Bottom Line: Courting investors with expertise in foreign markets can provide companies with a crucial, but often overlooked, advantage in pulling off international M&A deals.
When a firm decides to make a big move, most people assume managers hold the upper hand over investors. After all, discussions in the boardroom drive corporate strategy, and unless they’re members of the board, investors who provide capital are usually left with little say in the important activities and decisions that can affect the value of their stock — and with good reason, because companies can’t take the time to survey every shareholder or investor about every big decision. But according to a new study by researchers at Cass Business School in London, international deals should be the exception to this rule: When undertaking mergers and acquisitions of companies based in other countries, executives can learn plenty from institutional investors who possess a deep knowledge of the foreign market.
Previous research has suggested that institutional analysts based in a particular market might have an advantage over their counterparts who have to monitor events from afar, and that “local analysts have better access to information because they can talk to firm representatives in person and observe what goes on in firms directly.” But empirical evidence has been lacking. This absence led Anna Faelten and her colleagues at Cass to examine whether the support of key investors with expertise in a given market could affect the success of cross-border M&A deals.
They analyzed nearly 50 deals attempted by large, publicly listed firms during a recent nine-year stretch, restricting the sample to those M&A deals in which the target and acquirer had different home countries. Because the authors wanted to focus on deals that would pique the interest of institutional investors such as banks, hedge funds, mutual funds, and insurance companies, they analyzed only those deals in which the transaction represented at least 25 percent of the bidding firm’s market value and would likely require approval from shareholders before being finalized.
Combining several databases, the authors first determined what types of institutional investors were listed in a company’s register, focusing on those who tended to trade infrequently and place their bets for the long haul, because these investors would be more likely to conduct thorough research on companies and marketplaces and avoid gambling on stocks in search of a quick payoff. To determine whether these dedicated investors supported an M&A deal, the researchers calculated the change in their shareholdings in the acquiring company from one year before the takeover announcement to the end of the month following the news.
After controlling for several factors — including the acquiring firms’ equity value, their pre-bid performance, and differences in national laws and regulations — the authors found that deals were more likely to be finalized when investors with local expertise and geographic proximity to the targeted firm indicated their support by increasing their holdings once the prospective transaction was made public.
Deals were more likely to be finalized when investors with local expertise indicated their support.
“Our analysis suggests that long-term institutional investors with regional expertise could act as a mechanism which facilitates the acquisition of soft information and evaluates this type of information to help cross-border bidders make better decisions with regards to the specific M&A deal,” the authors write.
Furthermore, the authors analyzed the share price of acquiring companies over a two-year window, beginning 10 months prior to the bid announcement to compare the run-up with how the firm performed for a sustained period after the takeover. The bids supported by serious financial backers tended to result in successful long-term stock returns for the purchasing firm, the authors found, indicating that these investors possess valuable knowledge about the merits of potential deals because they understand both managers’ decision-making skills and the vagaries of the local economy.
As a result, executives should acknowledge the payoff from two-way communication with investors before embarking on costly initiatives such as M&A deals, the authors advise. They should also admit that long-term, locally knowledgeable investors can act as a conduit between managers and markets, helping international bidders overcome the information disadvantage brought about by long distances and cultural differences.
Of course, no one is suggesting that either managers or investors flout insider-trading laws by disclosing sensitive details to one another. But the reality is that senior executives routinely run across important investors in both social and professional contexts, and the flow of proprietary knowledge and speculative analysis becomes quite nuanced. For example, previous research has described a “mosaic process,” in which investors collect information from their investee companies but also analyze public news reports, run their own comparisons with peer firms and industry sectors, and build private valuation models to arrive at alternative viewpoints of a company’s worth, potential, and opportunities for M&A.
To tap into some of that information, the authors advise firms to establish proactive relations with key investors before embarking on international deals. By monitoring their stock register and separating transient shareholders from those who are dedicated to the company, managers can cultivate contacts with investors whose knowledge of foreign markets gives them a leg up on potential deals.
“Learning From Your Investors: Can the Geographical Composition of Institutional Investors Affect the Chance of Success in International M&A Deals?” by Anna Faelten, Miles Gietzmann, and Valeriya Vitkova (all of Cass Business School), Journal of Management & Governance Feb. 2015, vol. 19, no. 1