Preliminary draft, comments welcome MOTIVES FOR DOMESTIC AND CROSS-BORDER ACQUISITIONS: A COMPARATIVE ANALYSIS

Studies examining value creation in cross-border acquisitions are few, and there are none that compare value creation of domestic vs. cross-border acquisitions. Institutional differences (at both the firm and industry level) may, in addition to economic factors, cause systematic differences in the value created by cross border vs. domestic acquisitions, thus affecting a firm’s international competitiveness. We seek to investigate the characteristic features that distinguish cross-border acquisitions from U.S. domestic acquisitions and how total gains are shared between the target and the acquirer. Our empirical results indicate that acquisitions are primarily driven by synergy motives though managerialism and hubris also coexist in the sample. Acquisitions by US acquirers of domestic as well as international targets are characterized by hubris rather than managerialism in our sample of negative total gains, while acquisitions by foreign acquirers of US targets are characterized by managerialism. We show that institutional characteristics matter and that target gains are lower for US acquirers of foreign targets in bank or group oriented countries, which is consistent with the evidence on lower valuations with lower protection of minority shareholder rights in these countries. For the foreign acquirer-US target sub-sample the institutional structure of the foreign acquirer’s home country appears to have no impact on target gains. Why do firms undertake acquisitions? Do acquisitions create economic value? These linked questions have engaged researchers in the fields of strategy, finance and economics for decades. More recently, with the burgeoning incidence of cross-border acquisitions, they have attracted the attention of international business research. Although a vast and rich literature exists to explain various aspects of acquisition activity, some interesting and important puzzles remain: Are there systematic differences between the extent of value creation in domestic versus cross-border acquisitions? Are there systematic differences between the motives for undertaking each of these types of transactions? Clearly, answers to these questions have the potential to make an important contribution not only to our understanding of acquisition activity and its value consequences, but also to explain idiosyncrasies associated with doing business internationally. The purpose of this paper is to empirically examine these questions. The literature has long postulated that managers’ motives for acquisition activity can be classified into three different categories. First, the synergy hypothesis (Penrose, 1995; Bradley, Desai and Kim, 1990; Seth, 1990) suggests that changes in the scale and scope of the firm via acquisition activity reflects entrepreneurial attempts by managers to create economic value. Second, the hubris hypothesis (Roll, 1986) postulates that acquisition activity arises from managerial overconfidence in their own abilities to extract economic value from such transactions. Third, the managerialism hypothesis (Marris, 1964) argues that since acquisition activity carries private benefits for managers, it merely reflects their attempts to enrich themselves at the cost of shareholders. The three hypotheses described above employ critical assumptions about the level of discretion afforded to managers by the economic environment. So, the synergy hypothesis assumes a) frictions exist in asset and input markets that afford managers the opportunity to create economic value from acquisition activity and b) managers’ discretion to enrich themselves at the expense of shareholders is limited by corporate governance constraints such as monitoring, bonding and incentive mechanisms. The hubris hypothesis, in contrast, assumes that a) asset and input markets are perfectly efficient so that there are no effective opportunities to create economic value from acquisition activity and b) managers do not confront binding constraints from the corporate governance environment to desist from the “mistakes” that acquisitions 1 According to Mergerstat Review, the total number of deals including cross-border deals in the US increased from 2,074 acquisitions or 108 billion dollars in 1990 to 10,296 acquisitions or 823 billion dollars in 2004.