Information asymmetry, cross-listing, and post-M&A performance

Abstract

This study examines how target opaqueness and the acquirer’s cross-listing in a developed financial market impact the alignment between the stock market’s initial reaction to an M&A deal announcement and the acquirer’s post-M&A performance by affecting the level of information asymmetry between acquirers’ managers and stock market investors. We hypothesize that target opaqueness weakens, whereas the acquirer’s cross-listing enhances, the alignment between the initial stock market reaction and the acquirer’s post-acquisition performance. Additionally, the weakening effect of target opaqueness is smaller when the acquirer is cross-listed in a financially more developed market. From a sample of mergers and acquisitions (M&A) deals made by Chinese acquirers, we find that the alignment between the initial stock market reaction and acquirer’s post-acquisition performance is weakened when the targets are private, high-tech, or foreign, while being strengthened when the acquirers are cross-listed in Hong Kong stock exchanges. Further, the weakening effects of private, high-tech, or foreign targets are smaller when the acquirers are cross-listed. This study contributes to the M&A literature by examining factors that moderate the alignment between stock market’s ex-ante valuation of M&A deals and the ex-post performance of those deals.

Introduction

Mergers and acquisitions (M&As) have been a primary means of corporate expansion. According to a report by Bureau van Dijk, which tracks M&A activities, a total of 97,709 M&A deals were announced globally in 2018, involving a total deal value of over $5.3 billion (Bureau van Dijk, 2018). A clear trend in global M&A activities is the increasing involvement of firms from emerging economies. According to Thomson Reuters, 29% of the global M&As in 2016 were made by emerging-market firms, an 11% increase from 2015 (Thomson Reuters, 2016). The aforementioned Bureau van Dijk report reveals that 15% (or 14,743 deals) of the global M&A announcements in 2018 involved firms in China, one of the largest emerging economies.

Corresponding to their popularity in business practices, M&As have been one of the most studied topics in management (see reviews of Barkema & Schijven (2008)). In particular, M&A performance has been the subject of intensive investigations. Zollo and Meier, 2008, Meglio and Risberg, 2011 each identified nearly 90 articles examining M&A performance in top management and finance journals. Although a variety of approaches have been used to measure acquisition performance, both studies found that the initial stock market reaction, captured by the abnormal return on the acquirer’s stock around an M&A deal announcement, has been the most frequently used. Recent studies on M&As involving firms from emerging economies also consider the initial stock market reaction when assessing post-M&A performance (Arık and Kutan, 2015, Ma et al., 2009, Rani and Jain, 2015, Tao et al., 2017).

Despite the widespread use of the measure, scholars disagree on the extent to which the initial stock market reaction aligns with post-acquisition performance. Some scholars question the stock market’s ability to estimate post-acquisition performance at the time of an M&A announcement (e.g., Papadakis & Thanos, 2010; Zollo & Meier, 2008). Meanwhile, others find a positive relationship between the initial stock market reaction and post-acquisition performance (e.g., Duso, Gugler, & Yurtoglu, 2010; Kaplan & Weisbach, 1992; Sirower and O'Byrne, 1998, Switzer, 1996).

This inconsistency in the literature raises an important research question: under what conditions may the initial stock market reaction be more or less aligned with the post-acquisition performance? This question becomes particularly meaningful under the trend of increasing M&As by firms from emerging economies where the financial markets are relatively underdeveloped. This study helps answer this question by examining the impacts of both target characteristics and the financial market surrounding the acquirer on the alignment between the initial stock market reaction and post-acquisition performance.

The approach of using the initial stock market reaction to measure M&A performance is based on the market efficiency theory, which assumes that stock market investors have access to pertinent information to make objective evaluations of firm activities based on value-maximizing criteria (Angwin et al., 2015, Fama, 1970, Shiller, 2003). However, this assumption does not always hold. This is because the acquirer’s managers may have private information about the combining firms and their combination synergies that is not available to stock market investors (Barney, 1988, Schijven and Hitt, 2012, Shleifer and Vishny, 2003), resulting in information asymmetry between the two (Bergh, Ketchen Jr, Orlandi, Heugens, & Boyd, 2019). Consequently, stock market investors may misvalue M&A deals at the time of their announcement, causing misalignment between the initial stock market reaction and post-acquisition performance (Agrawal & Jaffe, 2000; Ben-David, Drake, & Roulstone, 2015; Loughran and Vijh, 1997, Rau and Vermaelen, 1998).

Information asymmetry between stock market investors and the acquirer’s managers may be particularly salient under two conditions. The first is when targets are informationally opaque, for instance when they are privately owned, operate in high-tech industries in which intangible assets are critical, or are located in foreign countries (Barbopoulos et al., 2012, Coldbeck and Ozkan, 2018, Cuypers et al., 2017, Officer et al., 2009). The acquirers’ managers likely have an information advantage over stock market investors about those targets because they can obtain private information during the due diligence, evaluation, and negotiation processes (Capron and Shen, 2007, Laamanen, 2007, Schijven and Hitt, 2012, Luypaert and Caneghem, 2017). The second is when the acquirer is listed in a less developed financial market where reliable information about firms is not easily available to stock market investors due to weak regulations on financial disclosure, poor accounting practices, and institutional voids caused by a lack of information intermediaries (Chae et al., 2014, Khanna and Palepu, 2010, Tao et al., 2017). Under this condition, acquirers’ managers likely have an information advantage over stock market investors about both their firms and the targets to evaluate a particular acquisition deal.

While target opaqueness is a deal-level characteristic that captures differences among M&As, financial market development is typically measured at the country level, and its effect cannot be readily isolated from the impact of other country characteristics. To overcome this difficulty, we compare M&As made by Chinese firms that are only listed in Mainland China and those made by firms that are cross-listed in Hong Kong. The two markets are similar in several aspects (cultural, geographic, etc.), but their financial market development levels are very different. According to the 2012 Financial Development Report published by the World Economic Forum, Hong Kong ranked the first, and the Mainland China ranked twenty-third based on the overall financial development index among the 62 countries surveyed by the institution (World Economic Forum, 2012). Additionally, in the FTSE country classification, Hong Kong belongs to the developed group, while Mainland China belongs to the emerging secondary group (FTSE Russell, 2018). Firms in emerging markets choose to be cross-listed in developed financial markets to overcome the inferior financial regulations and corporate governance standards of their home markets (Li et al., 2019, Coffee, 1999, Peng and Su, 2014, Zhou and Lan, 2018). As a result, they are subject to stricter regulations regarding investment disclosure and the scrutiny of information intermediaries (Bhargava et al., 2017, Siegel, 2005, Siegel, 2009, Tchuigoua, 2014).

Using data containing 589 completed M&As by listed Chinese acquirers, 38% of which are cross-listed in Hong Kong, between 1998 and 2015, we find that the initial stock market reaction positively relates to post-acquisition performance. Still, this relationship becomes negative when the target is private, high-tech, or foreign. Additionally, in M&As by cross-listed acquirers, not only does the positive relationship between the initial stock market reaction and post-acquisition performance become more robust, but the negative impacts of private, high-tech, or foreign targets also become smaller.

Our study makes meaningful contributions to research on M&As by examining contingency factors that moderate the alignment between the initial stock market reaction and the ex-post acquisition performance. We shed light on how financial market development may interact with target opaqueness in impacting stock market investors’ ability to evaluate the economic impacts of M&A deals, a topic that has rarely been examined in the literature. We also contribute to research on Chinese firms by investigating their M&A activities as well as their strategies for cross-listing in Hong Kong, both of which were identified by Peng et al. (2001) as research areas that are “worth paying attention to.”

The rest of this paper is organized as follows: the next section discusses the theoretical background and develops our hypotheses. The third section describes the methodology. The fourth section presents the empirical results, followed by a discussion and conclusions in the final section.