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| The Effect of Exchange Rate Uncertainty on Cross-border Mergers and Acquisitions |
| MENG Wei, JIANG Guohua, ZHANG Yongji
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Guanghua School of Management, Peking University;
School of Management and Economics, Beijing Institute of Technology |
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Abstract In the context of an increasingly uncertain international situation and the market-oriented reform of the RMB exchange rate, exchange rate fluctuations among countries have become the norm. The potential financial risks and the operational risks for micro firms associated with these increasingly unpredictable exchange rate fluctuations will have a profound impact on the sustainable development of China's economy. The international environment is becoming increasingly complex, characterized by growing uncertainty and instability. Firms engaged in cross-border mergers and acquisitions (M&As) face three additional uncertainties: (1) uncertainties caused by anti-globalization, trade disputes and protectionism, and geopolitical conflicts; (2) uncertainty in the relationship between the acquirer's and the target's countries; and (3) uncertainties in the economic, political, security, legal, and other spheres of the target country.Unexpected exchange rate fluctuations are related to these three uncertainties.
Based on the China's aim to achieve a high-quality opening up, we define Exchange Rate Uncertainty as the condition of being unable to accurately predict the direction, range, or distribution probability of future exchange rate fluctuations. In this condition, exchange rate fluctuations cannot be predicted based on historical trends and existing information. In general, Chinese firms join international markets through cross-border M&As. This study suggests two mechanisms through which fluctuations in exchange rates affect this process. (1) Real Option Effect. Exchange rate uncertainty constrains firms' cross-border M&A decisions by increasing transaction costs and earnings uncertainty and by aggregating external financing difficulties. (2) Risk Hedging Effect. Exchange rate uncertainty encourages firms to increase their market share and hedge exchange rate risks by engaging in cross-border M&As that enhance their market competition. Using a sample of cross-border M&As announced by A-share firms in the 2000 to 2019 period, we find that uncertainty in the nominal exchange rate of the RMB against the US dollar (NUTR) reduces the likelihood of cross-border M&As, indicating the dominance of the real option effect; while uncertainty in the nominal effective exchange rate of RMB (NEER) has a positive impact on the number of M&As, which reflects the risk hedging effect. Further cross-sectional analysis shows that the negative effect of NUTR uncertainty is more significant among firms with higher trading and translation risks and tighter financing constraints. In addition, firms in industries with intense competition and firms that face higher economic risk from exchange rate fluctuations are more likely to conduct cross-border M&As when NEER uncertainty intensifies. Tests of the mediating effects of financial friction and corporate risk further prove that both NUTR and NEER uncertainty affect firms' decisions to engage in cross-border M&As via the real option mechanism and risk hedging effect, respectively. Finally, the financial performance of cross-border M&As is better during periods when the exchange rate is uncertain. Cross-border M&As reduce the sensitivity of firm stock prices to changes in effective exchange rates (NEER); that is, they reduce the economic risks of exchange rates, but have no significant mitigation effect on the risk exposure created by bilateral exchange rates.
This study distinguishes the role of bilateral and effective exchange rate uncertainty and expands our understanding by considering the economic consequences of exchange rate fluctuations and uncertainty. At the same time, this study also supplements the literature on the factors that influence cross-border M&As. It provides a theoretical basis for regulators' guidelines for firms seeking active international economic cooperation. These guidelines could help firms to improve their core competitiveness and to participate in the reform of the global economic governance system. In particular, to obtain stability in an uncertain environment, firms must pay attention to exchange rate risk and improve the efficiency of cross-border M&As. This study explores the spillover effect of exchange rate uncertainty from the perspective of the stock market and provides a basis for the market-oriented reform of the RMB exchange rate system under the Dual Circulation development pattern.
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Published: 02 June 2021
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