestic US M&A where we are able to isolate the effect of culture on initiation, completion and duration. The WVS data separates the US in to 10 census geographic regions. The culture across these regions is different, but the institutions are identical. Our regional analysis for US domestic M&A confirms our findings that culture plays a decisive role in the initiation of cross-border M&A whereas completion and duration are not effected by cultural differences.

We make several interesting and meaningful contributions. The existing literature is in agreement that higher cultural differences are associated with lower volume of cross border M & A. However, from the existing literature we do not know whether the companies announce the deals and because of cultural reasons they are not able to complete the deals or they take culture into consideration in selecting the targets and then the culture does not affect the completion. We are the first to distinguish where exactly in the M & A process culture play decisive role.

In this paper, we are the first to differentiate between group of companies that complete their M & A process and then make the announcement and those that make the announcement of M & A and then work towards completion of the deal. By analyzing these two groups separately, we are able to analyze the effect of due diligence before the announcement and between the announcement and completion of cross border M & A. Our results show that culture plays an important role in the initial decision making about the selection of the targets. The completion and duration of the deal does not depend on the cultural and institutional factors.

We are the first to study the role of Top-tier advisors in the context of completion and duration of cross border mergers and acquisitions. Similar to Golubov et al. (2012) we create Top-tier advisor for acquirer and Top-tier advisor for targets as the top eight advisors by the number of deals undertaken. We find that presence of Top-tier advisor for acquirer and Top-tier advisor for target increases the probability of deal completion. We also find a higher duration for the deals where acquirer uses Top-tier advisors. Our results for the role of Top-tier advisors for cross border mergers and acquisitions are in contrast to their roles in the US domestic mergers acquisitions as in Golubov et al. (2012). They find no effect of Top-tier advisors on deal completion and a lower time to completion for deals involving Top-tier advisors.

We also contribute to the literature by being the first to investigate if there is any relationship between the hiring of Top-tier advisors and the cultural distance between acquirer and target countries. We also investigate if Top-tier advisors are more successful in completing the culturally distant deals. Our results show a higher probability for acquirers to use Top-tier advisors for targets in culturally distant countries. We also find that the use of Top-tier advisor by acquirer increases the probability of deal completion when acquirer and targets are culturally distant.

The remainder of the paper is organized as follows: Section 2 discusses the hypothesis development; Section 3 discusses the empirical strategy; Section 4 provides details of data used; Section 5 provides results for country level analysis, and in Section 6 we discuss the results for deal level analysis; Section 7 has the analysis for Top-tier advisor and cultural distance; and Section 8 concludes.