SUMMARY OF THE ENIGMA
McCarthy et al. (Reference McCarthy, Dolfsma and Weitzel2016) found evidence of a sixth merger wave that took place from 2003–2008 and this was the first ‘truly’ global merger wave because it originated in Asia, Europe, and North America simultaneously. This is a significant and interesting contribution. In addition, their empirical findings support the notion that acquirers with ‘Confucian’ governance systems, and Chinese acquirers in particular, created value in merger deals of 5.1% and 5.8% respectively. This was in contrast to value destruction with ‘Anglo-Saxon’ acquirers and US acquirers (−5.8% and −3.8% respectively) and the 4.8% value creation, or break-even, that took place in the case of ‘Continental’ acquirers and French acquirers respectively.
These results are contrary to what the authors hypothesized; they were expecting the Anglo-Saxon acquirers to outperform the Confucian acquirers – reasoning that Anglo-Saxon corporate governance systems would better control agency problems. Likewise, they had reasoned that ‘Because Confucian legal systems in general, and the legal systems in emerging Confucian countries like China, in particular, are generally unequipped for handling [agency] problems. . . it is likely that Confucian acquirers will destroy value with mergers and acquisitions’ (McCarthy et al., Reference McCarthy, Dolfsma and Weitzel2016: 228). So these surprising results go against the conventional wisdom and are interesting. But why did Chinese acquirers perform so well?
In the post-hoc explanation for these enigmatic findings, the authors provide several possible reasons for why the Confucian and Chinese acquirers performed so much better than the other firms in the sample. First, they suggest that family-dominated business in Asia may help to control agency problems and that the Asian cultural characteristics of collectivism and long-term orientation mean that Asian managers were more likely to make good acquisition deals. Second, they suggest that the Asian cultural characteristics emphasizing harmony, relationships, humanity, benevolence, righteousness, propriety, wisdom, and trustworthiness will curb agency problems in the absence of explicit monitoring. Third, they suggest that Confucian cultural traits may help Asian firms to do a better job of managing social capital and integrating the acquired firms during the post-announcement phase of the mergers. All of these explanations are plausible explanations, but it is likely that they do not tell the whole story.
WHY DID CHINESE MERGERS EXHIBIT SUCH STRONG PERFORMANCE?
Why did Chinese acquirers perform so much better than acquirers from other countries? Although McCarthy and colleagues’ sample contains mergers from 10 Anglos Saxon countries, 6 Confucian countries, and 33 Continental countries, I focus on the differences in performance between the US and Chinese acquirers for four reasons: First, the US acquirers comprised 90% of the Anglo-Saxon sample (8,380 of 9,312 firms) and the Chinese acquirers comprised 44.3% of the Confucian sample (249 out of 562 firms). Second, the largest difference in performance was found between US acquirers (−3.8%) and Chinese acquirers (+5.8%), while the French firms, which dominated the Continental sample, had no significant change in value. Third, the United States and China are the 2 largest economies in the world and the countries with which the readers of Management and Organization Review are most familiar. Fourth, these two countries are notably different in terms of development of market institutions, industry practices and firm technology and they are often compared. So in short, to keep things simple I focus on alternative explanations for why, in the period 2003–2008, Chinese acquirers’ cumulative abnormal returns (CAR) increased on average by 5.8%, while US acquirers’ CAR decreased by 3.8% during the 20 day event window of this study.
Please note that I do not wish to detract from the scholarship of this study. This is meticulous work that explicitly documents a sixth global merger wave and I feel privileged that I was asked to comment on it. Furthermore, the authors acknowledge that the results are surprising and that the data does not allow them to get at the real reasons for the performance differences. In the spirit of uncovering the truth and advancing knowledge, I suggest alternative explanations for the findings.
While I agree with the authors that Chinese firms are likely to go about mergers and acquisitions differently for cultural reasons and some of their practices are likely to be superior, I suggest that they may have shown better performance because their financial markets, industry structures and organizational technology were at a very different stage of development from 2003–2008. Given different levels of maturity, China stock markets were more likely to have reacted more positively to merger announcements than were US stock markets regardless of actual prospects for performance of the mergers which would affect the interpretation of the Event Study Methodology (ESM) results.
In addition to this inflated investor reaction, during the time period of the study (2003-2008) many Chinese industries were at a stage where they were in need of consolidation. Much of the Chinese M&A activity was government directed and aimed at eliminating excess capacity and building economies of scale able to compete in global markets. So in addition to stock markets being overly optimistic on mergers prospects, the actual merger prospects were likely to be better in this environment than in a more mature economy, such as the United States. Finally, from 2003–2008 many nascent Chinese firms were in the process of rapidly improving their technology and management processes in an attempt to ‘move up the value chain’. Hence they had different motivations for acquiring companies (often from abroad) to incorporate and utilize technology and processes that would not have been of value to more mature organizations (Shapiro & Li, Reference Shapiro and Li2016). Again, this would create an environment for successful mergers. In summary, while acknowledging the post-hoc rationale of Confucian corporate governance and culture offered by McCarthy and colleagues, I suggest that differences in stock market reactions as well as different stages of industrial and organizational development better explains the empirical findings of superior Chinese performance.
The rest of this commentary article is as follows: First, I provide a non-technical explanation of why the use of Event Study Methodology (ESM) to compare mergers from the United States with those from China in the period 2003–2008 may have produced results that did not necessarily reflect actual performance of the mergers. I then discuss why Chinese industrial policy and consolidation provided a fertile environment for mergers and acquisitions from 2003–2008. I also suggest that the state of technological development of Chinese firms meant that they were motivated to acquire mature companies, often from abroad, during the period 2003–2008.
Chinese Investors’ Reactions to Merger Announcements
From 2003–2008, Chinese stock markets likely reacted differently to merger announcements than did US financial markets for several reasons: (1) most Chinese firms were majority owned by the state; (2) there was explicit or implicit political involvement in merger decisions; (3) there was a lack of accurate publicly available information; (4) Chinese investors were relatively less capable of evaluating mergers prospects for success; and (5) Chinese regulatory regimes were relatively less mature (Chen & Young, Reference Chen and Young2010; Walter & Howie, Reference Walter and Howie2003). Thus, using ESM to compare stock market reaction to merger announcements between US and Chinese firms is likely to have produced results that do not reflect the actual performance of the mergers.
ESM is essentially a short-term measure of investor perceptions and reactions that determines if there is an abnormal stock price effect associated with an unanticipated event (MacKinlay, Reference MacKinlay1997; McWilliams & Siegel, Reference McWilliams and Siegel1997). ESM was originally designed for application in a single country and when used in multiple countries, this introduces several operational and conceptual difficulties, especially when there are large differences in the investor base and regulatory regimes (Lease et al., Reference Lease, Masulis and Page1991; Park, Reference Park2004). For example, ESM assumes that markets are efficient and that information is accurate and available to all traders (McWilliams & Siegel, Reference McWilliams and Siegel1997). Clearly, these assumptions are more likely to hold in mature countries like the United States and less likely to hold in emerging economies like China (Morck et al., Reference Morck, Yeung and Yu2000; Walter & Howie, Reference Walter and Howie2003). Thus, the positive empirical results of Chinese acquirers likely did not (necessarily) reflect the actual performance prospects of the mergers.
At the time of the study, US stock markets were the largest and most sophisticated in the world. Most share trades were made by institutional investors, such as mutual and pension funds like Teachers Insurance and Annuity Association – College Retirement Equities Fund (TIAA-CREF) and The California Public Employees’ Retirement System (CALPERS); institutional investors owned 73% of the outstanding equity of the 1,000 largest US corporations in 2009 (Tonello & Rabimov, Reference Tonello and Rabimov2010). These institutional traders typically used sophisticated analytical modeling techniques to estimate future discounted cash flows and priced shares accordingly (Kock, Reference Kock2005). In the case of a merger announcement, the traders were likely to be understandably skeptical because, as noted by McCarthy et al. (Reference McCarthy, Dolfsma and Weitzel2016) and others, mergers have a notoriously poor track record of creating value (Haleblian, Devers, McNamar, Carpenter & Davison, Reference Haleblian, Devers, McNamar, Carpenter and Davison2009). In the 20-day event window it is not surprising that the cumulative average returns (CAR) were significantly negative (−3.8%).
On the other hand, Chinese stock markets were only introduced in December 1990 and July 1991 in Shanghai and Shenzhen respectively. When the sixth global merger wave began, Chinese stock markets had only been in existence for 13 years and the average Chinese investor knew little about Capitalism, much less about evaluating the prospects for complex merger deals (Walter & Howie, Reference Walter and Howie2003). The Chinese government began reforms slowly and only listed part of the equity of large State Owned Enterprises (SOEs) that comprised the vast majority of traded firms (Steinfeld, Reference Steinfeld1998). McGuinness et al., (Reference McGuiness, Lee, Wong, Cheung and Yan2000) estimate that, at the end of 2000, only 36% of shares were actually negotiable/tradable. The vast majority of shares was held by government or various other ‘nonpersons’ and was not traded. As most of the firms traded on Chinese markets were majority-owned by the state, information was tightly controlled on ‘national security’ or political grounds especially if that information reflected badly on a state-owned firm or its politically-connected managers (Walter & Howie, Reference Walter and Howie2003; Young & McGuinness, Reference Young and McGuinness2001).
Since only a small portion of shares was tradable and information tightly controlled, share prices were more volatile. For example, Du and Yong (Reference Du and Yong1998) found that share prices on the Shanghai exchange were about 800 times and 400 times more volatile than those on the NYSE and Stock Exchange of Hong Kong respectively. Furthermore, although most shares were not tradable, those shares that were tradable were traded by unsophisticated retail investors. Trades were more likely to be made on rumors and speculation and Chinese financial markets were poorly regulated (Walter & Howie, Reference Walter and Howie2003; Reference Walter and Howie2011; Young & McGuiness, Reference Young and McGuinness2001). While progress has been made since 2003–2008, China's stock markets are still subject to wild swings based on speculation, herd behavior and bandwagon effects as shown by the massive run up followed by a 30% drop in June and July of 2015. As economist Hu Xingdou recently said: ‘Some people say China's stock market is like a casino, and others say it is worse than that’ (SCMP, 2015).
When a merger was announced in China, investors were likely under the impression that it was at least partly because of a political decision and likely had explicit or implicit approval from some higher authority (Walter & Howie, Reference Walter and Howie2003). Furthermore, information surrounding the merger deal was likely to be controlled. In particular negative information surrounding the deal was more likely to be suppressed, therefore share prices were more likely to move on rumor or speculation (Morck et al., Reference Morck, Yeung and Yu2000; Young & McGuinness, Reference Young and McGuinness2001). Perhaps more importantly, the organizations involved in the merger were suddenly brought to the attention of relatively unsophisticated retail investors who lack the means to evaluate merger deals, but are aware that ‘something is happening’, creating a bandwagon effect (Scharfstein & Stein, Reference Scharfstein and Stein1990). In fact, the sudden increased visibility of the acquiring firms after the merger announcement may have caused an increase in share prices regardless of the prospects of success as visibility alone is associated with improved stock returns for Chinese firms (Tang, 2015). Given the implicit political backing, the acquisition of a foreign firm may have served as a ‘signal’ that the acquiring firm has access to resources (both financial and political) of which investors had not previously been aware. Hence the increased share price may have reflected investors increased valuation of the acquiring firm and not (necessarily) the valuation of the specific merger deal.Footnote
[1]
This would also help explain why Chinese acquirers did well even though they were high market-to-book value ‘glamour’ firms (McCarthy et al., Reference McCarthy, Dolfsma and Weitzel2016) those firms with high visibility were perceived to be better positioned in general regardless of whether that was actually the case and this halo effect likely spilled over into merger announcements.
In summary, I suggest that some of difference in performance between US acquirers and Chinese acquirers reported in the study were due to differences in stock market reactions that make the ESM results unreliable (Park, Reference Park2004). In particular, during the 20-day event window, Chinese financial markets’ positive reaction may have been partly due to reasons other than the prospects of the specific deal so the high CAR did not necessarily reflect actual ‘performance’.
Industry and Organizational Factors Leading to Favorable Merger Outcomes
While ESM-based results from this study may reflect something other than actual performance prospects of the Chinese acquirers, it may still be true that industry and organizational characteristics lead the Chinese acquirers to have an environment that was more conducive to successful prospects for acquisitions. During the period 2003–2008, it had been approximately 25 years since the Chinese economy had begun its opening up and reforms. This was a period of major consolidation among many industries. The Central government was consolidating firms under a policy referred to as ‘grasping the large and releasing the small’ that was fully implemented by then premier Zhu Rongji in 1997 and 1998 (Walter & Howie, Reference Walter and Howie2003; Reference Walter and Howie2011). Policy makers had concluded that many industries had excess capacity. In order to create economies of scale and generate critical mass for innovation, they embarked on a plan of consolidation. Mergers taking place in industries with excess capacity as part of industrial policy meant they had better prospects for actual success (Du & Yong, Reference Du and Yong1998).
In addition to government industrial policy directed at creating economies of scale and eliminating excess capacity, Chinese organizations may have been in a better position to benefit from mergers and acquisitions. Chinese acquirers may have been tempted to acquire foreign companies to ‘springboard’ into internationally competitive positioning (Luo & Tung, Reference Luo and Tung2007). This might be particularly true for the firms involved in acquiring foreign firms (Rui & Yip, Reference Rui and Yip2008). Even the most advanced Chinese firms lagged behind their counterparts in terms of strategic assets needed for foreign competition (Deng, Reference Deng2009). In which case, assets that would have been of no value to other firms may have been of value to Chinese organizations (Rui & Yip, Reference Rui and Yip2008). This also helps explain how, as McCarthy et al. (Reference McCarthy, Dolfsma and Weitzel2016: 223) put it, China ‘outperformed its Western peers while doing what the literature suggests that they shouldn't do [like cross-border mergers]’.
For example, in 2004 Lenovo announced the acquisition of IBM's PC division. At this time, there was excessive capacity in the US computer industry. HP had acquired Compaq and several smaller players had disappeared in the industry shakeout. Given this environment, there was no US company that could utilize those assets. Lenovo was able to better utilize those assets because they wanted to learn. They gained expertise in international brand-building and distribution. IBM, being a more mature company, divested the PC unit because the industry was mature; they wanted to focus on high-end servers and services. ‘Lenovo's acquisition of the IBM PC business was motivated primarily by the desire to obtain IBM PC's technology and capability for making products for high end users so as to become a globally competitive firm’ (Deng, Reference Deng2009: 80). In summary, in addition to the optimistic reactions of Chinese stock markets noted above, it is likely that mergers by Chinese organizations took had better prospects for actual success because of industrial policy and the stage of development of Chinese organizations (Deng, Reference Deng2009; Luo & Tung, Reference Luo and Tung2007; Rui & Yip, Reference Rui and Yip2008).
CONCLUSION
McCarthy, Dolfsma, and Weitzel (Reference McCarthy, Dolfsma and Weitzel2016) should be commended for producing this interesting and well-constructed study. This is first and foremost a work of solid empirical scholarship that has uncovered some very interesting findings. They have documented a global merger wave and they have provided evidence that, at the very least, prospects for merger success are perceived differently by investors from different financial markets. My main concern is with the post hoc rationalization for the findings of superior performance of Chinese acquirers. As the ESM employed in the study is a measure of investor expectations, the higher CAR of the Chinese firms in the 20-day event window may be because Chinese investors overestimated mergers’ prospects for success due to the characteristics of Chinese stock markets from 2003–2008. I would urge readers to reinterpret the findings with this in mind. Additional studies may wish to use additional measures of merger performance, or to track the success of the mergers over time to see if investors’ optimistic perceptions panned out.
Furthermore, similar to Shapiro and Li (Reference Shapiro and Li2016) I suggest that different stages of development better accounts for the differences in merger performance than does a general theory of Chinese acquirer superiority based on culture or corporate governance. As Meyer (Reference Meyer2015) points out, it is important to note the boundaries, such as temporal and contextual factors, when interpreting empirical findings in emerging economies. In summary, comparing countries in this particular context (at different stages of development) during this particular time period (2003-2005) was likely conducive to positive CAR for Chinese acquirers due to both inflated investors’ perceptions as well as fertile conditions for actual merger performance. More studies are needed to determine if this is the case.
INTRODUCTION
Although McCarthy, Dolfsma, and Weitzel (Reference McCarthy, Dolfsma and Weitzel2016) cover much ground in their study, in this commentary I focus on alternative explanations for the empirical results indicating that Chinese acquirers outperformed acquirers from other countries – particularly acquirers from the United States. First, based on research I have done with colleagues (e.g., Chen & Young, Reference Chen and Young2010; Young & McGuinness, Reference Young and McGuinness2001) and that of a doctoral student (Tang, Reference Tang2016), I suggest that comparison of Chinese stock market reactions to merger announcements with stock market reactions to merger announcements from more mature markets, such as the United States, may create some misleading results. The Event Study Method (ESM) used in this study is a measure of investors’ short-term reactions to unanticipated events and it assumes that investors are capable of accurately evaluating such events (MacKinlay, Reference MacKinlay1997; McWilliams & Siegel, Reference McWilliams and Siegel1997). I suggest that, given the relative newness of Chinese stock markets, Chinese investors may have reacted more positively to merger announcements regardless of the mergers’ prospects for success. Second, similar to Shapiro and Li (Reference Shapiro and Li2016), I suggest that stages of industry and organizational development better explain the actual motivation and success of Chinese acquirers than does a general theory of culture or corporate governance traditions.
SUMMARY OF THE ENIGMA
McCarthy et al. (Reference McCarthy, Dolfsma and Weitzel2016) found evidence of a sixth merger wave that took place from 2003–2008 and this was the first ‘truly’ global merger wave because it originated in Asia, Europe, and North America simultaneously. This is a significant and interesting contribution. In addition, their empirical findings support the notion that acquirers with ‘Confucian’ governance systems, and Chinese acquirers in particular, created value in merger deals of 5.1% and 5.8% respectively. This was in contrast to value destruction with ‘Anglo-Saxon’ acquirers and US acquirers (−5.8% and −3.8% respectively) and the 4.8% value creation, or break-even, that took place in the case of ‘Continental’ acquirers and French acquirers respectively.
These results are contrary to what the authors hypothesized; they were expecting the Anglo-Saxon acquirers to outperform the Confucian acquirers – reasoning that Anglo-Saxon corporate governance systems would better control agency problems. Likewise, they had reasoned that ‘Because Confucian legal systems in general, and the legal systems in emerging Confucian countries like China, in particular, are generally unequipped for handling [agency] problems. . . it is likely that Confucian acquirers will destroy value with mergers and acquisitions’ (McCarthy et al., Reference McCarthy, Dolfsma and Weitzel2016: 228). So these surprising results go against the conventional wisdom and are interesting. But why did Chinese acquirers perform so well?
In the post-hoc explanation for these enigmatic findings, the authors provide several possible reasons for why the Confucian and Chinese acquirers performed so much better than the other firms in the sample. First, they suggest that family-dominated business in Asia may help to control agency problems and that the Asian cultural characteristics of collectivism and long-term orientation mean that Asian managers were more likely to make good acquisition deals. Second, they suggest that the Asian cultural characteristics emphasizing harmony, relationships, humanity, benevolence, righteousness, propriety, wisdom, and trustworthiness will curb agency problems in the absence of explicit monitoring. Third, they suggest that Confucian cultural traits may help Asian firms to do a better job of managing social capital and integrating the acquired firms during the post-announcement phase of the mergers. All of these explanations are plausible explanations, but it is likely that they do not tell the whole story.
WHY DID CHINESE MERGERS EXHIBIT SUCH STRONG PERFORMANCE?
Why did Chinese acquirers perform so much better than acquirers from other countries? Although McCarthy and colleagues’ sample contains mergers from 10 Anglos Saxon countries, 6 Confucian countries, and 33 Continental countries, I focus on the differences in performance between the US and Chinese acquirers for four reasons: First, the US acquirers comprised 90% of the Anglo-Saxon sample (8,380 of 9,312 firms) and the Chinese acquirers comprised 44.3% of the Confucian sample (249 out of 562 firms). Second, the largest difference in performance was found between US acquirers (−3.8%) and Chinese acquirers (+5.8%), while the French firms, which dominated the Continental sample, had no significant change in value. Third, the United States and China are the 2 largest economies in the world and the countries with which the readers of Management and Organization Review are most familiar. Fourth, these two countries are notably different in terms of development of market institutions, industry practices and firm technology and they are often compared. So in short, to keep things simple I focus on alternative explanations for why, in the period 2003–2008, Chinese acquirers’ cumulative abnormal returns (CAR) increased on average by 5.8%, while US acquirers’ CAR decreased by 3.8% during the 20 day event window of this study.
Please note that I do not wish to detract from the scholarship of this study. This is meticulous work that explicitly documents a sixth global merger wave and I feel privileged that I was asked to comment on it. Furthermore, the authors acknowledge that the results are surprising and that the data does not allow them to get at the real reasons for the performance differences. In the spirit of uncovering the truth and advancing knowledge, I suggest alternative explanations for the findings.
While I agree with the authors that Chinese firms are likely to go about mergers and acquisitions differently for cultural reasons and some of their practices are likely to be superior, I suggest that they may have shown better performance because their financial markets, industry structures and organizational technology were at a very different stage of development from 2003–2008. Given different levels of maturity, China stock markets were more likely to have reacted more positively to merger announcements than were US stock markets regardless of actual prospects for performance of the mergers which would affect the interpretation of the Event Study Methodology (ESM) results.
In addition to this inflated investor reaction, during the time period of the study (2003-2008) many Chinese industries were at a stage where they were in need of consolidation. Much of the Chinese M&A activity was government directed and aimed at eliminating excess capacity and building economies of scale able to compete in global markets. So in addition to stock markets being overly optimistic on mergers prospects, the actual merger prospects were likely to be better in this environment than in a more mature economy, such as the United States. Finally, from 2003–2008 many nascent Chinese firms were in the process of rapidly improving their technology and management processes in an attempt to ‘move up the value chain’. Hence they had different motivations for acquiring companies (often from abroad) to incorporate and utilize technology and processes that would not have been of value to more mature organizations (Shapiro & Li, Reference Shapiro and Li2016). Again, this would create an environment for successful mergers. In summary, while acknowledging the post-hoc rationale of Confucian corporate governance and culture offered by McCarthy and colleagues, I suggest that differences in stock market reactions as well as different stages of industrial and organizational development better explains the empirical findings of superior Chinese performance.
The rest of this commentary article is as follows: First, I provide a non-technical explanation of why the use of Event Study Methodology (ESM) to compare mergers from the United States with those from China in the period 2003–2008 may have produced results that did not necessarily reflect actual performance of the mergers. I then discuss why Chinese industrial policy and consolidation provided a fertile environment for mergers and acquisitions from 2003–2008. I also suggest that the state of technological development of Chinese firms meant that they were motivated to acquire mature companies, often from abroad, during the period 2003–2008.
Chinese Investors’ Reactions to Merger Announcements
From 2003–2008, Chinese stock markets likely reacted differently to merger announcements than did US financial markets for several reasons: (1) most Chinese firms were majority owned by the state; (2) there was explicit or implicit political involvement in merger decisions; (3) there was a lack of accurate publicly available information; (4) Chinese investors were relatively less capable of evaluating mergers prospects for success; and (5) Chinese regulatory regimes were relatively less mature (Chen & Young, Reference Chen and Young2010; Walter & Howie, Reference Walter and Howie2003). Thus, using ESM to compare stock market reaction to merger announcements between US and Chinese firms is likely to have produced results that do not reflect the actual performance of the mergers.
ESM is essentially a short-term measure of investor perceptions and reactions that determines if there is an abnormal stock price effect associated with an unanticipated event (MacKinlay, Reference MacKinlay1997; McWilliams & Siegel, Reference McWilliams and Siegel1997). ESM was originally designed for application in a single country and when used in multiple countries, this introduces several operational and conceptual difficulties, especially when there are large differences in the investor base and regulatory regimes (Lease et al., Reference Lease, Masulis and Page1991; Park, Reference Park2004). For example, ESM assumes that markets are efficient and that information is accurate and available to all traders (McWilliams & Siegel, Reference McWilliams and Siegel1997). Clearly, these assumptions are more likely to hold in mature countries like the United States and less likely to hold in emerging economies like China (Morck et al., Reference Morck, Yeung and Yu2000; Walter & Howie, Reference Walter and Howie2003). Thus, the positive empirical results of Chinese acquirers likely did not (necessarily) reflect the actual performance prospects of the mergers.
At the time of the study, US stock markets were the largest and most sophisticated in the world. Most share trades were made by institutional investors, such as mutual and pension funds like Teachers Insurance and Annuity Association – College Retirement Equities Fund (TIAA-CREF) and The California Public Employees’ Retirement System (CALPERS); institutional investors owned 73% of the outstanding equity of the 1,000 largest US corporations in 2009 (Tonello & Rabimov, Reference Tonello and Rabimov2010). These institutional traders typically used sophisticated analytical modeling techniques to estimate future discounted cash flows and priced shares accordingly (Kock, Reference Kock2005). In the case of a merger announcement, the traders were likely to be understandably skeptical because, as noted by McCarthy et al. (Reference McCarthy, Dolfsma and Weitzel2016) and others, mergers have a notoriously poor track record of creating value (Haleblian, Devers, McNamar, Carpenter & Davison, Reference Haleblian, Devers, McNamar, Carpenter and Davison2009). In the 20-day event window it is not surprising that the cumulative average returns (CAR) were significantly negative (−3.8%).
On the other hand, Chinese stock markets were only introduced in December 1990 and July 1991 in Shanghai and Shenzhen respectively. When the sixth global merger wave began, Chinese stock markets had only been in existence for 13 years and the average Chinese investor knew little about Capitalism, much less about evaluating the prospects for complex merger deals (Walter & Howie, Reference Walter and Howie2003). The Chinese government began reforms slowly and only listed part of the equity of large State Owned Enterprises (SOEs) that comprised the vast majority of traded firms (Steinfeld, Reference Steinfeld1998). McGuinness et al., (Reference McGuiness, Lee, Wong, Cheung and Yan2000) estimate that, at the end of 2000, only 36% of shares were actually negotiable/tradable. The vast majority of shares was held by government or various other ‘nonpersons’ and was not traded. As most of the firms traded on Chinese markets were majority-owned by the state, information was tightly controlled on ‘national security’ or political grounds especially if that information reflected badly on a state-owned firm or its politically-connected managers (Walter & Howie, Reference Walter and Howie2003; Young & McGuinness, Reference Young and McGuinness2001).
Since only a small portion of shares was tradable and information tightly controlled, share prices were more volatile. For example, Du and Yong (Reference Du and Yong1998) found that share prices on the Shanghai exchange were about 800 times and 400 times more volatile than those on the NYSE and Stock Exchange of Hong Kong respectively. Furthermore, although most shares were not tradable, those shares that were tradable were traded by unsophisticated retail investors. Trades were more likely to be made on rumors and speculation and Chinese financial markets were poorly regulated (Walter & Howie, Reference Walter and Howie2003; Reference Walter and Howie2011; Young & McGuiness, Reference Young and McGuinness2001). While progress has been made since 2003–2008, China's stock markets are still subject to wild swings based on speculation, herd behavior and bandwagon effects as shown by the massive run up followed by a 30% drop in June and July of 2015. As economist Hu Xingdou recently said: ‘Some people say China's stock market is like a casino, and others say it is worse than that’ (SCMP, 2015).
When a merger was announced in China, investors were likely under the impression that it was at least partly because of a political decision and likely had explicit or implicit approval from some higher authority (Walter & Howie, Reference Walter and Howie2003). Furthermore, information surrounding the merger deal was likely to be controlled. In particular negative information surrounding the deal was more likely to be suppressed, therefore share prices were more likely to move on rumor or speculation (Morck et al., Reference Morck, Yeung and Yu2000; Young & McGuinness, Reference Young and McGuinness2001). Perhaps more importantly, the organizations involved in the merger were suddenly brought to the attention of relatively unsophisticated retail investors who lack the means to evaluate merger deals, but are aware that ‘something is happening’, creating a bandwagon effect (Scharfstein & Stein, Reference Scharfstein and Stein1990). In fact, the sudden increased visibility of the acquiring firms after the merger announcement may have caused an increase in share prices regardless of the prospects of success as visibility alone is associated with improved stock returns for Chinese firms (Tang, 2015). Given the implicit political backing, the acquisition of a foreign firm may have served as a ‘signal’ that the acquiring firm has access to resources (both financial and political) of which investors had not previously been aware. Hence the increased share price may have reflected investors increased valuation of the acquiring firm and not (necessarily) the valuation of the specific merger deal.Footnote [1] This would also help explain why Chinese acquirers did well even though they were high market-to-book value ‘glamour’ firms (McCarthy et al., Reference McCarthy, Dolfsma and Weitzel2016) those firms with high visibility were perceived to be better positioned in general regardless of whether that was actually the case and this halo effect likely spilled over into merger announcements.
In summary, I suggest that some of difference in performance between US acquirers and Chinese acquirers reported in the study were due to differences in stock market reactions that make the ESM results unreliable (Park, Reference Park2004). In particular, during the 20-day event window, Chinese financial markets’ positive reaction may have been partly due to reasons other than the prospects of the specific deal so the high CAR did not necessarily reflect actual ‘performance’.
Industry and Organizational Factors Leading to Favorable Merger Outcomes
While ESM-based results from this study may reflect something other than actual performance prospects of the Chinese acquirers, it may still be true that industry and organizational characteristics lead the Chinese acquirers to have an environment that was more conducive to successful prospects for acquisitions. During the period 2003–2008, it had been approximately 25 years since the Chinese economy had begun its opening up and reforms. This was a period of major consolidation among many industries. The Central government was consolidating firms under a policy referred to as ‘grasping the large and releasing the small’ that was fully implemented by then premier Zhu Rongji in 1997 and 1998 (Walter & Howie, Reference Walter and Howie2003; Reference Walter and Howie2011). Policy makers had concluded that many industries had excess capacity. In order to create economies of scale and generate critical mass for innovation, they embarked on a plan of consolidation. Mergers taking place in industries with excess capacity as part of industrial policy meant they had better prospects for actual success (Du & Yong, Reference Du and Yong1998).
In addition to government industrial policy directed at creating economies of scale and eliminating excess capacity, Chinese organizations may have been in a better position to benefit from mergers and acquisitions. Chinese acquirers may have been tempted to acquire foreign companies to ‘springboard’ into internationally competitive positioning (Luo & Tung, Reference Luo and Tung2007). This might be particularly true for the firms involved in acquiring foreign firms (Rui & Yip, Reference Rui and Yip2008). Even the most advanced Chinese firms lagged behind their counterparts in terms of strategic assets needed for foreign competition (Deng, Reference Deng2009). In which case, assets that would have been of no value to other firms may have been of value to Chinese organizations (Rui & Yip, Reference Rui and Yip2008). This also helps explain how, as McCarthy et al. (Reference McCarthy, Dolfsma and Weitzel2016: 223) put it, China ‘outperformed its Western peers while doing what the literature suggests that they shouldn't do [like cross-border mergers]’.
For example, in 2004 Lenovo announced the acquisition of IBM's PC division. At this time, there was excessive capacity in the US computer industry. HP had acquired Compaq and several smaller players had disappeared in the industry shakeout. Given this environment, there was no US company that could utilize those assets. Lenovo was able to better utilize those assets because they wanted to learn. They gained expertise in international brand-building and distribution. IBM, being a more mature company, divested the PC unit because the industry was mature; they wanted to focus on high-end servers and services. ‘Lenovo's acquisition of the IBM PC business was motivated primarily by the desire to obtain IBM PC's technology and capability for making products for high end users so as to become a globally competitive firm’ (Deng, Reference Deng2009: 80). In summary, in addition to the optimistic reactions of Chinese stock markets noted above, it is likely that mergers by Chinese organizations took had better prospects for actual success because of industrial policy and the stage of development of Chinese organizations (Deng, Reference Deng2009; Luo & Tung, Reference Luo and Tung2007; Rui & Yip, Reference Rui and Yip2008).
CONCLUSION
McCarthy, Dolfsma, and Weitzel (Reference McCarthy, Dolfsma and Weitzel2016) should be commended for producing this interesting and well-constructed study. This is first and foremost a work of solid empirical scholarship that has uncovered some very interesting findings. They have documented a global merger wave and they have provided evidence that, at the very least, prospects for merger success are perceived differently by investors from different financial markets. My main concern is with the post hoc rationalization for the findings of superior performance of Chinese acquirers. As the ESM employed in the study is a measure of investor expectations, the higher CAR of the Chinese firms in the 20-day event window may be because Chinese investors overestimated mergers’ prospects for success due to the characteristics of Chinese stock markets from 2003–2008. I would urge readers to reinterpret the findings with this in mind. Additional studies may wish to use additional measures of merger performance, or to track the success of the mergers over time to see if investors’ optimistic perceptions panned out.
Furthermore, similar to Shapiro and Li (Reference Shapiro and Li2016) I suggest that different stages of development better accounts for the differences in merger performance than does a general theory of Chinese acquirer superiority based on culture or corporate governance. As Meyer (Reference Meyer2015) points out, it is important to note the boundaries, such as temporal and contextual factors, when interpreting empirical findings in emerging economies. In summary, comparing countries in this particular context (at different stages of development) during this particular time period (2003-2005) was likely conducive to positive CAR for Chinese acquirers due to both inflated investors’ perceptions as well as fertile conditions for actual merger performance. More studies are needed to determine if this is the case.