On the role of investment banks in M&As in Europe: Deal completion, deal application, or just value creation?

On the role of investment banks in M&As in Europe: Deal completion, deal certification, or just value creation? The last decade has featured the most intense period of M&A activity ever. Moreover, while acquisitions used to be popular particularly in the USA, the most recent M&A wave has turned out to be a worldwide phenomenon, with many deals originating in Asia and especially in Europe (e.g., Huyghebaert and Luypaert, 2010). In 2007, the top year of number of completed deals, Mergerstat recorded 11,584 European transactions, accounting for USD 1,472.5 billion, compared to 10,574 M&As in the USA, for a total deal value of USD 1,345 billion. However, research on takeovers, typically relying on data from earlier waves and on data from the USA, has pointed out that many acquisitions are often unable to meet the great expectations expressed at their announcement. Agrawal et al. (1992) report that investors in US acquiring companies during 19551987 endured a significant average loss of 10% in shareholder value over the five years following a deal. Danbolt (1995) comes to the same conclusions for foreign bidders in cross-border acquisitions into the UK during 19861991. Other studies have provided evidence of a detrimental impact of M&As on accounting performance (e.g., Ravenscraft and Scherer, 1987; Dickerson et al., 1997). In a more recent study on European M&As initiated by listed bidders during the fifth wave (19972006), Craninckx and Huyghebaert (2011) point out high failure rates too from analyzing the combined firms stock and accounting performance after deal completion. The literature to date has largely focused on misaligned managerial incentives, such as empire building, hubris, and herding behavior, to explain these huge M&A failure rates (see, for example, Craninckx and Huyghebaert, 2012). Nonetheless, conflicts of interest between M&A-initiating firms and their investment bankers might also contribute to M&A failure. The latter topic has been under-explored in M&A research and has only recently attracted some attention in the literature. As an astonishing example, Bodnaruk et al. (2009) find that investment banks sometimes buy a stake in the target firm before the M&A announcement, allowing them to realize the acquisition premium that is usually offered by bidding companies. Moreover, these stakes are positively associated with the probability of observing a takeover bid and even with the acquisition premium. Also, this advisory stake is positively related to the likelihood of subsequent deal completion. McLaughlin (1990) was the first to emphasize the intrinsic conflict of interest faced by financial advisors in M&A negotiations. He points out that financial advisors typically receive fees contingent upon the completion of a deal rather than upon the success of the transaction. So, the deal-completion hypothesis for financial advisors in M&As argues that financial advisors assisting the acquiring company could induce their clients to initiate deals with lower total M&A gains and to pay out a larger part of M&A gains to target shareholders in order to complete the deal. Besides, top-tier financial advisors assisting the acquiring company may have strong incentives to stimulate their clients to complete takeover offers in order to defend their own market share in the M&A market. Rau (2000) and Bao and Edmans (2011) provide empirical support as to this view by showing that the market share of financial advisors does not depend on the value created in prior M&As, but is positively affected by the percentage of completed deals in the past. Overall, there is indeed some empirical evidence supporting the idea that bid offers are more likely to be completed and are completed more quickly if the acquiring firm is assisted by a top-tier financial advisor (see also Hunter and Jagtiani, 2003). Conversely, top-tier financial advisors assisting the acquiring firm could also use their highly developed M&A skills to help acquiring firms to select the best takeover targets and to structure the deal such that the total value of synergies is not paid out upfront to target shareholders. This superior-deal hypothesis has also received some support in the academic literature (e.g., Kale et al., 2003; Benou and Madura, 2005; Golubov et al., 2011). In sum, empirical research on the role of investment banks remains limited to date and has yielded conflicting results. Furthermore, some ideas have not been explored yet in this literature to date, like the management insisting on the involvement of a highly reputable investment bank in order to convince its stakeholders that the deal under consideration is a valuable one, i.e. the deal-certification hypothesis. With this application for finance by the National Bank of Belgium, we want to start up a new research project to explore the role of investment banks in M&As. First, we wish to examine under what conditions listed companies hire an investment bank(s) to advise them in their M&A decisions rather than implement the deal in-house. From our current database, we already know that listed acquirers in Continental Europe hire an investment bank in only 53% of their deals. Also, only 20% of acquirers hire a top-tier financial advisor. To empirically analyze these hiring decisions, we would focus on all M&As initiated in Europe as of 1997, given that this M&A market remains under-researched and given that we have already collected the data on these deals in an earlier research project. We do plan to update the data with more recent years, as currently the database ends in 2008. The methodology would be a nested logit model, where the first nest is the decision to hire an external advisor or not and the second nest is to rely on a top-tier advisor or not. Alternative nests are possible: to hire an unaffiliated versus an affiliated investment banker (e.g., an investment bank that has already advised the company in the past in its capital market transactions, a bank that has many financial analysts following the stock of the bidding company, etc.). Besides, we wish to explore how the industry expertise of the investment bank influences the selection decisions of bidding companies: investment banks that have played an advisory role in previous deals in a particular industry may be more likely to be selected in future deals in this industry, as they probably can complete and structure deals in a more satisfactory manner, without this necessarily being related to a conflict of interest. Second, we wish to explore under what conditions investment banks help bidding companies to select good deals and to structure the transaction in an appropriate way. To proxy for the perceived quality of a deal, we will use the event study methodology to calculate M&A value creation at deal announcement. Craninckx and Huyghebaert (2011) have demonstrated its predictive ability for the long-term success of M&As. Regarding deal structuring, we will focus on the consideration paid to target shareholders (cash, stock, or a combination) and the financing of the deal (e.g., relying on internal cash, raising a new bank loan, placing bonds or stocks in public financial markets). Also, we will study the relation with the likelihood of completion and time to completion, controlling for variables that reflect the complexity of the deal. Important to note here is that we can compare deal structuring of M&As in which external advice was hired versus deals that were implemented in-house. Finally, we wish to examine how investment banks set fees for their advisory role in M&As. We are not aware of any research to date that has explored this latter topic.

Keywords:Value creation, Deal completion, M&As in Europe, Investment bank

Disciplines:Applied economics