3.7 Domestic and Cross-Border M&As in Emerging Markets
3.7.6 Challenges Emerging Market Acquirers Encounter with Cross-Border M&As
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impact on Russian firms’ foreign acquisitions (Bertrand & Betschinger, 2012). Gomes et al.
(2013) also state that, communication and cross-cultural sensitivity are very important when it comes to cross-border M&A, the lack of these skills could negatively affect the firms undertaking the M&A activity to integrate properly.
7. To take advantage of discount acquirers enjoy in cross-border M&As
According to Denis, Denis, and Yost (2002), industrial and international diversifications are each associated with a substantial firm discount. Internationally as well as industrially, firms that become diversified experience a more significant higher discount. Cross-border M&A transactions, all other things being equal, increase the level of international diversification, but a domestic M&A deal for a firm that is already internationally diversified reduces the level of its international diversification. Denis et al. (2002) reveal that, international diversification over time has increased steadily compared to industrial diversification which has over the years decreased.
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therefore makes it difficult for new capabilities and knowledge to be learnt in cross-border acquisitions, all because of issues of double-layered acculturation and liability of foreignness.
Second is lack of international experience. Internationally inexperienced emerging market acquirers that desire to quickly access highly developed markets usually exacerbate the challenges they are confronted with, because they mostly do not have the experience and organisational skills to handle these challenges. Even though local talent can be hired to handle day-to-day activities of the company in the foreign country, several operations of the company still rely on the directions from head offices of these acquirers and their counterparts situated in other countries. To solve issues such as these, thorough international planning is needed.
Several Korean and Japanese multinational enterprises were adversely affected after their expansion abroad in the 80s and 90s for mistakes such as these. They have subsequently revised their internationalisation policy to that of gradual attempts and conservative style of M&A transactions (Li, 1994; Chang, 1995). The dynamic capability theory, therefore, suggests that, the ability of a firm to transfer, deploy and manage important resources that are not found in one geographical area, particularly in radical and risk-taking investments, is an important requirement that must be met to achieve continuous success in international competition (Teece et al., 1997). To address acquisition challenges such as this, acquirers from the emerging economies need to strategise in advance of the global product and resource-flow systems before any such bold investments overseas is undertaken, by putting in place designated offices or teams to coordinate its activities and handle issues of integration.
Third has to do with corporate governance challenges which have effects on cross-border acquisitions. If the minority shareholders in the target firm’s legal protection can improve through the merger activity by offering them some of the rights the acquirers’ shareholders enjoy, then through the acquisition, wealth or value may be generated. The general discussion in corporate governance is that, firms situated in countries that promote governance by instituting proper and strong accounting and legal standards become acquirers of those in countries where these standards are poor and weak. Emerging market firms generally show weak forms of corporate governance. This is usually due to poor disclosures and accountability, underdeveloped stock markets domestically and lack of transparency because of their close associations with their governments (Luo & Tung, 2007). These constraints adversely affect the corporate image of these firms and erode the confidence of shareholders
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and relationship building with international stakeholders. Although corporate governance in developing economies is not the same everywhere, relationship-based governance mechanisms, as highlighted by Luo and Tung (2007) are commonly used in these economies.
Foreign investors mostly perceive attitudes of executive, managers and board members in firms in these economies as less transparent, trustworthy and accountable.
Fourth is the level of market development. This creates a challenge for cross-border acquisition deals. In particular, acquirers from the developed-market benefit more from weaker contracting environments in emerging markets.
Fifth but equally important in cross-border acquisitions is the challenge of valuation. Since several markets in various countries are not integrated perfectly, differences in valuation across markets may motivate cross-border acquisitions. For instance, a firm's currency may rise because of certain exogeneous reasons that are not related with the profitability level of the firm. This firm would find possible target firm in other countries comparatively inexpensive, making certain acquisition transactions to be profitable which under the old exchange rates would not have been so. It is, therefore, expected to see several firms originating from this country to participate in M&A deals, because these acquisition transactions will be paid by them in currency that is inflated. The main point of whether differences in valuation can result in cross-border acquisitions depends on whether the stakeholders involved accept these movements as being permanent or temporary. If the differences in valuation are not permenant, then cross-border acquisitions well arbitrage these differences, resulting in anticipated profits for the acquirers. Shleifer and Vishny (2003) developed a behavioural model where values of the firm deviate from their fundamentals.
Managers of acquirer firms that are overvalued consequently have the necessary motivations to issue shares at higher prices to purchase assets of a less value or at least a less overvalued target. This transaction transfers value to the shareholders of the acquiring firm by arbitraging the price difference between the firms' stock prices. A major component of this model is that, information regarding where the valuation difference comes from is mainly owned and known by the managers.
Even though it is not likely that a specific manager will tend to have better information regarding the valuation of the entire market or any particular currency, Baker, Foley and Wurgler (2009) claim that, cross-border transactions could equally occur because of irrational anticipations about a market's value or mispricing of securities from fluctuations in local
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investors' risk aversion. This implies that, target firms’ managers would be interested in accepting payment in a temporarily depreciated currency or overvalued stock. If the valuation differences are permanent, the attractiveness of acquisitions, particularly those that include target firms whose cash flows are in local currency would not be affected by variations in valuations.
However, there are many ways in which even permanent valuation differences can impact on acquisition propensities. As Kindleberger (1969) stated originally, cross-border acquisitions may occur because, under foreign control, either the cost of capital is lower or expected earnings are higher. For instance, if goods are produced by local firms for sale abroad or compete in their domestic market with foreign competitors, then profits of local firms potentially increase because of permanent depreciations of currency, making these firms attractive to prospective acquirers from outside. On the other hand, when the value of a foreign firm increases compared with that of a domestic firm, for instance, through unhedged exchange rate changes or stock market fluctuations, its cost of capital declines relative to that of a domestic firm because of a reduction in the magnitude of the information problems it faces in raising capital (Froot & Stein, 1991). The implication of this argument is that, permanent changes in valuation can result in cross-border acquisitions since the value changes result in a lower cost of capital under foreign control, allowing prospective foreign acquirers to bid more aggressively for domestic assets than domestic rival bidders. Because this explanation for a relation between currency movements and cross-border mergers is based on asymmetric information, it is likely to be particularly relevant in the case of private targets, for which asymmetric information tends to be high relative to otherwise similar public targets.