Investment banks or boutiques: Why are they chosen and what firm type makes the better M&A deals? An empirical investigation regarding domestic M&A deals in the USA Master Thesis Author: S.R. Faber ANR (SNR): 215677 (1275258) Program: Master of Finance Supervisor: dr. C.A.R. Schneider University: University of Tilburg, Netherlands Abstract Between 2000 and 2015 there has been an increase in the M&A advisory business for boutiques advisors. The main difference between boutique advisors and full-service investment banks is that boutique advisors generally have knowledge in a specific sector or have a specialization on M&A, whereas full-service investment banks often cover a wide variety of services. This thesis investigates whether the findings found by Song et al. (2013) are still valid using another dataset. Song et al. (2013) investigated the firms’ choice for a boutique- or full-service advisor and what consequences it has for the deal outcome. It was found that boutique advisors (mixed advisory teams) have a higher probability of getting hired, when the deal size is small (high). In addition to this, boutique advisors generate higher deal premiums on both the target and acquirer side of the deal. No statistical evidence is found to draw conclusions regarding the influence of advisors on deal duration and deal completion. Overall, no significant statement can be made regarding the performance of boutique advisors when they are compared to full-service advisors. Master Thesis – B a s F a b e r – MSc. Finance (2016 - 2017) | 2 1. Introduction Over the last years there has been an increase in mergers and acquisitions (hereafter: M&A) deals, both domestic and international. Thomson Reuters published an overview of 2015, and found that it has been the biggest year for mergers and acquisitions ever, with worldwide announced deals worth of a total of $4.7 trillion1, compared to $3.3 trillion in 2014 (an increase of 42%). America’s M&A volume increased 43.3% during 2015 compared to 2014, accruing nearly $2.9 trillion in activity from 15,922 announced deals. The majority of these deals were advised by at least one financial advisor, known to be an investment bank, an investment boutique or a mix of both. The report that was published by Thomson Reuters in 2015 also reports about the advising parties and how they did over 2015. One interesting factor to consider is that the advising companies that were ranked as number one to seven are all investment banks in the performance rankings, and thereafter it becomes more a mix of boutiques and investment banks. Both investment banks and boutiques provide financial advising services to their clients. However, boutiques are usually independent (free of conflicts), specialized in a specific branch and have an expertise in M&A, yet they are often not well-known and small. Meanwhile, investment banks are often large and well-known, and have, besides M&As, other fields of expertise. Despite this, Reuters found that, since the financial crisis boutiques have been aggressively grabbing market share from M&A deals from their investment bank counterparts. In 2016, the boutiques accounted for 34% of the fees paid out to advising fees, an increase of 20% compared to 20072. This is a strong indicator that the boutiques have gained increasing popularity over the last years, and this reflects on the results they achieved. Song et al. (2013) wrote an analysis about factors that make firms chose for a boutique advisor or a mixed advisory team and the consequences for the deal outcome. The paper was focused on the differences between investment banks, boutiques and a mix of both on the takeover premium, deal duration and deal completion using data between 1995 and 2006. As stated above, much has happened in M&A over time. The aim of this paper is to find out whether the findings of Song et al. (2013) are still valid, using data between 2000 and 2015. Research will be conducted under the two hypotheses that were used by Song et al. (2013) which are the scale and the skill hypotheses. The scale hypothesis will investigate whether the 1 Thomson Reuters Website; ArticleNr: MA-4Q15-(E). Accessed at: http://share.thomsonreuters.com/general/PR/MA-4Q15-(E).pdf (page 4) Note: These numbers are the deals in which a US company is the target company. This may be domestic and international deals. 2 Retrieved from http://www.reuters.com/article/us-banks-boutiques-strategy-idUSKBN1432WH Master Thesis – B a s F a b e r – MSc. Finance (2016 - 2017) | 3 deal size determines the choice between an investment bank and a boutique. On the other hand, the skill hypothesis will investigate whether the complexity of the deal determines the choice between an investment bank and a boutique, and states that in a complex deal it is more likely that a boutique will be chosen as an advising company due to their specific knowledge of a branch. The data finds contradictory evidence regarding the scale hypothesis: it is found that boutique advisors are less likely to be hired over full-service advisors in larger deals; however, it is also found that mixed advisory teams are more likely to be hired over a full- service advisor when deal size increases. These findings are valid for both acquirer advisors and target advisors. Furthermore, it was found that the evidence regarding the skill hypothesis is inconclusive and insignificant. From the perspective of the acquirer it is found that boutiques are more likely to be hired in hostile deals and cross-industry deals, yet less likely to be hired in deals with a competing offer. Mixed advisory teams, on the other hand, are more likely to be hired by an acquirer in cross-industry deals, yet less likely to get hired in hostile and deals with a competing offer. From a target advisor perspective, it is found that both boutique advisors and mixed advisory teams are less likely to be hired in stock deals and hostile deals, which is opposing the skill hypothesis. The results regarding the impact of advisors on deal outcomes find that boutiques on both the acquirer and target side of the deal significantly increase the deal premium. Adding to this, the results regarding deal duration imply that the advisor choice does play a significant role, contradictory to the deal completion where the advisor choice does not play a significant role. It is found that the deal characteristics have a greater significant impact on both deal duration and deal completion. This paper contributes to the existing literature financial advisor and M&A literature as it will investigate whether previous research is still valid while other more recent data is used. In previous research it was firstly concluded that firms that face difficult deals are more likely to employ a boutique as an advising company. Secondly, it was concluded that boutique advisors provide better deal outcomes, and that they are therefore gaining in popularity. Finally, Song et al. (2013) found that the deal premium decreases when a boutique advisor is consulted on the acquirer side of the deal, boutique advisors take significantly longer to complete a deal and that the choice of an advisor does not matter for the probability of completion. Using another dataset, it is concluded that acquirer boutiques significantly Master Thesis – B a s F a b e r – MSc. Finance (2016 - 2017) | 4 increase the deal premium in a deal. The results regarding deal duration and deal completion are insignificant. The remainder of this paper is structured as follows. Section 2 will review the existing literature regarding the effect of financial advisors on M&As. In section 3 the hypotheses will be stated and explained, equitable to their empirical testability. Section 4 describes the data, and section 5 will report the empirical findings. The paper will be concluded in section 6. Master Thesis – B a s F a b e r – MSc. Finance (2016 - 2017) | 5 2. Literature review Previous literature regarding M&As is mainly focused on abnormal stock returns around the M&A announcement date, with control variables regarding the target company, the acquiring company, and the deal itself. The literature regarding the importance of advisors in M&A deals is more limited and can be divided into two sub-categories: (i) the early literature mainly focuses on contract terms and fees transactions, and (ii) the more recent literature focuses more on reputation effects on the completion and advisor choice. Angwin and Karamat (2015), consider reputation to be a mechanism for increasing the likelihood of repeat participation in M&A activity by developing attributes that positively influence M&A deal characteristics, and for clients to engage investment banks with the relevant traits matching 230 the deal criteria to improve deal performance. First of all, Hunter and Jagtiani (2003) and Ma (2005) find that top-tier advisors are generally more capable of bringing a deal to completion than lower tier advisors. In addition to this, Graham, Walter, Yawson and Zhang (2017) find that compared to non-industry specialists, advisors specializing in the target industry help acquirers garner higher announcement returns. Forte, Iannotta, and Navone (2010) find that the abnormal returns of target company shareholders increase with the intensity of the previous banking relationship. On the other hand, Schiereck, Sigl-Grüb and Unverhau (2009) find that there is no significant difference in wealth for transactions advised by different advisor tiers. In addition to this, Allen, Jagtiani, Peristiani, & Saunders (2002) find that acquirers tend to choose their own banks (banks they had a previous relationship with) as advisor in mergers.