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| Diversified M&As: Premium and Corporate Transformation |
| YANG Wei, ZHAO Zhongkuang, SONG Min
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| Economics and Management School, Wuhan University |
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Abstract In recent years, increasing attention has been paid to the role of the M&A (merger and acquisition) market in improving the quality of companies and optimizing the allocation of resources. The scale of the M&As of listed companies has expanded year by year, and exceeded 1 trillion RMB in 2015. The active M&A market emerged when China's economy began to shift from high-speed growth to high-quality development, and the successful transformation of traditional enterprises has been a key factor in achieving long-term stable economic growth. Therefore, whether M&As, especially diversified M&As, can help enterprises successfully transform has become an increasingly important issue for all parties.
Diversified M&As refer to M&As in which the acquirer and the target are from different industries. Foreign studies and the early domestic research have generally found that diversified M&As do not perform as well as mergers within the same industry. However, considering the rapid development of the M&A market in China, we believe that the performance of diversified M&As may have changed. In this paper, we use the M&A data of A-share listed companies from 2008 to 2014 (from the Wind database). The cumulative excess returns of the intra-industry and diversified M&As in the event window are 18.73% and 27.15%, respectively, and diversified M&As carry a premium of 8.42% compared with intra-industry M&As. To investigate why diversified M&As have a premium, we explore the determinants of different types of M&As and the underlying roots of the M&A premiums. First, we find that a lower return on assets before a merger can predict whether a company chooses to conduct a diversified M&A, which suggests that many acquirers have reached a developmental bottleneck in their original industry and have to enter new business areas through diversified M&As. Second, we find that the proportion of the profit from a newly acquired business and the difference between the profit of the newly acquired business and the original business can significantly explain the diversification premium. Our results consistently show that companies with weak performance achieve transformation through diversified M&As. We also use the change in performance over one to three years after the merger as an explanatory variable and find that the improvement in a company's performance is established within one to three years. This shows that investors recognize the improvement in a company's fundamentals in an M&A. Thus, the stock price response on the announcement day is not solely due to the optimism of investors.
The results of this paper show that many poorly performing companies have undergone transformations through diversified M&As, which not only improved their performance but also gained the attention of investors. However, we need to examine why good quality assets are being acquired by poorly performing listed companies through M&As. The reason may be that the listing and delisting system in the Chinese capital market has some limitations. On the one hand, high-quality assets cannot obtain financial resources through IPOs. On the other hand, enterprises with poor performance still have a relatively high shell value because they will not be delisted (Li and Cheng, 2006). Under these constraints, the optimal choice of both parties is to integrate the high-quality assets of the target enterprises and the financial resources of the listed enterprises through an M&A. Because the two parties are likely to be in different industries, the M&A will be presented in the form of a diversified M&A. To further confirm that diversified M&As help enterprises transform, we exclude three alternative theories that may explain the preference for diversified M&As: principal-agent theory, internal market theory, and life cycle theory.
The findings of this paper add to the literature on the motivations for conducting diversified M&As (Fang, 2008; Liu et al., 2009). We find that companies with poor performance are more inclined to participate in diversified M&As, which suggests that diversified M&As originate from the needs of the company. Our findings also enrich the research on whether diversified M&As can create value for shareholders (Berger and Ofek, 1999; Li and Zhu, 2006). Based on the recent development of the A-share M&A market, we find that the market reaction to diversified M&As and the improvements in the companies' fundamentals are superior to those of intra-industry M&As, and are mainly conducted by companies wishing to enter a new business. Moreover, we propose that diversified M&As can serve as a realistic means for enterprises to transform, and provide new evidence for the role of the capital market in servicing the real economy (Cheng et al., 2016; Pan et al., 2019).
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Published: 29 May 2019
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