| 1976–1985 | 1985–1992 | 1995–1999 | |
|---|---|---|---|
| Argentina | 3% | 10% | 52% |
| Brazil | –7% | 13% | 48% |
| Chile | –11% | 32% | 46% |
| Mexico | 13% | 49% | 60% |
| Thailand | –9% | 43% | 53% |
Source of data: Standard & Poor’s/International Finance Corporation, “The S&P Emerging Market Indices: Methodologies, Definitions, and Practices,” February 2000, page 32.
Is risk reduced more effectively by diversifying across countries or across global industries?14 Until the mid-1990s, low correlations among countries’ stock markets led to the conventional wisdom that much of the variability in returns from global investing stemmed from country choice. Marber (1998, p. 172) reported the findings of Barr Rosenberg Associates and the International Finance Corporation (IFC), who studied the extent to which choices about country, industry, and specific firm explained cross-sectional variation in global equity returns. They estimated the percent of returns variance explained by country, industry, and stock-specific factors for investments in developed markets and emerging markets. The results of the study, summarized in Exhibit 5.6, are that industry factors are dominant in developed countries and country factors are dominant in emerging countries. Other studies15 show that country choices are very important, if not the most important, drivers of returns performance. Solnik (1991, p. 360) reported a study by Frank Russell Company of investment activities of international managers, finding that on average the manager puts 50 percent of resources into country analysis, 15 percent into industry analysis, and 35 percent into company analysis. But recent research has suggested that growing integration of the global equity market and the rising multinationality of companies elevate the importance of industry and firm-specific factors. However, other research suggests that country choice remains of preeminent importance. The relative significance of industry and country persists as a debate at the frontier of empirical finance. Either way, country choice will remain a material factor for some time to come. The global M&A analyst will seek to diversify across both countries and industries.16
EXHIBIT 5.6 Factors Explaining Equity Returns in Emerging and Developed Markets
| Investments in Emerging Markets | Investments in Developed Markets | |
|---|---|---|
| Stock-specific factors | 16% | 22% |
| Industry factors | 38% | 48% |
| Country factors | 46% | 30% |
| Total | 100% | 100% |
Source of data: Marber (1998), page 172.
Exploit Differences in Capital Market and Currency Conditions
One of the most reliable findings about M&A activity in the U.S. is the strong relationship between deal doing and high stock and bond prices. In the cross-border world, a strong relationship also exists though it is complicated by the fact that it is driven by comparative differences between two local financial markets. Feliciano and Lipsey (2002) found that acquisitions of U.S. firms by foreign firms decline with high U.S. stock prices, high industry profitability, and high industry growth, and increase with high U.S. interest rates, high U.S. growth rates, and high foreign currencies relative to the U.S. dollar. Vasconcellos et al. (1990) found that foreign firms increase their acquisitions in the United States when U.S. economic conditions are favorable compared to the foreign country, interest rates are high in the foreign country compared to the United States, and the dollar is weak relative to the foreign currency. Gonzalez, Vasconcellos, and Kish (1998) found that undervalued U.S. companies were more likely to be targets of acquisition by foreign companies.
Closely related to capital market conditions are currency market conditions. Variation in exchange rates can render one country’s firms cheaper or dearer to buyers from another country. But conventional economic analysis would reject this, arguing that in an integrated global market, real rates of return on assets will be equal across countries, preventing profitable arbitrage on the basis of currency exchange rate variations. Froot and Stein (1991) linked currency changes to the relative wealth of buyers to argue, in effect, that countries with deep financial pockets because of strong currencies will tend to originate foreign direct investment. They find a strong relationship between exchange rate movements and FDI. Harris and Ravenscraft (1991) found a strong relationship between exchange rate movements and cross-border acquisition announcement effects. Vasconcellos and Kish (1998) reported a strong relationship between acquisition activity and exchange rate movements. Vasconcellos, Madura, and Kish (1990) concluded, “In the final analysis, the long-run outlook on the dollar is the critical factor in foreign acquisition of or by U.S. firms.” (Page 184)
Improve Governance
Good governance pays, a point discussed in Chapter 26. Corporate governance practices vary significantly across countries. Researchers have examined whether M&A changes in investor protection stemming from these cross-border differences influence merger outcomes. Bris and Cabolis (2002) studied the change in investor protection arising from cross-country deals. They found that the valuation multiples (Tobin’s Q17) in the home market rise when a foreign firm buys into that industry, coming from a country with greater investor protection. Rossi and Volpin (2001) suggest that M&A is a means by which companies can exit from a poor governance environment. Companies from countries with poorer governance practices are more likely to be acquired; those with stronger governance are more likely to buy.
Other Drivers of M&A Activity
Biswas et al. (1997) list a range of other possible motives for cross border acquisitions. These include regulatory avoidance, financing, and the desire to maintain good relationships with customers who themselves may have a need for multinational delivery of goods or services.
RETURNS FROM CROSS-BORDER M&A
Does all of this activity pay? The following points