University of Cincinnati

UNIVERSITY OF CINCINNATI Date:___________________ I, _________________________________________________________, hereby submit this work as part of the requirements for the degree of: in: It is entitled: This work and its defense approved by: Chair: _______________________________ _______________________________ _______________________________ _______________________________ _______________________________ Essays in Mergers and Acquisitions: Roles of the Third Party A dissertation submitted to the Graduate School of the University of Cincinnati In partial fulfillment of the requirements for the degree of Doctoral of Philosophy In the Department of Finance-Real Estate College of Business By Jie Wei B.S., Wuhan University, 1997 M.S., University of California, Los Angeles, 2002 Committee Chair: Michael Ferguson, Ph.D. May 2008 Abstract Merger and Acquisition market is a very active section of the financial market, involving multi-trillion dollar businesses every year. Extensive research has been done on this field, mostly focusing on the two parties of the trade, namely the acquirer and the target. However, the third party like deal advisors and risk arbitrageurs play very important roles in these transactions too. They not only get directly involved by negotiating the price and the terms, but also indirectly influence deal outcomes and facilitate price discovery by trading both party’s equities. In the first part of this study, we focus on risk arbitrageurs. They participate the M&A games by providing the target shareholders a safe exit and make money from the P − P speculative spread ( offer +1 ). But if and why risk arbitrageurs earn risk adjusted P+1 excess returns is a big unanswered question in the M&A literature. Our empirical study shows that deal characteristics, as well as market conditions affect risk arbitrageur’s return. More importantly, after considering the liquidity risk (for which we use VIX as the proxy) M&A arbitrageurs are not making excess return. In the second part of this study, we turn our attention to financial advisors. We examine the effect of using boutique vs. full service investment banks as financial advisors on deal outcomes and shareholder’s wealth in M&A transactions. Boutique investment banks are defined as independent financial advisors whose focus is M&A advising. This is the first paper to examine the role of financial advisors from this perspective. We find that deal size and target management’s attitude towards the deal are ii important factors that affect acquirer’s choice of boutique versus full service advisors. We also find that on average, boutique advisors achieve a higher deal success rate while it takes them a longer time to complete deals. Boutique bank’s expertise in valuation is more appreciated than their independence by both the client and the market. They are better advisors in particular deals because of their expertise. iii Copyright by Jie (Diana) Wei and University of Cincinnati iv Acknowledgements This dissertation would not have been possible without the help, support, guidance and efforts of a lot of people. I would like to thank my committee members Dr. Michael Ferguson, Dr. Weihong Song, Dr. Martin Levy for their guidance over the years. I am also indebted to Dr. Steve Slezak, Dr. Brian Hatch, Dr. Steve Wyatt and Dr. Hui Guo for their inspiring teaching over the years. I am grateful for the financial support of the University of Cincinnati Graduate Scholarship. I would also like to take this opportunity to thank several of my fellow PhD students including Doina Chichernea, Anthony Holder, David Manzler and Joshua Knapp for interesting and helpful discussions and debates which helped me to remain calm and keep the sense of wonder during this process. I am also especially grateful for the patience shown by my family throughout this process. Without their support and encouragement I would not be able to finish this and maintain my sanity (if I am still considered as having some). Thanks a lot for everything. v Table of Contents List of Tables and Figures…. ………………………………………………………… vii Introduction …….……………………………………………………..…………………1 Essay 1: The Profitability of M&A Arbitrageurs 1. Introduction.……………………………………...…………..…………………4 2. Literature Review……………...…………………………………..……………9 3. Data ………………………………………………..…………………………13 4. Empirical Results 4.1 Methodology ……………………………………………….….........14 4.2 Testing Hypothesis…………………………………………………. 18 1) Controlling Idiosyncratic Risk………………………...……19 2) Controlling Liquidity Risk………………………………….21 3) Controlling both Idiosyncratic Risk and Liquidity Risk...….23 4) The Interaction between Idiosyncratic Risk and Liquidity Risk.27 4.3 Robustness Check …………………………………..………………29 5. Conclusion ……………………………………………………..…………….29 6. References………………………………………..……………..……. ……...31 7. Tables ………...……………………………………………………………….33 Essay 2: The Value of “Boutique” Financial Advisors in M&A 1. Introduction ……………...……………………..……………………………..42 2. Literature Review ……...……………………………..……………………….47 3. Data and Methodology ...……………..……………………………………….49 vi 4. Empirical Results 4.1 Univariate Analysis………………………..……………………......50 4.2 Multivariate Analysis ……………………………………………….58 5. Conclusion …………………………………..………………………………..65 6. Appendix 1…………………………………..………………………………..67 7. Appendix 2…………………………………..………………………………..68 8. References……………………………………..……………………. ……….79 9. Tables and Figures ……………………………………………………………70 Concluding Remarks and Perspectives…………..……………………………...…….85 vii List of Tables and Figures Essay 1 Table 1.1 Sample Summary …………….……………………………………………….33 Table 1.2 Regression of Risk Arbitrage Return on Common Risk Factors………….…..34 Table 1.3 The Determinants of Probability of Deal Success…………………….………35 Table 1.4 The Idiosyncratic Risk Factor ………………. ……………………….………36 Table 1.5 The Market Liquidity Risk Factor…………………………………………...37 Table 1.6 Excess Returns in Different Portfolios Panel A- Deal Size and the Medium of Payment………………..………………38 Panel B- Deal Size and Market Liquidity…………………..………………..38 Panel C- The Medium of Payment and Market Liquidity...…………………39 Panel D- Deal Size, the Medium of Payment and Market Liquidity………..39 Table 1.7 Interaction Effects of Deal Characteristics and Market Liquidity Panel A - The Difference of Excess Return ……………………………………..40 Panel B -The Coefficients of VIX ……………………………………………41 Essay 2 Table 2.1 Sample Distribution …………………………….…………………….………70 Table 2.2 Deal Characteristics …………………………….…………………….………71 Table 2.3 The Comparison between Boutique and Full Service Banks ………….……..72 Table 2.4 Univariate Analysis Panel A-Classified by Acquirer’s Advisor …………………………..………….74 Panel B- Classified by Target’s Advisor ……………………….…….…………75 viii Table 2.5 Determinants of the Use of Boutique Advisor Panel A- Acquirer’s Choice on Advisors………..……….…………..…………..76 Panel B- Target’s Choice on Advisors………..……….………………..………..87 Table 2.6 The Impact of Boutique Advisors on Deal Completion ….……….………….78 Table 2.7 The Impact of Boutique Advisors on Deal Duration… ….………..………….79 Table 2.8 The Impact of a Boutique Advisor on the Deal Premium Panel A-OLS Regression ….………………….……………………..………….80 Panel B-Two Stage Least Square Regressions – Mergers ……………...……….81 Panel C-Two Stage Least Square Regressions – Tenders …………………...….82 Table 2.9 Impact of Boutique Advisor on Announcement Period Returns…………..….83 Figure 1 Time Trend of the Merge Wave and the Use of Boutique Advisors……….…..84 ix Introduction M&A is a very active section of the financial market involving multi-trillion dollar businesses every year. Extensive research has been done on this battle field for corporate control, covering a wide range of topics. Most studies focus on two parties of the trade, namely the acquirer and the target. However, the third party of this game, like financial advisors and risk arbitrageurs, play very important roles too. Risk arbitrageurs buy target’s stocks when a deal is announced. By providing target shareholders a sure return and taking on the risk of deal failing, they make the return of the speculative P − P spread ( offer +1 ). They not only facilitate the price discovery process by trading P+1 target’s (some times acquirer’s too when the medium of payment involves acquirer’s stock) equity, but also indirectly assist the deal completion. Financial advisors, as the third party, play an even more direct role than risk arbitrageurs. They help both sides negotiate the price and terms of the trade; they even help with the financing in some cases. Their own identities and objectives directly affect the outcome of the takeover. However, research on these third party players is limited. There are puzzles and interesting open questions that have not been fully studied yet. In this study, we focus our attention on these third party players. The first puzzle we try to resolve is the risk arbitrageur’s excess profit. If and why M&A arbitrageurs earn risk adjusted excess returns is a big unanswered question in the M&A literature. The goal of the first chapter of this study is to examine the risk and return relation of M&A arbitrageurs in different idiosyncratic and systematic 1 environments. On one hand, deal characteristics create idiosyncratic risk for arbitrageurs by affecting the ex-ante probability of deal success. On the other hand, market liquidity conditions also affect the probability of deal success and more importantly the P − P speculative spreads ( offer +1 ), which is the source of these arbitrageur’s profit. For P+1 example, when the market experienced the credit crunch in mid 2007, speculative

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