acquirer faces a better governance regime than the target.
The model therefore
predicts that in cross-border mergers and acquisitions, companies from coun-
tries with good corporate governance should be acquirers and companies from
countries with poor corporate governance should be targets.
This basic hypothesis is tested and confirmed in a sample of all cross-border
mergers and acquisitions involving 49 countries in the 1990s. We use several
proxies for the quality of the corporate governance regime in a country and find
that targets tend to come from countries with lower investor protection and less
developed financial sector. We also find that the average corporate governance
of companies acquiring in one country is higher than the governance standards
of the country, consistent with the findings of Rossi and Volpin (2004).
The model also delivers cross-industry predictions.
Cross-border merger and
acquisition activity should be concentrated in industries that need more exter-
nal capital and face greater agency problems. The intuition is that the benefit of
better governance standards is relatively larger in industries that need more
external capital and face greater agency problems. Hence, we expect that com-
panies from countries with worse governance should be more likely to be
acquired in cross-border deals in industries that need more external financing
and in industries that face greater agency costs. These predictions are tested and
confirmed by using the measure of external dependence at the industry level
developed by Rajan and Zingales (1998) and by developing a measure of agency
problems at the industry level, following their methodology.
The phenomenon of cross-border mergers and acquisitions is recent and still
largely unexplored by the finance literature. The literature has focused on share-
holder wealth effects (Bris and Cabolis, 2003; Goergen and Renneboog, 2004) and
bondholder wealth effects (Renneboog and Szilagyi, 2006) across countries, and on
the relevance of industry shocks (Mitchell and Mulherin, 1996). This chapter offers
an interpretation for the aggregate pattern of cross-border activity by showing that
it serves a governance purpose, both across countries and across industries.
Section 3.2 presents a simple model of cross-border mergers and acquisitions;
Section 3.3 contains the empirical analysis; Section 3.4 concludes.
3.2 A simple model of cross-border merger
and acquisition activity
Consider the following two-period model of a firm in a generic moment of its
life cycle. At t = −1, an entrepreneur/manager decides whether to sell the firm to
a potential acquirer.
The governance motive in cross-border mergers and acquisitions 45
This result is consistent with recent evidence suggesting that the quality of a corporate governance
regime is reflected in higher valuation. La Porta et al. (2002) show that across country valuation
is positively correlated with investor protection when using indices of investor protection as a
measure of the quality of a corporate governance regime within a country.
Rossi and Volpin (2004) do not study cross-industry variation of mergers and acquisitions.