Sources of data: Thomson Financial Securities Data and Bureau of Economic Analysis, U.S. Department of Commerce.
Notes:
The foreign direct investment values in column 9 include only capital flows sourced from foreign markets. Funds sourced from the U.S. capital markets for acquisitions or investments made by foreign companies are not included. Hence, the comparison between column 5 and 9 is not perfect. Column 5 includes all sources of funding, domestic and abroad. Column 9 only includes foreign capital that “flowed in.” A similar incomparability exists for columns 6 and 10.
Despite the imperfect comparison between cross-border value and FDI, an analyst at the Bureau of Economic Analysis confirms that the majority of capital flowing into the United States for FDI in recent years has been for acquisitions. The analyst estimated the fraction to be between 60% and 80%.
M&A ACTIVITY WITHIN REGIONS AND TRADING BLOCS
Viewed from a global perspective, the most interesting laboratories for M&A today are the new trading blocs such as NAFTA and the European Monetary Union (EMU, or “Euroland”).6 The reason for this is that free trade changes the rules of competition by reducing entry barriers, making it easier to exploit economies of scale, increasing capital market integration (which improves capital flows and lowers the cost of capital), improving the transfer of technology and intellectual capital, and reducing the idiosyncrasies of government regulation and tax policies. These changes, in turn, will affect M&A activity. Most observers expect product market competition within trading blocs to increase thanks to greater transparency about product and factor prices within the blocs. For instance, with product prices denominated in the same units across Euroland, the more efficient producers are motivated to enter new markets and compete on price. In this context, M&A is used as both a defensive and an offensive tactic. The history of M&A in the United States offers abundant evidence that M&A waves are significantly driven by product market changes. Capital markets are likely to integrate more rapidly within trading blocs, making M&A financing cheaper, easier to obtain, and available in forms that are tailored more readily to the needs of M&A participants. We know that the level of capital costs and the availability of financing significantly influence M&A activity. Sleuwagen (1998) found that over the period 1994–1996, about 60 percent of all mergers and acquisitions in the EU involved firms located in the same member state. Pointing to the experience with NAFTA, many analysts believed that with the advent of the euro, the percentage of same-country mergers would decline and cross-border deals would rise.
Exhibit 5.2 shows the percentage change in cross-border acquisitions among the United States, Canada, and Mexico from 1991 to 1993, before NAFTA was formed, to 1994–1997, the three years following NAFTA. Within the United States, the number of U.S./U.S. acquisitions grew 60 percent, reflecting the onset of the largest acquisition wave in U.S. history; this domestic growth rate is a rough benchmark for comparing cross-border M&A growth rates within NAFTA. The exhibit shows that acquisitions by U.S. firms into Canada and by Canadian firms into the United States outpaced the domestic U.S. acquisition growth rate. The results with respect to Mexico are significantly lower than the U.S. domestic deal growth, reflecting perhaps the massive devaluation of the peso in 1995 and offering a caution to executives.
EXHIBIT 5.2 Percentage Rate of Growth in Transactions Domestically and Cross-Border among the United States, Mexico, and Canada, Comparing Deal Volumes from 1991–1993 to 1994–1996
| Country of Acquirer | Country of Target | ||
|---|---|---|---|
| United States | Canada | Mexico | |
| United States | 60% | 65% | 38% |
| Canada | 70% | ||
| Mexico | 44% | 70% |
Note: The growth rate is calculated by dividing the number of all transactions 1991–1993 into the number of all transactions 1994–1996, and subtracting 1.0.
Source: Thomson Financial Securities Data Corporation, Mergers and Acquisitions Database.
Increasing capital market integration elevates the importance of the equity investor mind-set probably at the expense of other stakeholders. As the equity orientation grows, M&A practice changes. Overpayment is penalized; price becomes an object of greater attention. The volume of unsolicited acquisition attempts may rise. The product market scenario outlined earlier may place special importance on the advantage of the “first mover.” To enter new markets rapidly, decisively, and first may dictate tactics that are at their core impatient. The unsolicited acquisition attempt is risky, but may be justified in managers’ minds by the circumstances. Before the euro, the hostile tender offer was a rarity in Europe. But the weeks following the birth of the euro witnessed major hostile offers on the continent.7 Deal structures following increased capital market integration may also reflect greater use of innovative terms including derivative securities, bridge loans, and “junk” debt. Growing sophistication in the capital markets will make this possible.
Acquisitions are inherently acts of optimism. Deteriorating economic conditions would likely impair that optimism, and the resulting volume of deals. Again, the experience of Mexico/U.S. cross-border deals is illustrative here. Exhibit 5.3 shows that Mexican acquirers virtually disappeared from the cross-border M&A market in the wake of the peso devaluation in late 1994. The financial crisis in East Asia in 1997 triggered a wave of M&A activity in that region. Precrisis in 1996, the regional volume of deals was $3 billion per year. In 1999, the volume had risen to $22 billion; this stemmed significantly from M&A activity in Korea and Thailand, two countries deeply affected by the “Asian flu” crisis. Especially strong activity was seen in real estate, financial services, retailing, and wholesaling. Mody and Negishi (2001) argued that driving the increased M&A was a general rise in inbound foreign direct investment associated with economic restructuring of the region after the crisis. Further, they argue that the M&A activity was driven by the creation of new opportunities due to government policy changes in the region than by the lure of bargain-basement asset prices.
EXHIBIT 5.3 Cross-Border Transactions between Mexico and the United States, 1994 and 1995
| 1994 | 1995 | % Change | |
|---|---|---|---|
| Acquisitions by U.S. firms into Mexico | |||
| Number of transactions |
|