Financing Constraints, Ownership Control, and Cross‐Border M&As: Evidence from Nine East Asian Economies

• Author: Yenn‐Ru Chen,Chun‐Nan Chen,Yu‐Lin Huang
• Published date: 01 November 2009
• DOI: http://doi.org/10.1111/j.1467-8683.2009.00770.x
• Date: 01 November 2009

Financing Constraints, Ownership Control, and

Cross-Border M&As: Evidence from Nine East

Asian Economies

Yenn-Ru Chen*, Yu-Lin Huang, and Chun-Nan Chen

ABSTRACT

Manuscript Type: Empirical

Research Question/Issue: This study distinguishes between the effects of f‌inancialconstraint determinants on cross-border

mergers and acquisitions (M&As) and domestic M&As for all takeover bids announced in nine EastAsian economies from

1998 to 2005.

Research Findings/Insights: The results of logistic regressions verify that the extent of stock market and governance

developments improves corporate f‌inancing conditions and subsequently encourages cross-border M&As in East Asia. The

results also indicate that, except for ownership control variables, the f‌irm-specif‌ic factors of f‌inancing constraints reduce the

occurrence of cross-border M&As relative to domestic M&As.Although family- and state-controlledf‌irms have better access

to external f‌inancing, they are reluctant to risk diluting their management control and thus prefer domestic M&As to

cross-border deals.

Theoretical/Academic Implications: This study enhances the empirical studies of the relation between f‌inancing con-

straints and corporate investments based on the market imperfection hypothesis of corporate f‌inance theories. In addition,

this study also addresses the interaction between the market imperfection hypothesis and agency theory in explaining the

effects of special ownership control on cross-border M&As relative to domestic deals. Furthermore, by examining the

research questions across nine East Asian economies, this study provides an understanding of how such a relation applies

to f‌irms in countries where information asymmetry is high.

Practitioner/Policy Implications: The f‌indings indicate the importance of corporate governance and verify the effects of

unique organizational structures on major corporate decisions. Specif‌ically, family-controlled f‌irms are often free of the

f‌inancing constraints inherent in investment decisions. Thus, it is necessary to consider such organizational uniqueness

when explaining the f‌inancing behavior of cross-border M&As conducted by Asian f‌irms.

Keywords: Corporate Governance, Cross-Border M&As, Financing Constraints, Ownership Control, Asian Economies

INTRODUCTION

Information asymmetry invalidates the perfect market

assumption of neoclassical theory. When information

asymmetry exists between corporate insiders and external

investors, the cost of external f‌inancing is higher than the

cost of internal f‌inancing, which in turn constrains f‌irms’

investment activities (Fazzari & Athey, 1987; Myers &

Majluf, 1984). Thus, Fazzari, Hubbard, and Petersen (1988)

argue that the investments of f‌irms suffering from f‌inancing

constraints can vary with the availability of internal funds,

rather than with the availability of positive net present value

cases. Consequently, some of the literature investigates the

effects of f‌inancing constraint determinants on corporate

investment behavior (Beck, Demirguc-Kunt, & Maksimovic,

2005; Laeven, 2003; Lamont, 1997; Whited, 1992). Neverthe-

less, the role of investment types is relatively uncertain

although a f‌irm’s investments can in turn affect its f‌inancial

condition and constrain its f‌inancing for investments.

Based on the market imperfection hypothesis, we posit

that f‌inancing constraint concerns are more critical to cross-

border mergers and acquisitions (M&As) than domestic

deals. Generally, the longer distance and greater uncertainty

*Address for correspondence: Department of Accountancy and Graduate Institute of

Finance and Banking, National Cheng Kung University, 1 University Road, Tainan

City,70101, Taiwan. Tel: 886 6 2757575 ext.53425; Fax: 886 6 2744104; E-mail: yrchen@

mail.ncku.edu.tw

665

Corporate Governance: An International Review, 2009, 17(6): 665–680

© 2009 Blackwell Publishing Ltd

doi:10.1111/j.1467-8683.2009.00770.x

of the targets usually make cross-border M&As less infor-

mation transparent than domestic M&As. Consequently,

cross-border M&As often place higher f‌inancial burdens on

acquiring f‌irms than do domestic M&As. Thus, instead of

investigating f‌inancial constraint determinants, this study

aims to distinguish between their impact on cross-border

and domestic M&As.

In addition to f‌inancial concerns, managerial motives can

also affect M&A decisions. Prior literature f‌inds a negative

relation between ownership control and equity-f‌inanced

mergers (Amihud, Lev, & Travlos, 1990; Martin, 1996), which

has been suggested to be due to dilution concerns. Cross-

border deals are associated with relatively more local man-

agers and greater uncertainty, forcing acquiring managers to

give up control and bear greater risks. As a result, we also

examine the effects of ownership control on M&A activities

based on the market imperfection hypothesis and agency

theory.

This study covers a sample of takeover attempts

announced from 1998 to 2005 in nine East Asian economies.

There are two reasons for using this sample to examine the

research question. First, the value of cross-border M&As in

the Asia-Pacif‌ic Economic Cooperation (APEC) economies

has grown dramatically since the mid-1990s (Chen &

Findlay, 2003). Even though APEC’s developing economies

are not large players, cross-border M&A activities in these

economies have increased since the f‌inancialcrisis of the late

1990s, especially in East and Southeast Asia.

Second, a fundamental part of this study is the idea that

the ownership control of f‌irms inside and outside the United

States differs signif‌icantly (La Porta, Lopez-de-Silanes, &

Shleifer, 1999) and f‌irms in Asia are mostly family- or

state-controlled corporations (Claessens, Djankov, & Lang,

2000). This unique f‌irm characteristic often gives them better

access to external f‌inancing and bank connection (Harrison

& McMillan, 2003; Laeven, 2003) and thus the market

imperfection hypothesis that a f‌irm’s f‌inancing condition

will constrain its investments due to information asymmetry

does not necessarily apply here. Additionally, this study

attempts to take into account this unique characteristic of

Asian f‌irms in examining the research question.

This study contributes to the existing literature on M&A

activities in several ways. First, by comprehensively exam-

ining the effects of f‌inancing constraint determinants on the

decision of whether to engage in cross-border M&As or

domestic M&As, empirical results reinforce the idea that the

relations between f‌inancing constraint determinants, espe-

cially ownership control, and investments are more critical

for cross-border M&As than for domestic M&As. Second,

information asymmetry is the main reason for market

imperfections and leads to f‌inancing constraints on corpo-

rate investments. Consequently, by examining the f‌inancing-

investment relation across nine East Asian economies, this

study provides an understanding of how it applies to f‌irms

in countries where information asymmetry is a more serious

issue.

The following section of this paper reviews related litera-

ture on cross-border M&As and corporate f‌inancing and

develops hypotheses. The next section then describes the

data and sample selection and explains the methodology

and variable def‌initions. This is followed by a discussion of

the empirical evidence regarding the different effects of

f‌inancing constraint determinants and ownership control on

cross-border M&As relative to domestic M&As. The last

section presents this study’s conclusions.

LITERATURE REVIEW AND HYPOTHESES

Neoclassical theory suggests that a f‌irm’s investment deci-

sions are unaffected by its f‌inancial conditions because exter-

nal and internal funds are perfect substitutes within perfect

capital markets. However, information asymmetry and the

conf‌licts of interest between corporate insiders and outside

investors render such capital market perfection unlikely.

Myers and Majluf (1984) state that information asymmetry

caused by the separation between f‌irm managers and poten-

tial outside investors negatively affects a f‌irm’s external

f‌inancing, especially equity f‌inancing. Under such circum-

stances, f‌irms tend to f‌inance investments with internal

funds or external debt to avoid conf‌licts of interest between

existing stockholders and outside investors. Once f‌irms are

short of f‌inancial slack, either internal funds or debt, they

can pass some projects up rather than f‌inance them by

issuing equity. Therefore, capital market imperfections due

to information asymmetry lead to higher costs of external

f‌inancing than internal f‌inancing for f‌irms funding invest-

ment projects.

The magnitude of market imperfections is thus related to

the degree of information asymmetry. The legal systems and

capital market developments of different countries lead to

different magnitudes of information asymmetry. As capital

markets develop, the eff‌iciency of information f‌lows in-

creases, as does investor participation. Similarly, when a

country def‌ines better protection for shareholders and credi-

tors, external investors are more willing to provide capital.

This further promotes the effectiveness of f‌inancial markets

as well (La Porta, Lopez-de-Silanes, Shleifer, & Vishny,

1997, 1998). Thus, these macroeconomic factors determine a

f‌irm’s capability to f‌inance its investments (Claessens &

Laeven, 2003; Demirguc-Kunt & Maksimovic, 1998; Love,

2003).

Besides being in a country with a better-developed legal

system and capital markets, f‌irms have other ways of

improving the condition of f‌inancing constraints. Stulz

(1999) argues that listing a f‌irm’s shares abroad improves

investor protection and information transparency, lowering

the cost of capital and f‌inancial obstacles. Moreover, other

f‌irm-specif‌ic characteristics also show different inf‌luences

on information transparency and thus impose f‌inancing

constraints to varying degrees. For example, the literature

identif‌ies a f‌irm as f‌inancially constrained based on such

characteristics as dividend payouts, business group aff‌ilia-

tions, size, and age (Almeida, Campello, & Weisbach,

2004; Devereux & Schiantarelli, 1990; Fazzari et al., 1988;

Gilchrist & Himmelberg, 1995; Hoshi, Kashyap, &

Scharfstein, 1991).

Fazzari andAthey (1987) state that corporatef‌inancial vari-

ables, such as internal liquidity and interest expenses, affect

corporate capital spending due to information asymmetry.

Similarly, excessive f‌inancial leverage increases conf‌licts of

interest between existing and new investors, which in turn

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