Foreign Ownership and Firm Performance
U.S. target firms undergo significant restructuring after acquisition by emerging market firms....Increasing profitability measured by the return on assets coupled with declining sales, employment and capital is consistent with improvements in firm efficiency.
In Foreign Ownership and Firm Performance: Emerging Market Acquisitions in the United States (NBER Working Paper No. 14786), Anusha Chari, Wenjie Chen, and Kathryn M.E. Dominguez conduct the first systematic examination of the recent phenomenon of American firms being acquired by companies in emerging economies, particularly China and India. Specifically, they ask what happens to an American firm's performance after it is taken over by a corporation in an emerging economy (for example, the Chinese Lenovo's 2004 purchase of IBM's personal computer operations or Indian Tata Motors 2008 purchase of Ford's Jaguar and Land Rover divisions).
The researchers note that traditionally foreign investment flowed from developed countries to developing countries, bringing with it superior technology, organizational capital, and access to international capital markets, with the result being improved productivity. In the case of recent emerging-market acquisitions, however, while the role of sovereign wealth funds and the build-up of U.S. dollar reserves in emerging markets are seen as motivations for acquisitions in developed markets, the productivity-improving role of technology transfers from emerging to developed markets is not obvious.
The first question Chari, Chen, and Dominguez face in estimating post-acquisition performance is: causality versus selection? Are emerging-market firms simply picking certain types of acquisition targets, or do foreign acquisitions change target-firm performance? The data strongly support the proposition that the selection of U.S. firms for acquisition is not random, but favors U.S. targets with high levels of sales, employment, and assets.
They find next that the stock market response of the acquired firms is positive and significant around the time of the acquisition announcement. Average cumulative returns on the target stock price within a three-day window around the announcement date of the acquisition increase by 8 percent and remain significant and positive when the window is extended to 10 and 21 trading days. Following the acquisition, the performance of target firms also improves. In particular, the return on assets in target firms grows by an average of 16 percent in the five years following the takeover.
The evidence suggests that U.S. target firms undergo significant restructuring after acquisition by emerging-market firms. Employment and the capital stock decrease, suggesting that unprofitable divisions may be sold off or closed. This conjecture is supported by the fact that sales also decline after acquisition.
To measure the performance of the acquired firms, the authors focus on the accounting measure 'operating income before depreciation, amortization, and taxes' (OIBD) scaled by total assets to provide "return on assets" (ROA). They also track changes following the acquisition in other aspects of the target firm's operations, such as investment, employment, and sales. Their data come from the Thompson Financial SDC Platinum database, specifically the records of all mergers and acquisitions involving publicly traded U.S. firms announced between January 1, 1980 and July 1, 2007.
The pattern of increasing profitability as seen by an increase in the return on assets coupled with declining sales is consistent with improvements in firm efficiency following acquisition. If, for example, firms shut down or divest themselves of unprofitable divisions, then sales would go down but profits as a percentage of assets would increase. In addition, declining employment and net Property, Plant, and Equipment (PP&E) suggest downsizing of divisions to improve overall profitability as a percent of assets. The downsizing of employment and net PP&E are also consistent with the 'comparative input cost hypothesis' whereby acquirers from emerging markets may be in a position to exploit the low wages in their home countries by downsizing labor-intensive activities in the foreign country following the acquisition.
The analysis here indicates that there is selection along observable characteristics, such as higher sales, assets, and employment, upon which emerging-market firms choose acquisition targets in the United States. The researchers also find that despite the decrease in sales, capital, and employment, profits rise for U.S. firms acquired by companies in emerging markets. Overall, the evidence strongly indicates that emerging-market firm acquisitions affect the performance of U.S. target firms.
-- Matt Nesvisky