This chapter first explored whether working capital positions drive M&A activities by acquirers from the emerging markets in the wake of increases in acquisition transactions the world over with numerous reports accusing firms of having excess cash reserves in anticipation of various investment activities including M&As. Secondly, we investigated whether working capital of the firms influences these acquirer firms’ decisions regarding the type of merger deals they undertake. Lastly, the study tested the free cash flow hypothesis to determine if FCFs available to these emerging market firms also influence their motivations for acquisition deals. The study employed the probit methodology. This is a binary regression technique considered powerful when the research purpose is to determine the likelihood of an event or the probability of its occurrence. This method was used to avoid the limitations of OLS and multiple discriminant analysis (MDA) which have been used in similar studies by Stevens (1973), Simkowitz (1971) and Monroe (1973). Discriminant analysis requires the data to have multivariate normal distribution and the dispersion matrices of the group to be equal. Neter and Wasserman (1974) state both theoretical and empirical considerations which suggest that when the dependent variable is binary, the underlying relationship is frequently curvilinear.
However, in probit analysis, no such assumptions need to be made about the prior probability that the firm belongs to a specific group, and the assumptions of normal distribution and the equality of variances and covariances across groups are less critical. The probit technique again enabled us to measure the marginal effect of the coefficients of the main and the other explanatory variables used on M&As. We defined working capital as current assets as well as
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current liabilities which is calculated as the firm’s current assets minus its current liabilities, and M&As are defined as one (1) if a firm executed a deal and zero (0) otherwise, while type of merger also was one (1) if the type of transaction horizontal or vertical and conglomerate otherwise. Further, free cash flow to firms was defined as the amount of money left over after satisfying all current operating and financing needs (Jensen, 1986). All measures have been used extensively in similar studies and continued to remain relevant. Based on the findings, the study concludes that working capital positions of emerging market acquirers do not motivate them to execute mergers and acquisitions transactions. This is contrary to assertions by (Iyer and Miller, 2008; Kayo et al., 2010) that managers in firms that have high amounts of cash reserves, high current ratios and low financial leverage may be encouraged to make use of these loose resources to fund investment projects, even including those with negative NPV, for example acquiring another company only for empire building purposes. With cash being the mode of transaction for most of the acquisitions in emerging markets, the argument for acquirer’s financial liquidity becomes strong. It is also inconsistent with Agrawal and Sensarma (2007) who found cash reserves as one significant parameter that drove acquisition propensity positively.
Again, findings of this study suggest that, the type of merger deals acquirers execute are also not motivated by their working capital positions. This is because, the marginal effect coefficient indicating the relationship between firms’ working capital positions and the type of M&A they pursue is negative and statistically significant at 1%, implying that it is less likely to influence them to execute either horizontal or vertical type of merger.
However, the acquirers’ total assets (proxy for firms’ sizes) and their ROAs (proxy for profitability) seem to have some level of influence on the type of merger deals these acquirers execute and also drive them to pursue M&As deal since the marginal effect coefficient for both of them are positive and significant at 1% and 10% statistical levels respectively.
With regard to findings on the free cash flow (FCF) and M&As executions, the study concludes that, the firms’ FCF influences them to undertake M&As. Their debt levels and ROAs are also more likely to have influence on their investment decisions such as M&As.
However, the firms’ total assets and Tobin’s q representing their sizes and growth opportunities respectively are less likely to motivate them to execute M&As under the free cash flow hypothesis.
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Based on the findings of this study, we recommend that, first, even though working capital positions of acquirer firms from the emerging markets are less likely to influence their investment decisions particularly M&A transactions, firm managers should not ignore the management of them (working capital positions). They should institute proper working capital management practices in their companies, in order not to experience liquidity challenges of either excess or shortages since any of them could affect the smooth running of their business operations especially in the short-term period. Second, managers should make conscious effort in growing their total assets base and help improve returns on their assets to ensure sustainability in profits, because they have the potential to influence their investments decisions such as M&As. Third, since findings of this study suggest that FCFs available to firms are more likely to influence them to undertake M&As, the study recommends that, policy makers or boards should enact policies that will ensure proper use of any free cash available to firms so that they will be channelled to more rewarding investment projects.
Further, the study also recommends that, board of firms should institute measures that will ensure that, the practice where firms keep free cash for the discretion of managers is avoided so that agency costs will be reduced.
The study contributes to the literature on mergers and acquisitions in the emerging markets.
To the best of our knowledge, this study is the first empirical work on firms’ working capital as a potential driving factor of M&As focusing on acquirers from ten (10) emerging market countries using a multivariate probit cross-sectional regression technique. Further, it adds a theoretical insight to literature on drivers of M&As by firms from developing economies through the testing of the free cash flow hypothesis. The chapter that follows explores whether managerial ownership of acquirer firms from the emerging markets also plays any role to motivate them to execute acquisition transactions.
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CHAPTER FIVE
MANAGERIAL SHARE OWNERSHIP AND M&A TRANSACTIONS BY EMERGING MARKET ACQUIRERS