shareholder rights and the effects of acquirer cash
TRANSCRIPT
Shareholder Rights and the Effects of Acquirer Cash Holdings on Merger
Performance*
Ning Gao a,† and Abdulkadir Mohamed b
a University of Manchester, Manchester Business School, Manchester Accounting and Finance Group, Booth
Street West, M15 6PB, UK. Email: [email protected]. b University of Liverpool, Management School, Liverpool, L69 3BX, UK. Email:
March 2015
Abstract
In the U.S., cash richer acquirers perform better in the presence of strong shareholder
rights, both at deal announcement and over the long run post mergers. Cash-rich acquirers
underperform only when they are less financially constrained and their shareholders possess
weak rights. In the U.K. the positive cash effect on acquirer performance persists on average.
In both countries, positive cash holdings effects are stronger when an acquirer is more
financially constrained. The positive effects of acquirer cash holdings can be explained by the
precautionary motive.
Key words: shareholder rights, acquirer performance, cash holdings, the precautionary motive, mergers and acquisitions. JEL Classification: G30, G34
* We thank Kevin Aretz, Heitor Almeida, Paul André, Sanjay Banerji, Onur Bayar, Mike Bowe, Michael Brennan, Francis Breedon, Gary Cook, Murray Dalziel, Viet Dang, Sudipto Dasgupta, Chris Florackis, Laurent Frésard, Ian Garrett, Alfonsina Iona, Weimin Liu, Evgeny Lyandres, Maria Marchica, Aydin Ozkan, Neslihan Ozkan, Jay Ritter, Konstantinos Stathopoulos, Ronald Masulis, Christos Mavis, Ser-Huang Poon, Norman Strong, Richard Taffler, Martin Walker, and Huainan Zhao. We also thank seminar participants at Durham University, University of Nottingham, University of Nottingham (Ning Bo), University of Manchester, University of Liverpool, Queen Mary University of London, and Zhejiang University as well as the participants of the FMA 2012 annual conference in Atlanta, the ESRC Conference on Corporate Governance and Corporate Investment 2011, the European Financial Management Association (EFMA) 2011 conference, and the British Accounting and Finance Association Northern Area Group Annual Conference 2011. All errors are ours. We gratefully acknowledge the support of ESRC Grant RES-061-25-0225. † Corresponding author, Accounting and Finance Group, Manchester Business School, University of Manchester, Booth Street West, M15 6PB, U.K. Email: [email protected], Tel: +44 (0) 1612754847, Fax: +44 (0) 2754023.
Shareholder Rights and the Effects of Acquirer Cash Holdings on Merger
Performance
Abstract
In the U.S., cash richer acquirers perform better in the presence of strong shareholder
rights, both at deal announcement and over the long run post mergers. Cash-rich acquirers
underperform only when they are less financially constrained and their shareholders possess
weak rights. In the U.K. the positive cash effect on acquirer performance persists on average.
In both countries, positive cash holdings effects are stronger when an acquirer is more
financially constrained. The positive effects of acquirer cash holdings can be explained by the
precautionary motive.
Key words: shareholder rights, acquirer performance, cash holdings, the precautionary motive, mergers and acquisitions.
JEL Classification: G30, G34
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1. Introduction
That cash-rich acquirers make value-destroying acquisitions is frequently cited as
evidence of the agency theory of free cash flow (Jensen, 1986). Nevertheless, extant literature
has failed to consider how cash-rich acquirers’ performances are determined according to the
strength of shareholder rights (e.g., Lang, Stulz, and Walkling, 1991; Harford, 1999; Oler, 2008).
In several influential studies, researchers demonstrate a robustly negative relation between firm
value and restrictions on shareholder rights in the past thirty years, which strongly suggests that
the analysis of cash-rich acquirers’ performances should incorporate the impact of shareholder
rights (Gompers, Ishii, and Metrick, 2003; Bebchuk and Cohen, 2005; Cremers and Nair, 2005;
Bebchuk, Cohen, and Ferrell, 2009; Bebchuk, Cohen, and Wang 2013; Giroud and Mueller,
2011; Lewellen and Metrick, 2010; Cremers and Ferrell, 2014).1 In this paper, we demonstrate
that, under strong shareholder rights, cash-rich acquirers in the U.S. perform better both at deal
announcements and over the long run after merger completion. The negative relation between
acquirer cash holdings and performance exists only when the acquirers are less financially
constrained and their shareholders possess weak rights. Our further analysis using U.K. data
reveals a positive relation between acquirer cash holdings and performance, which is more
pronounced when institutional shareholders have non-trivial share holdings.
1 We refer to shareholder rights at the firm level. Several influential studies examine shareholder rights at the
country level, e.g., La Porta, Lopez-de-Silanes, Shleifer, and Vishny (1998), which is not our focus.
2
Overturning the entrenched negative perception of acquirer cash holdings requires a solid
conceptual framework in addition to robust empirical evidence. We argue that in the presence of
strong shareholder rights, a manager is more likely to hold cash under the precautionary motive
than under the agency motive. In the presence of the precautionary motive, the manager of a
financially constrained firm may forgoe current investment opportunities and holds cash to invest
in future projects that are more profitable.2 In the presence of strong shareholder rights, a
manager is less likely to stockpile cash to obtain private benefits.
We briefly describe here the mechanism through which the precautionary motive yields a
positive cash holdings effect on acquirer performance. A more detailed discussion is in Appendix
C. Almeida, Compello, and Weibach (2004) formalize the idea of the precautionary motive,
which can be traced back to Keynes (1936). In their model, the manager of a financially
constrained firm faces a trade-off between current and future investment projects. She saves cash
out of current cash flows if a future project is expected to be more valuable than the current
project. Cash holdings are optimized when the expected marginal return of the future project
equals the expected marginal return of the current project. Consequently, a financially
constrained firm holds more cash today if the manager believes that the future project is more
profitable. In other words, ceteris paribus, a cash-rich firm foresees more valuable projects in the
future compared to a cash-poor firm. Stock prices prior to an acquisition should have
incorporated such an expectation; however, an update to the acquisition probability induces
2 The terminology is inconsistent in the previous literature (see Kim, Mauer, and Sherman, 1998, p336). In this
paper, we adopt the definition provided by Almeida, Campello, and Weisbach (2004) as well as Han and Qiu (2007), which focuses on the trade-off between current and the future projects.
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greater announcement returns for cash-rich acquirers. To establish this idea, assume that
acquisition is the only type of future investment. Let E(VH) denote the expected value of an
acquisition available to a cash-rich company H and E(VL) denote the expected value of an
acquisition available to a cash-poor company L. According to the precautionary motive, E(VH) >
E(VL) if the concavity of the production function is constant (Appendix C provides a more
detailed discussion). Assume that both acquisitions are anticipated equally by the market with
probability p < 1. At deal announcement, the return to company H should be higher than the
return to company L, i.e., (1 − p) E(VH) > (1 − p) E(VL). Note that our hypothesis is not based on
the cash flow sensitivity of cash proposed by Almeida et al. (2004) but builds on their analysis of
how the value of a future project relates to optimal cash holdings.
Previous studies overlooked the moderating role of shareholder rights. Conversely, we
emphasize the importance of shareholder rights in determining the direction of acquirer cash
holdings effects. Throughout this paper, we use the term shareholder rights with the knowledge
that shareholder rights and managerial power are two sides of the same coin. We analyze cash
holdings effects in the U.K. and U.S. In the U.S., shareholder rights vary substantially at the firm
level (Cremers and Ferrell, 2014). We use the E-index (the entrenchment index developed by
Bebchuk, Cohen, and Ferrell, 2009) and CEO duality (Brickley, Coles, and Jarrell, 1997;
Rechner and Dalton, 1991; Baliga, Moyer, and Rao, 1996) to distinguish between firms with
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strong and weak shareholder rights.3 We use the terms combined and separated leadership rather
than CEO duality to facilitate our subsequent discussions. As previously mentioned, we observe
positive acquirer cash holdings effects on acquirer performance over both the short and long run
for those U.S. acquirers with strong shareholder rights (using low E-index values or separated
leadership structure as proxy). The positive effect at deal announcement emerges when a
transaction surprises the market (Appendix D explains how we classify predicted and
unpredicted acquirers), which is consistent with the view that the update of acquisition
probability produces differing announcement returns for cash-rich and cash-poor acquirers. In
the U.K., acquirer cash holdings on average have a positive effect on merger performance, which
is more pronounced under stronger shareholder rights (using non-trivial institutional holdings as
proxy). The U.K. market is particularly relevant to demonstrating the validity of our observations
in a different institutional environment. Although these two countries are similar on several
dimensions of shareholder rights (La Porta, Lopez-De-Silanes, Shleifer, and Vishny, 1997), a
closer examination reveals that, on a number of other dimensions, the U.K institutions give more
rights to shareholders than those of the U.S. (In Appendix A, we explain the U.K. institutional
context in more details). Several influential studies postulate that shareholder rights on average
are particularly strong in the U.K. due to its legal, regulatory, and cultural institutions (Black,
1990; Black and Coffee, 1994; Bebchuk, 2005; Armour and Skeel, 2007). Bebchuk (2005), in
contrast, argues that the U.S. is exceptional among developed economies in that its institutions
3 Using the G-index of Gompers, Ishii, and Metrick (2003) yields similar results. The E-index summarizes six
most essential elements of the G-index (Bebchuk, Cohen, and Ferrell, 2009). Moreover, RiskMetrics does not provide all the data needed to calculate the G-index for years after 2006.
5
empower managers too much. A few previous studies also demonstrate that the U.K. institutions
offer better protection to minority shareholders from self-dealing (Djankov, La Porta, Lopez-de-
Silanes, Shleifer, 2008) and provide incumbent shareholders better protection from disruptive
takeovers (Nenova, 2006), compare to the U.S. institutions. Strong shareholder rights in the U.K.
are exemplified by the high-profile takeover of Cadbury by Kraft in 2009. Despite objections
from Cadbury management, the deal was completed without much trouble. As is noted in an
article published by the New York Times, “…If the takeover battle were happening in the United
States, it would most likely be a fierce fight… The potential for a CEO or entrenched board to
block a deal — or otherwise act in its own self-interest — is virtually nil. In other words,
England (U.K.) is as close as any country gets to a true shareholder democracy. Any bid gets put
to a vote, and all the board can do is to offer an opinion” — November 17, 2009, New York
Times.4
To the extent that the precautionary motive is more relevant when a firm is more
financially constrained, we observe that the positive cash holdings effect is particularly strong
when acquirers either have high Whited-Wu index (Whited and Wu, 2006) or do not have bond
ratings (Whited, 1992; Almeida, et al., 2004; Denis and Sibilkov, 2010; Duchin, 2010) regardless
of the acquirer’s country of domicile.5 The Whited-Wu index was developed by Whited and Wu
(2006) and captures a wide range of firm characteristics that relate to financial constraints. The use
of bond rating is motivated by several theoretical studies that examine how information
4 In Appendix A, we explain the U.K. institutional context in more detail. 5 We estimate Whited-Wu indexes for the U.S. and the U.K. using their respective data.
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asymmetry in the bond market affects firm ability to obtain external financing (Myers, 1977;
Jensen and Meckling, 1976; Whited, 1992). We follow previous studies (Almeida, et al., 2004;
Denis and Sibilkov, 2009; Duchin, 2010) to define a No bond ratings dummy as equal to 1 if an
acquirer has ever obtained a bond rating and 0 otherwise. We also find in the U.S. that, even
under weak shareholder rights (i.e., combined leadership or high E-index values), the negative
cash holdings effect disappears when acquirers are more financially constrained.
In all regressions of acquirer announcement returns, we control for the estimated
acquisition probability to ensure that the differing returns to acquirers of differing cash status are
not driven by the extent of market anticipation. To ensure that our results are not driven by self-
selection of the acquirer sample, we estimate a Heckman (1979) model and demonstrate that our
results are robust to self-selection bias. Another plausible concern about the U.K. results is that
the positive cash holdings effect is due to unmeasured institutional differences between the U.K.
and U.S. To the extent that these countries are characterized by similar legal origins, financial
market developments, and dispersed company shareholder bases, this concern is substantially
mitigated. Furthermore, we observe that positive cash holdings effects in the U.K. over both the
short and long run are strengthened in the presence of non-trivial institutional share holdings in
acquirers. To measure the level of cash holdings, we follow the excess cash holdings estimated
by Opler, Pinkowitz, Stulz, and Williamson (1999), but our results are robust to several
alternative measures of excess cash holdings (Appendix B provides more details).
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Our study demonstrates that the performance of cash-rich acquirers depends on the
strength of shareholder rights. When shareholder rights are strong, acquirer cash holdings are
positively associated with performance. We extend the original study of Harford (1999) by
demonstrating that the negative acquirer cash-holdings effects on performance are reversed in the
presence of strong shareholder rights. Harford’s (1999) analysis covers a sample period in the
U.S. from 1976 to 1993. We analyzes an updated period from 1990 to 2007 during which market
participants in the U.S. experienced increased importance and awareness of shareholder rights
(Bebchuk, Cohen, and Wang, 2013; Cremers and Ferrell, 2014) and enhanced relevance of the
precautionary motive for corporate cash holdings (Bate, Kahle, and Stulz, 2009).6 Our evidence
from the U.K., a regime that offers shareholders strong rights, further confirm the positive
acquirer cash-holdings effects suggested by the precautionary motive. Jensen (1986) maintains
that, left unchecked, self-serving managers spend cash on value destroying investments. We
mirror his argument by suggesting that cash holdings enhance firm value in the presence of
strong shareholder rights that discipline managerial incentives. We argue that agency theory
alone is insufficient to explain all cash holdings effects in acquisitions. As Fresard (2010) noted,
not long ago, cash holdings were considered dangerous to shareholders. However, recent
developments in finance research and turmoil in financial markets have highlighted the possible
benefits of cash holdings. Our study suggests that, while the agency theory of free cash flow may
dominate when shareholder rights are weak, the precautionary motive of cash holdings is likely
6 Data needed to calculate the E-index become available from RiskMetrics since 1990.
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to prevail under strong shareholder rights. The balance between costs and benefits of corporate
cash holdings relies on the strength of shareholder rights.
Our finding that strong shareholder rights relate to cash-rich acquirers’ better
performances are very much in line with those of Dittmar and Mahrt-Smith (2007) and
Pinkowitz, Stulz, and Williamson (2006), who find that strong corporate governance and
investor protection are associated with greater value of cash. Moreover, Faulkender and Wang
(2006) and Pinkowitz and Williamson (2007) posit that the value of cash holdings increases with
the degree of financial constraints. We demonstrate that the positive cash holdings effect on
acquirer performance is particularly pronounced when an acquirer is more financially
constrained. Our study also contributes to a broader literature that document a robust positive
association between shareholder rights and firm value (Gompers, Ishii, and Metrick, 2003;
Bebchuk and Cohen, 2005; Cremers and Nair, 2005; Bebchuk, Cohen, and Ferrell, 2009;
Bebchuk, Cohen, and Wang 2013; Giroud and Mueller, 2011; Lewellen and Metrick, 2010;
Cremers and Ferrell, 2014). Our evidence suggest that an important channel through which
shareholder rights enhance firm value is the incentive for managers to invest cash holdings
optimally.
Our study also closely relates to the precautionary motive of cash holdings, which is
formalized in a few theoretical studies (Almeida, et al., 2004; Kim, Mauer, and Sherman, 1998;
Han and Qiu, 2007) and supported by a strand of empirical literature (Kamien and Schwartz,
1978; Opler, et al., 1999; Almeida et al., 2004; Ozkan and Ozkan, 2004; Khurana, Martin, and
9
Pereira, 2006; Opler et al., 1999; Bates, Kahle, and Stulz, 2009; Gryglewicz, 2011; Mikkelson
and Partch, 2003; Acharya, Almeida and Campello, 2007; Duchin, 2010). However, previous
research focuses on the determinants of cash holdings. Much less is understood about how cash
reserved under the precautionary motive enhances firm value. We fill in some of this gap by
demonstrating that cash held under strong shareholder rights relates to better acquirer
performance. We also specify the mechanism that leads to a positive cash holdings effect on
acquirer returns at merger announcement, building on the precautionary motive of cash holdings.
Our study therefore also contributes to the literature that analyzes the implications of the
precautionary motive on corporate decisions.
The remainder of this paper proceeds as follows. Section 2 reviews the relevant literature
and provides the context to develop our hypotheses. Section 3 specifies the hypotheses; Section 4
describes the sample and data; and Section 5 reports the empirical results. Section 6 concludes.
2. Literature review
2.1. The performances of cash-rich acquirers
Jensen (1986) predicts that firms with excessive cash flows tend to make value-destroying
investments. Several studies find that acquirer cash flows or cash holdings are negatively related
to acquirer performance, consistent with Jensen’s (1986) prediction. Lang et al. (1991) find that
acquirers that possess low Tobin’s Q ratios but high free cash flows experience lower
announcement returns. Schlingemann’s (2004) study of all-cash deals reports that free cash flow
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negatively affects bidder announcement returns. Harford (1999) finds that, on average, the more
excess cash holdings an acquirer has prior to a deal announcement, the worse that acquirer’s
performance is (excess cash holdings can be viewed as free cash flows accumulated over time).
Extending Harford’s (1999) analysis, Oler (2008) observe that cash-rich acquirers have worse
performance measured by both long-term post-acquisition stock market returns and accounting-
based operating performance. What is more, Morck, Shleifer, and Vishney (1990) argue that
acquisitions can be driven by managerial motives; Richardson (2006) maintains that firms with
high levels of free cash flow tend to invest above the optimal levels. In contrast, Mikkelson and
Partch (2003) argue that firms that persistently hold large cash reserves neither perform poorly
nor exhibit evidence of agency conflicts between managers and shareholders.The extant studies,
however, are silent on how shareholder rights affect cash-rich acquirers’ performance.
2.2. Shareholder rights
In their seminal study, Gompers, Ishii, and Metrick (2003) examine an important
dimension of corporate governance—shareholder rights. They aggregate 24 governance
provisions to form a G-index to proxy the strength of shareholder rights and find that stronger
shareholder rights relate to higher stock abnormal performance and greater firm value. In a later
study, Bebchuk, Cohen, and Ferrell (2009) demonstrate that firm value is crucially related to 6 of
the 24 governance provisions. They use these 6 provisions to form and entrenchment index (E-
index) to proxy for shareholder rights. Those 18 provisions not included in their E-index were
found irrelevant to firm value or abnormal returns.
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Extant studies have examined how shareholder rights relate to either abnormal stock
returns or firm value or both. Those studies on abnormal returns are complicated by expectations
of and learning by market participants and by pricing of risks. Following the original studies of
Gompers, Ishii, and Metrick (2003) and Bebchuk, Cohen, and Ferrell (2009), researchers have
demonstrated that the relation between shareholder rights and abnormal stock returns are only
present for firms with significant pension fund ownership (Cremers and Nair, 2005), firms in
non-competitive industries (Giroud and Mueller, 2011), or firms in the 1990s (Bebchuk, Cohen,
and Wang, 2013). Johnson, Moorman, and Sorescu (2009) argue that the relation between
shareholder rights and abnormal stock returns disappears once industry clustering is considered.
However, Lewellen and Metrick (2010) offer the opposite conclusion.
Despite the mixed observations of the relation between shareholder rights and abnormal
stock returns, Bebchuk, Cohen, and Wang (2013) and Cremers and Ferrell (2014) conclude that
shareholder rights have a robust and persistent negative association with firm value and
operating performance. Related, several studies demonstrate that weaker shareholder rights are
associated with lower announcement-period abnormal stock returns for acquirers in merger
transactions (Masulis, Wang, and Xie, 2007), higher cost of equity (Chen, Chen, and Wei, 2011)
and lower value of cash holdings (Dittmar and Mahrt-Smith, 2006; Pinkowitz, Stulz, and
Williamson, 2006).
2.3. The value of cash and the precautionary motive of cash holdings
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The value of cash has attracted much academic attention. On the one hand, excessive cash
flows or holdings can concern shareholders, as theorized by Jensen (1986) and Stulz (1990). On
the other hand, the precautionary motive (Almeida, et al., 2004; Froot, Scharfstein, and Stein,
1993; Keynes, 1936) maintains that financially constrained firms benefit from holding more cash
than they currently need if future opportunities are more profitable. These two theories are based
on contrasting premises of principle-agency relations. Managers are self-interested under the
agency theory, while they maximize shareholder value under the precautionary motive. Several
studies document that the relation between cash and firm value varies according to the robustness
of company corporate governance policies. Dittmar and Mahrt-Smith (2006) estimate that the
value of $1.00 in cash is between $1.27 and 1.62 for well-governed firms but only $0.42–0.88
for poorly governed firms. Pinkowitz, Stulz, and Williamson (2006) use international data and
observe that the value of cash is higher in countries with better investor protection. Both studies
report evidence consistent with the view that firms waste cash under poor corporate governance
(or weak investor protection), but strong shareholder rights reverses the negative effect of cash
on firm value.
The precautionary motive forms the theoretical foundation of the positive cash holdings
effect identified in this paper. Keynes (1936) originally posited that a major benefit of cash
reserves is that it enables a firm to undertake valuable investment opportunities whenever they
arise, which enhances firm value ex ante. He further notes that the benefits of cash reserves are a
function of the extent to which a company is financially constrained. An unconstrained company
can access external financing any time and, therefore, has no need for cash holdings.
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Consequently, cash holdings do not affect firm value in the absence of financial constraints.
Subsequent studies demonstrated that financial constraints arise under common market
imperfections, e.g., adverse selection in equity markets (Myers and Majluf, 1984) and the agency
cost of debt (Myers, 1977; Jensen and Meckling, 1976).
Almeida et al. (2004) formally analyze the precautionary motive. In their model, a
financially constrained firm chooses between a current and a future project. If the manager
believes that the future project is more valuable than the current one is, she discards the current
project and saves cash from current cash flows generated by the assets in place so that she can
invest in the future project when the opportunity arises. Optimal cash savings occur when the
expected marginal return to the future project equals the expected marginal return to the current
project. Importantly, holding the concavity of the production function constant, the more
valuable the future project is compared to the current one, the stronger the incentive to save part
of the current cash flow (p1785 Almeida et al., 2004). Almeida et al. (2004) assume that
companies can fully hedge the risk of cash flow generated from the assets in place. As a result, a
company is only concerned about the expected value of cash flows and not cash flow volatility.
Han and Qiu (2007) extend Almeida et al.’s (2004) model by assuming that firms can only
partially hedge their cash flow risk. They demonstrate that, when the marginal return to investing
in the future project is convex for a given amount of cash saved out of the current cash flows, the
marginal return to the future project increases with cash flow volatility. The increased marginal
return to the future project induces managers to save more cash out of the current cash flows to
equalize the marginal returns to both current and future projects (proposition 1, Han and Qiu,
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2007). When the concavity of the production function is constant, a greater marginal return
implies a higher value future project. In Appendix C, we elaborate the mechanism that generates
this positive relation between optimal cash savings and future project value. Our focus here is not
on the cash flow sensitivity of cash. Rather, we emphasize the positive relation between optimal
cash holdings and the value of a future project relative to a current project, as modelled by
Almeida et al. (2004).
An earlier study conducted by Kim, Mauer, and Sherman (1998) also models optimal
company cash savings in relation to future investments. However, the trade-off in their model is
not between current and future projects but between investments and cash savings in the same
period. In another theoretical study, Froot, Scharfstein, and Stein (1993) posit that higher cash
reserves enhance firm value by shielding investment capability from the negative impact of
volatile cash flows. More recently, Riddick and Whited (2009) demonstrate that firms hold more
cash when external financing is more costly or when firm cash flows are riskier.
A strand of literature provides empirical evidence consistent with the precautionary
motive. Extant studies have demonstrated that high-growth companies hold more cash in both
the U.K. and U.S. (Kamien and Schwartz, 1978; Opler, Pinkowitz, Stulz, and Williamson, 1999;
Almeida et al., 2004; Ozkan and Ozkan, 2004; and Khurana, Martin, and Pereira, 2006) and
higher cash flow volatility is associated with greater cash holdings (Han and Qiu, 2007; Opler et
al., 1999; Bates et al., 2009; and Gryglewicz, 2011). Acharya et al. (2007) demonstrate both
theoretically and empirically that firms prefer to hold more cash rather than retire debt when they
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expect a financing gap between cash flows and investment opportunities (i.e., cash flows and
investment opportunities are not synchronized). Duchin (2010) finds that diversified companies
hold less cash when investment opportunities at the divisional level are less correlated and when
cash flows at some divisions are highly correlated with the investment opportunities available to
other divisions (a smaller financing gap). He argues that this pattern occurs because diversified
companies can transfer cash across divisions to finance investments. However, to our
knowledge, the previous research focuses on the determinants of cash holdings under the
precautionary motive. Much less is known about how companies benefit from holding cash
under the precautionary motive. In this paper, we fill this gap by demonstrating that acquirers
with strong shareholder rights benefit from their cash holdings.
3. Hypotheses
When shareholder rights are strong, an acquirer is more likely to hold cash under the
precautionary motive, which induces a positive relation between acquirer cash holdings and
performance. Since the precautionary motive is most prominent when a firm faces severe
financial constraints, this positive relation should be most pronounced among more financially
constrained acquirers. As noted in the introduction, announcement returns are driven by the
updated acquisition probability, and we expect the positive cash holdings effect to be strongest
when a deal is not predicted by the market. Our hypotheses are presented below:
Hypothesis 1 (H1): When shareholder rights are strong, a cash-rich acquirer experiences higher announcement returns than a cash-poor bidder.
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Hypothesis 1a (H1a): The positive cash holdings effect on acquirer announcement returns is stronger for unpredicted acquisitions. Hypothesis 1b (H1b): The positive cash holdings effect on acquirer announcement returns is stronger for more financially constrained acquirers.
Deal synergies should manifest through long-term operating performance after an
acquisition; therefore, we test the following hypotheses:
Hypothesis 2 (H2): When shareholder rights are strong, a cash-rich acquirer experiences better post-acquisition operating performance than does a cash-poor acquirer. Hypothesis 2a (H2a): The positive cash holdings effect on acquirer operating performance is stronger for more financially constrained acquirers. We distinguish between predicted and unpredicted acquirers (H1a); a full discussion is
presented in Appendix D. We elaborate the mechanism that drives the positive relation between
acquirer cash holdings and the value of an acquisition in Appendix C, i.e., why E(VH) > E(VL) as
is highlighted in the introduction.
4. Sample and Data
Our sample of acquisitions were obtained from the SDC mergers and acquisitions (M&A)
database. For the U.K., the sample period is from 1984 to 2007. For the U.S., we begin in 1990
when the E-index became available. The sample period ends in 2007 to allow several years over
which to measure post-acquisition operating performance. We then impose several selection
criteria to the initial samples. First, following Harford (1999), we include only the major types of
acquisitions, namely mergers, acquisitions of majority interests, acquisitions of remaining
17
interests, and acquisitions of partial interests.7 Second, all acquisitions were completed, which
allows us to analyze post-acquisition operating performance. Third, following Harford (1999),
both the acquirer and target must be publicly listed firms. One benefit of focusing on public
targets is that we avoid confounding issues, such as concerns about loss of control to potential
block shareholders and target demand for liquidity (Chang, 1998; Fuller, Netter, and
Stegemoller, 2002). It also allows us to compare our results to those of previous studies. A
practical reason to exclude private targets is that target data are required to calculate the
operating performance of the merging firms prior to the acquisition. Fourth, the means of
payment (i.e., percentages of stock, cash, or mixed payments) must be available from the SDC.
To mitigate problems associated with recording error, we require the sum of the percentage
stock, cash, and mixed payments to be between 95% and 105%. Fifth, the transaction value must
be available and no less than £10 million. This criterion eliminates transactions that have little
price impact. Sixth, deal announcement and completion dates must be available from the SDC.
Seventh, we exclude financial acquirers (SIC 6000-6999) whose cash holdings are of a different
nature than those of industrial firms and utility acquirers (SIC 4900–4999) which are intensely
regulated. Eighth, we require data to be available to calculate performance measures (from
DataStream for the U.K. and Compustat for the U.S.). To measure acquirer announcement-
period performance, we calculate the cumulative abnormal returns (CAR) from two days before
7 These transactions are defined by the SDC and are commonly used in M&A studies. In a merger, all shares
outstanding of the target are acquired by the acquirer. In an acquisition of majority interests, the acquirer holds less than 50% of the target before the transaction and more than 50% after the transaction. In an acquisition of minority interests, the acquirer holds less than 50% of the target before the transaction and less than 50% after the transaction. In an acquisition of remaining interests, the acquirer holds more than 50% of the target before the transaction and the entire target after the transaction.
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to two days after the announcement, i.e., CAR (−2, +2). Abnormal returns are estimated using the
market model. If the announcement day is a public holiday, we use the subsequent trading day as
day 0. The estimation period is a 250-day window ending 15 trading days before the
announcement day (we require at least 30 non-missing daily stock returns within the estimation
window). A 5-day test period is chosen in case the announcement date listed in the SDC is
inaccurate. To measure operating performance, we follow Healy, Palepu, and Ruback (1992);
Harford (1999); and Powell and Stark (2005). In particular, we measure operating performance
by first calculating the difference between the operating cash flow and the change in working
capital and then dividing the difference by total assets. We adjust the calculated operating
performance using the median performance of other firms in the same industry, size decile, and
operating-performance decile. The final measure, Post-acquisition operating performance, is the
combined-firm’s adjusted operating performance averaged over the 3 years following deal
completion. Pre-acquisition operating performance is the value-weighted (using the market
value of assets) combination of acquirer and target adjusted operating performances, averaged
over the three years prior to deal announcement. Ninth, we require that data are available (from
DataStream and Thomson One Banker for the U.K. and CRSP and Compustat for the U.S.) to
calculate the excess cash reserve ratio as defined in Appendix B, and the predicted and
unpredicted acquirers as defined in Appendix D. High cash holdings can be accumulated out of
either internal or external cash flows. For example, McLean (2011) finds that firms issue shares
to hoard cash when the cost of external equity is low. The focus of this paper, however, is not on
how excess cash holdings are accumulated. The model presented by Almeida, et al. (2004) can
19
incorporate external cash flows with minimal modification. Tenth, we require all control
variables in our regressions to be calculated from the data provided by DataStream, Thomson
One Banker, CRSP, or Compustat. The following are the control variables: probability of being
an acquirer (defined in Appendix D); acquirer total assets; acquirer market-to-book ratio
(defined as the sum of market value of equity and book value of long-term liabilities divided by
the sum of book value of equity and book value of long-term liabilities); acquirer leverage
(defined as book value of debt over total assets); acquirer asset tangibility (defined as the ratio of
tangible assets to total assets); acquirer return on assets (ROA) (defined as operating income
over total assets); relative deal value (defined as deal value divided by bidder market value of
equity); acquirer average sales growth over the two years before the announcement; and cash
payment (%)(the percentage of cash paid in the consideration). All acquirer characteristics are
measured at the fiscal-year end prior to deal announcement unless otherwise stated. For
approximately 30% of our final U.K. sample, DataStream codes are available but accounting
information is missing from WorldScope. We manually collect accounting data from the annual
reports provided by Thomson One Banker for these acquirers. All variables are measured in real
1994 values. The final sample includes 185 (2196) acquisitions with the full range of data for our
main regression analysis for the U.K. (the U.S.). The U.K. sample is substantially smaller than
the U.S. sample; however, this sample size is comparable to other U.K. studies, e.g., Antoniou,
Petmezas, and Zhao (2007) report a sample of 148 public targets during the period 1985–2004.
Our regression specifications are robust to outliers and heteroskedasticity. We also winsorize all
continuous variablesat the 1st and 99th percentiles, except the CAR.
20
Panel A of Table 1 reports the summary statistics for the U.S. sample. The CAR (−2, +2) has
a mean of −1% and a median of −0.8%, which are both insignificant (test statistics not
tabulated). The mean excess cash reserve ratio is 0.2% (median −2.3%), which suggests the U.S.
acquirers are scattered around their target level of cash holdings. An average acquirer has an
adjusted operating performance of 4.8% prior to the deal announcement and 6.6% after deal
completion, which suggests that acquisitions are value enhancing in the U.S. The average
Whited-Wu index is 1.88 and the median is 0.33, which suggests that, in the U.S., some acquirers
are extremely financially constrained. Of the acquirers, 1104 of 2196 firms have never obtained a
bond rating. The average E-index value is 1.96 and the median is 2, suggesting that, on average,
the shareholders of our sample acquirers are not weak; however, substantial differences in
shareholder power exist (i.e., the standard deviation is 1.4). Of the acquirers, 1681 of 2196 firms
have separated leadership structures, which suggest that, for a majority of our sample, acquirer
managerial power is contained to some extent. There is no significant difference between high-
and low-cash groups in terms of the CAR (−2, +2). In terms of operating performance, the high-
cash group significantly outperforms the low-cash group both before and after the acquisitions.
Notably, acquisitions seem to improve operating performance only for the high-cash group (from
4.88 to 6.69). High-cash acquirers are less financially constrained. High-cash firms have a
Whited-Wu index of 0.26, and 772 of 1098 high-cash acquirers have ever received a bond rating,
while the low-cash group has a Whited-Wu index of 0.425, and 320 of 1098 low-cash acquirers
have ever obtained a bond rating. The high- and low-cash groups are similar in terms of their E-
index values, but the high-cash group contains more acquirers with separated leadership.
21
Panel B of Table 1 reports the summary statistics for the U.K. sample. These statistics are
comparable to the U.S. statistics. The acquirer CAR has a mean of −0.4% and a median of
−0.3%, and neither value is significantly different from zero (test statistics not tabulated). The
mean excess cash reserve ratio is −5.3% (median −3.4%), which indicates that the U.K.
acquirers, on average, have cash reserve ratios below their target levels. An average acquirer has
an adjusted operating performance of 5.2% prior to the deal announcement and 6.7% after deal
completion, which suggests that the acquisitions enhance value. The average Whited-Wu index is
0.88 (median 0.57), and 106 of the 185 acquirers have been assigned a bond rating. Institutional
holdings are substantial at 46.3% of the total shares outstanding (median 12.2%), and 53
acquirers possess total institutional holdings above 3%. In the right section of Panel A, we report
the median values for acquirers with high (above the median) and low excess cash holdings. As
in the U.S., there is no significant difference between the high- and low-cash groups in terms of
the CAR (−2, +2); however, a fair comparison should be conditioned on other variables that also
affect returns. In terms of operating performance, the high-cash group significantly outperforms
the low-cash group both before and after the acquisitions. Notably, the acquisitions seem to
improve operating performance regardless of the level of excess cash holdings. Our subsequent
regression analysis should demonstrate which group experiences greater improvement. The high-
cash group exhibits greater growth measured by market-to-book ratio of assets (1.6 vs. 1.3). This
group is less financially constrained. High-cash acquirers possess a median Whited-Wu index of
0.46, and 81 of 92 acquirers have bond ratings, while low-cash acquirers possess a median
Whited-Wu index of 0.69, and only 25 of 93 firms have bond ratings. Institutional holdings are
22
greater for the high-cash group, who possess median holdings of 14.2%, and 39 of 92 firms have
institutional holdings greater than 3%. The low-cash group possesses median institutional
holdings of 10.1%, and only 14 of 93 firms have institutional holdings greater than 3%.
[TABLE 1]
5. Empirical results
In this section, we present the U.S. results first, followed by the U.K. evidence.
5.1. The positive cash holdings effect on bidder announcement returns in the U.S.
We use the following baseline model to test H1:
1i i i i i iCAR Excash Controls YDUM INDDUM , (1)
where i indexes the acquisitions; CAR is the acquirer cumulative abnormal returns from 2 trading
days before to 2 trading days after the announcement day, i.e., CAR (−2, +2); Excash is the
acquirer excess cash reserve ratio; and Controls is a vector of control variables suggested by
previous research, which includes the probability of being an acquirer, bidder size measured by
log (1 + total assets), asset tangibility, returns on assets, log (1 + average sales growth), log (1 +
market-to-book ratio), leverage, relative deal value, cash payment (%), tender offer dummy,
friendly deal dummy, and diversifying deal dummy. YDUM and INDDUM are the year and
industry effects, respectively. We control for the probability of being an acquirer because
23
otherwise two acquisitions of the same synergistic value may have differing announcement
returns to the acquirers, depending on the extent to which the deals are anticipated by the market.
The probability of being a bidder is estimated using Equation (D.1) in Appendix D.
To test H1a, we use the following specification:
2
3
-
-
-
i i i
i i
i i i i i
CAR Excash Predicted acquirer Dummy
Excash Unpredicted acquirer Dummy
Unpredicted acquirer Dummy Controls YDUM INDDUM
, (2)
where the Unpredicted-acquirer Dummy is 1 for an unpredicted acquirer and 0 otherwise;
Predicted-acquirer Dummy is defined in the opposite manner (see Appendix D for a detailed
explanation of predicted and unpredicted acquirers).
We now analyze the acquirer cash holdings effects for U.S. firms. Although the institution
empowers management to a considerable extent, practices at the firm level vary substantially. It
is possible to identify a group of acquirers whose shareholders have sufficient rights to counter
managerial incentives towards spending cash. We use the E-index developed by Bebchuk,
Cohen, and Ferrell (2009) and combined/separated leadership (Brickley, Coles, and Jarrell, 1997;
Rechner and Dalton, 1991; Baliga, Moyer, and Rao, 1996) to distinguish between firms with
strong and weak shareholder rights. As mentioned, the E-index summarizes the most value-
relevant governance provisions identified by Gompers, Ishii, and Metrick (2003). A higher E-
index value suggests greater shareholder rights because shareholders face fewer restrictions on
their voting power and management is less shielded against internal or external control activities
24
(Bebchuk, Cohen, and Ferrell, 2009). Under separated leadership (the chairperson and CEO are
different persons), the chairperson provides an effective counterbalance to the dictatorial CEO
power inherent in the combined leadership structure (the same person is both CEO and
chairperson). Overall, our results reveal a positive association between acquirer cash holdings
and announcement returns when shareholder rights are strong. The negative cash holdings effect
appears to be restricted to those acquirers that have weak shareholder rights and are financially
less constrained. Table 2 provides more details. Panels A and B of Table 2 distinguish between
more and less financially constrained acquirers using the high Whited-Wu index dummy and bond
ratings dummy, respectively.
In Panel A of Table 2, Model 1 tests H1 using the full sample regardless of shareholder
rights. The variable log (1 + excess cash reserve ratio) possesses a significant (at the 1% level)
negative coefficient of −0.076, which appears consistent with the agency theory of free cash
flow. Model 2 tests H1a using the full sample regardless of shareholder rights but distinguishing
between predicted and unpredicted acquirers. The cash holdings effect for unpredicted acquirers
is significant and positive, which is consistent with H1a, that is, the interaction between
unpredicted acquirer dummy and log (1 + excess cash reserve ratio) is 0.142 and significant (at
5%). A one-standard-deviation increase in the acquirer excess cash reserve ratio is associated
with a 2.04 percentage point increase in acquirer CAR (−2, +2). This result is consistent when
we add the high Whited-Wu index dummy to Model 2 (not tabulated). This result contradicts the
negative impact of acquirer cash holdings on merger performance observed for 1976–1993 by
25
Harford (1999).That cash-rich acquirers perform better during our sample period of 1990–2007
concurs with the increased relevance of precautionary motive (Bates, Kahle, and Stulz, 2009)
and increases in market participants’ attention to governance and shareholder rights (Bebchuk,
Cohen, and Wang, 2013; Cremers and Ferrel, 2014; Gillian and Starks, 2000) in the same period,
which are plausible reason for the reversed cash holdings effect. To ensure that our results are
not due to empirical design, we estimate Model 2 for the period 1980–1993 (i.e., Model 11) and
observe a negative cash holdings effect for unpredicted bidders similar to those reported by
Harford (1999) for the period 1977–1993.
In Model 3, we test H1b using the full sample regardless of shareholder rights. We
include an interaction among the high Whited-Wu index dummy, unpredicted acquirer dummy,
and log (1 + excess cash reserve ratio) in this model. The interaction has a significant (at 1% )
positive coefficient of 0.376, which, combined with the coefficient (0.208) on the interaction
between the unpredicted acquirer dummy and log (1 + excess cash reserve ratio), represents an
increase of 8.40 percentage points in CAR (−2, +2) for more financially constrained acquirers
when the excess cash reserve ratio increases by one standard deviation.
Our primary interest is in how shareholder rights impact cash-rich acquirers’
performances. In Models 4 and 5, we re-estimate Model 3, distinguishing acquirers with low E-
index (strong shareholder rights) from those with high E-index (weak shareholder rights). We
observe that the E-index makes a notable difference in the coefficient on the two-item interaction
between the unpredicted acquirer dummy and log (1 + excess cash reserve ratio). The low E-
26
index subsample yields a positive coefficient of 0.319 (significant at the 1% level), while the
high E-index subsamples yields a statistically insignificant coefficient of −0.053. High E-index
also reduces the economic and statistical significance of the coefficient on the three-term
interaction among the high Whited-Wu index dummy, unpredicted acquirer dummy and log (1 +
excess cash reserve ratio), which is 0.510 in Model 4 (significant at 1%) and much weaker
(0.165) in model (5) (marginally significant at 10%). In model 4, adding the two coefficients on
the two-item and the three-item interactions yield a combined coefficient of 0.829 (i.e.,
0.319+0.510), which indicates that increasing the cash holdings by one standard deviation for
those more financially constrained acquirers relates to an increase of 11,92 percentage points in
their announcement abnormal returns in the presence of strong shareholder rights. The positive
cash holdings effect persists under strong shareholder rights even the acquirers are less
financially constrained: the two-item-interaction coefficient of 0.319 indicates that a one-
standard-deviation increase in acquirer cash holdings lead to an increase of 4.59 percentage
points in acquirer announcement abnormal returns.
On the right section of panel A (i.e., models 6–11), we use the leadership structure to
distinguish between acquirers with strong and weak shareholder rights. The sample size is larger
because we don’t require the E-index to be available. In models 6, 7, and 8, we repeat the
analysis in models 1, 2, and 3 respectively, and obtain similar results. Somewhat puzzling, we
observe a negative cash holdings effect for the predicted acquirers, that is, the interaction
between predicted acquirer dummy and log (1 + excess cash reserve ratio) is −0.154 and
27
marginally significant (at the 10% level). However, the marginal significance does not allow us
to make strong statistical inference. In Models 9 and 10, we distinguish acquirers with separated
leadership (strong shareholder rights) from those with combined leadership (weak shareholder
rights). Again, we observe a notable difference in the coefficient on the two-item interaction
between the unpredicted acquirer dummy and log (1 + excess cash reserve ratio). The separated
leadership subsample yields a positive coefficient of 0.129 (significant at 5% ), while the
combined leadership subsamples yields a negative coefficient of −0.207 (significant at 1% ). The
leadership structure does not significantly impact the coefficient of the three-item interaction
among the high Whited-Wu index dummy, unpredicted acquirer dummy and log (1 + excess cash
reserve ratio), which is 0.250 (0.351) in Model 9 (10) and statistically significant at 5% (1%). In
model 9, adding the two coefficients on the two-item and the three-item interactions yield a sum
of 0.379 (i.e., 0.129+0.250), which indicates that increasing the cash holdings by one standard
deviation for those more financially constrained acquirers relates to an increase of 5.45
percentage points in acquirer announcement abnormal returns under strong shareholder rights.
Even for less financially constrained acquirers, the coefficient of 0.129 on the two-item
interaction suggests that a one-standard-deviation increase in acquirer cash holdings concurs
with an increase of 1.86 percentage points in acquirer announcement abnormal returns when
shareholder rights are strong. Under combined leadership, the coefficient of −0.207 on the two-
item interaction between the unpredicted acquirer dummy and log (1 + excess cash reserve
ratio) indicates a one-standard-deviation increase in acquirer cash holdings relates to a decrease
of 2.98 percentage points in acquirer abnormal returns. However, this negative cash holdings
28
effect is offset when the acquirers are more financially constrained—an F-test (not tabulated)
cannot reject the null that the sum of the coefficient on the two-item interaction between the
unpredicted acquirer dummy and log (1 + excess cash reserve ratio), i.e., −0.207, and the
coefficient on the three-term interaction among the high Whited-Wu index dummy, unpredicted
acquirer dummy and log (1 + excess cash reserve ratio), i.e., 0.351, is insignificantly different
from zero.
In Panel B, we use the No bond rating dummy to distinguish between more and less
financially constrained acquirers. The results are qualitatively the same as those presented in
Panel A.It can be argued that target cash holdings also contribute to the investments post
mergers. In un-tabulated robustness tests, we check the cash holdings of target companies but
find the sizes of them are negligible relative to acquirer total assets. Our results do not change
when we add target cash holdings in our analysis.
The results reported in table 2 demonstrate a significant and substantial moderation effect of
shareholder rights on cash-rich acquirers’ performance. We find cash-rich acquirers outperform
cash-poor acquirers under strong shareholder rights. The previous-literature finding that cash-
rich acquirers perform poorly appears to be relevant only for those acquirers having less financial
constraints and weak shareholder rights. Our observation that greater financial constraints
amplify the positive relation between acquirer cash holdings and performances suggests that it is
the precautionary motive that underpins this positive relation, as we explained in the
introduction.
29
5.2. The positive cash holdings effect on acquirer post-acquisition operating performance in
the U.S.
In this section, we test H2 and H2a using U.S. data following the methodology used by
Healy et al. (1992), Harford (1999), and Powell and Stark (2005). We estimate a regression of
post-acquisition operating performance on pre-acquisition operating performance (defined in
Section 4). The baseline regression is specified as follows:
1
2 3
- -i i
i i i
Post Acquisition OPF Pre Acquisition OPF
High Excash Dummy CAR
, (3)
where i indexes the acquisitions; OPF is the adjusted operating performance; and α measures the
increment to operating performance post-acquisition. A significant, positive (negative) α implies
that acquisitions are, on average, value-increasing (value-decreasing). To examine the cash
holdings effect, we include a High Excash Dummy. In this analysis, a dummy variable yields
results that are easier to interpret than a continuous variable does because its coefficient can be
directly included in the intercept, which captures incremental operating performance. We also
include acquirer CAR measured over the five-day period (−2, +2) because we are interested in
determining whether the market returns at announcement correctly predict the changes in
operating performance post-acquisition. The results are consistent if we drop CAR from the
specification (not reported but available upon request). As in table 2, we use the Whited-Wu
index and No bond rating dummy to distinguish between acquirers that are more and less
financially constrained in Panels A and B of Table 3, respectively.
30
Model 1 of Panel A Table 3 indicates that the acquirer CAR has a significant (at 5%) and
positive coefficient of 0.0720, which implies that the acquirer CAR at announcement correctly
incorporates predictions of future operating performance. The intercept of Model 1 has a
significant (at 5% ) positive value of 0.0985, which indicates that acquisitions are, on average,
value enhancing, consistent with Healy et al. (1992). In Model 2 of Panel A, the high excash
dummy has a significant (at 1% ) and positive coefficient of 0.0551, and the interaction term
between high excash dummy and high Whited-Wu index dummy has a significant (at 1% ) and
positive coefficient of 0.0571. This result demonstrates that cash-rich acquirers outperform cash-
poor acquirers by 5.51 percentage points per year when the acquirers are less financially
constrained, and performance is significantly stronger (11.22 percentage points per year) when
the acquirers are more financially constrained. The coefficient of CAR becomes insignificant,
indicating that the variation in CAR mainly captures the variation in excess cash holdings. When
we estimate the regression on the separated and combined leadership subsamples, the coefficient
of the high excash dummy is statistically insignificant for acquirers with high E-index (weak
shareholder power) but significant (at 1% ) and positive (0.0761) for acquirers with low E-index
(strong shareholder power). Furthermore, the intercept of 0.0280 is insignificant for acquirers
with high E-index but exhibits a significant (at 5% ) and positive value of 0.1091 for acquirers
with low E-index. The coefficient of the interaction between high excash dummy and high
Whited-Wu index dummy is significant (at 1% ) and positive (0.0721) under low E-index and is
negative (−0.0362) and statistically insignificant under high E-index. Together, these results
indicate that under strong shareholder rights, cash holdings have a positive effect on acquirer
31
operating performance. Moreover, these effects are amplified when acquirers are more
financially constrained. Under weak shareholder power, cash holdings have no significant impact
on acquirer performance. In the right section of Panel A, we use the leadership structure to
measure shareholder rights. The results for the full sample and strong shareholder power (i.e.,
separated leadership) subsample are qualitatively the same. Acquirers with weak shareholder
rights (i.e., combined leadership) exhibit a significantly negative coefficient (−0.0322) on high
excash dummy, which is neutralized by the significantly positive coefficient (0.0371) on the
interaction between high excash dummy and high Whited-Wu index dummy, which again
indicates that underperformance, if any, is only related to less financially constrained acquirers
under weak shareholder rights. In Panel B, we measure financial constraints using the No bond
rating dummy. We obtain results that are consistent with those in Panel A. Overall, the results
presented in Table 3 are consistent with H2 and H2b.
5.3. The positive cash holdings effect on acquirer announcement returns in the U.K.
We now analyze the acquirer cash holdings effects for U.K. firms. Model 1 of Table 4
reveals that log(1+excess cash reserve ratio) has a significant (at 1% ) positive coefficient of
0.024, which indicates that a one-standard-deviation increase in the excess cash reserve ratio of
an average acquirer increases the CAR by 1.05 percentage points. Model 2 of Table 4 indicates
that the positive cash holdings effect mainly stems from unpredicted acquirers. The coefficient
on the interaction term between log (1 + excess cash reserve ratio) and the unpredicted acquirer
dummy is 0.030, which implies that when acquirer cash holdings increase by one standard
32
deviation, the acquirer CAR (−2, +2) increases by 1.18 percentage points. The coefficient of the
interaction term between log (1 + excess cash reserve ratio) and the predicted acquirer dummy
is −0.008 and statistically insignificant (p-value 0.761). The results of Model 2 are consistent
with hypothesis H1a, that is, the updating of acquisition probability promotes differing returns to
cash-rich and cash-poor acquirers.
A common criticism of the results obtained outside the U.S. is that unobservable
institutional features may drive the results. However, the U.K. and U.S share legal origins,
financial market developments, and dispersed company shareholder bases, which largely mitigates
such concerns. We also take additional precautions to examine whether stronger shareholder power
at the firm level strengthens the positive cash effect. Black and Coffee (1994) posit that institutional
investors in the U.K. are particularly powerful in intervening in company decisions. In this spirit,
Model 3 of Table 2 includes an interaction term among a nontrivial grand total institutional holdings
(> 3%) dummy variable, log (1 + excess cash reserve ratio), and the unpredicted acquirer dummy
variable. If unobservable institutional factors other than shareholder rights drive the positive cash
holdings effect in the U.K., we would not observe a significant interaction term coefficient. Model 3
indicates that this interaction term has a coefficient of 0.077 and is statistically significant at the 1%
level. The coefficient of the initial interaction term between cash holdings and unpredicted acquirer
dummy is 0.019 and remains statistically significant at the 5% level. This result indicates that the
positive effect of acquirer cash holdings is about four times stronger when institutional holdings are
nontrivial. Model 4 substitutes the dummy variable of nontrivial insurance company holdings for the
33
dummy variable of nontrivial grand total institutional holdings.8 We obtain results similar to those
from Model 3: the three-item interaction term is significant (at the 1% level) with a positive
coefficient of 0.081, and the interaction term of unpredicted acquirer dummy and cash holdings is
0.021 and statistically significant (at the 1% level). Given that the strength of the positive cash
holdings effect increases with shareholder rights as measured by institutional holdings, it is difficult
to argue that this effect is driven by unobservable institutional differences between the U.K. and U.S.
In Table 5, we test H1b using both the Whited-Wu index and the No bond rating dummy
variable to measure the extent to which an acquirer is financially constrained. In Model 1 of Table 5,
we add an interaction term among a high Whited-Wu index dummy (a value above sample
median), log (1 + excess cash reserve ratio), and the unpredicted acquirer dummy. This
interaction term is significant (at 1%) and has a positive coefficient of 0.266, which is over ten
times greater than the coefficient of the interaction term between the unpredicted acquirer
dummy and log (1 + excess cash reserve ratio) (0.022 and marginally statistically significant at
10%). The sum of these two coefficients represents the positive cash holdings effect of
financially constrained acquirers, while the coefficient of the latter interaction term captures the
cash holdings effect of financially unconstrained acquirers. In Model 2, we substitute the No
bond ratings dummy for the high White-Wu index dummy and obtain similar results. Table 5
indicates that the positive cash holdings effect is mainly present among more financially
constrained acquirers, which is consistent with H1b.
8 Black and Coffee (1994) claim that insurance companies are the most prominent institutional investors in the
U.K.
34
5.4. The positive cash holdings effect on acquirer post-acquisition operating performance in
the U.K.
We test H2 and H2a using U.K. data in this section. The specification is described in
Section 5.2. As in Section 5.3, we use the Whited-Wu index and No bond rating dummy to
distinguish between acquirers that are more and less financially constrained in Table 6. Model 1
of Table 6 indicates that the acquirer CAR has a significant (at the 5% level), positive coefficient
of 0.0102, which implies that the acquirer CAR at announcement correctly incorporates
predictions of future operating performance. In Model 2, the high excash dummy has a
significant (at 5% ) positive coefficient of 0.0020, which indicates that, on average, cash-rich
acquirers outperform cash-poor acquirers by 20 basis point per year for 3 years after the
acquisitions. The constant term is 0.0019 and is significant (at 1%), which is consistent with the
observation in Healy et al. (1992) that acquisitions are, on average, value increasing. The
coefficient of CAR is insignificant, which indicates that variation in CAR primarily reflects
variation in market predictions of operating performance. To address the usual concern that
unmeasured institutions specific to the U.K. drive our results, Model 3 includes an interaction
between the high excash dummy and non-trivial grand total institutional holdings dummy. The
coefficient of the interaction term is 0.0098, which is significant (at the 5% level). The
coefficient of the high excash dummy is 0.0024 and remains statistically significant (at the 5%
level). Therefore, when a cash-rich acquirer has non-trivial institutional holdings, it outperforms
cash-poor acquirers by 1.23 percentage points per year after deal completion. In Model 4, we
substitute the non-trivial insurance company holdings dummy for the non-trivial grand total
35
institutional holdings dummy and obtain similar results. We test H2b in Models 5 and 6. In
Model 5, we include an interaction between the high excash and high Whited-Wu index
dummies. The coefficient of the interaction term is 0.0035 and significant (at the 1% level). The
high excash dummy is significant (at the 1% level) with a positive coefficient of 0.0038. These
coefficients demonstrate that when a cash-rich acquirer is financially constrained, its operating
performance is 73 basis points greater per year than that of a cash-poor acquirer. The Whited-Wu
index on its own has a coefficient of 0.0023, which is significant (at the 1% level), implying that,
on average, more financially constrained acquirers make better acquisitions. Model 6 substitutes
the No bond ratings dummy for the high Whited-Wu index dummy; the results are robust to this
substitution.
5.5. Cash payment and cash-rich acquirers’ performance
As mentioned, underpinning the positive cash holdings effect on acquirer performance is
the precautionary motive. A company reserves cash out of current cash flows to invest in future
projects that are more profitable. A company would drawdown cash holdings and commits cash
to a good investment opportunity that emerges, e.g., an acquisition with high synergies. To
further demonstrate that it is the precautionary motive that determines cash-rich acquirers’
outperformance, we examine whether indeed cash-rich acquirers perform better when cash is
committed to a deal. We examine the announcement returns and the post-acquisition operating
performance, using both the U.K. and U.S. sample.
36
Specifically, for the analysis of announcement returns in panel A table 7, we form two
three-item interaction terms and add them to our baseline model of equation (2). The first three-
item interaction is formed using the unpredicted acquirer dummy, log (1 + excess cash reserve
ratio), and an all-stock offer dummy which is 1 if all the consideration is paid in stock and 0
otherwise; in the second, we replace the all-stock offer dummy using an all-cash offer dummy
which is 1 if all consideration is paid in cash and 0 otherwise. Model 1 of panel A table 7 reveals
a significantly (at 5%) negative coefficient of ‒0.049 on the interaction term formed using the all
stock-offer dummy, the unpredicted acquirer dummy and log (1 + excess cash reserve ratio). An
F-test (p-value 0.145; not tabulated) cannot reject the null that the sum of this coefficient and the
coefficient on the two-item interaction of the unpredicted acquirer dummy and log (1 + excess
cash reserve ratio) is insignificantly different from zero. The coefficient on the interaction term
formed using the all cash-offer dummy, the unpredicted acquirer dummy and log (1 + excess
cash reserve ratio) is ‒0.007 and statistically insignificant. Model 1 demonstrates that the positive
effect of cash reserve is absent when a bidder does not commit any cash to the deal. Therefore, a
commitment to spend at least some cash sends a signal that the current acquisition is valuable and is
an investment opportunity the acquirer has been holding cash for. Conversely, absent the
commitment of cash, cash-rich acquirers do not outperform and the market is not convinced the
current acquisition is a project that the acquirer has been saving for. In model 2, we perform the same
test base on our U.S. sample and obtain the same results.
For the analysis of post-acquisition operating performance in panel B table 7, we form two
two-item interaction terms and add them to our baseline model of equation (2). The first
37
interaction is formed using the high excash dummy and the all-stock offer dummy; in the second,
we replace the all-stock offer dummy using the all-cash offer dummy. For the U.K. sample
(model 1), the coefficient on the high excash dummy (0.0038) is significant (at 5%) and positive.
Similar to what we observe for the announcement returns, the negative coefficient ‒0.0017
(significant at 5%) on the interaction term between the all-stock offer dummy and high excash
dummy offsets the positive coefficient on the high excash dummy. The coefficient on the
interaction between the all-stock offer dummy and high excash dummy is statistically
insignificant, indicating that the effect of high cash holdings on post-acquisition operating
performance is significantly positive for all cash offers. In model 2, we obtain similar results
based on the U.S. sample. The only difference is that the positive cash holdings effect is only
present for all cash offers. Specifically, the sum of the coefficient on the high excash dummy
(0.0078) and that on the interaction term between all-cash offer dummy and high excash dummy
(0.0521) is statistically significant at 1% according to an F-test (not tabulated). The coefficient
on the high excash dummy however is statistically insignificant.
6. Conclusion
That cash-rich companies perform poorly in perhaps the most substantial type of
investments, i.e., mergers and acquisitions, has been often quoted as a prominent evidence for
the agency theory of free cash flow. However, our findings indicate that a cash-rich acquirer’s
performance depends crucially upon the strength of acquirer shareholders’ rights. We document
a positive cash holdings effect on acquirer performance when acquirer shareholder rights are
38
strong. The results are robust to the institutions in both the U.K. and U.S. and to alternative
measures of cash holdings and shareholder rights. There is some evidence of a negative cash
holdings effect in the U.S., but is only restricted to those acquirers having weak shareholder
rights and less financial constraints. The observation that the positive cash holdings effect is
more pronounced for more financially constrained acquirers is in line with our view that this
effect is derived from the precautionary motive.
Our findings extend the analysis of cash-rich acquirers’ performance in several previous
studies (Lang, Stulz, and Walkling, 1989; Harford, 1999; Schlingemann, 2004; Oler, 208), by
demonstrating the importance of shareholder rights and the relevance of the precautionary
motive in this context. Our findings are very much in line with the literature that observes that
strong corporate governance and investor protection are associated with greater value of cash
(Dittmar and Mahrt-Smith, 2007; Pinkowitz, Stulz, and Williamson, 2006). Our study also
contributes to a broader literature that documents a robust positive relation between the strength
of shareholder rights and firm value (Gompers, Ishii, and Metrick, 2003; Bebchuk and Cohen,
2005; Bebchuk, Cohen, and Ferrell, 2009; Cremers and Nair, 2005; Bebchuk, Cohen, and Wang,
2013; Giroud and Mueller, 2011; Lewellen and Metrick, 2010; Cremers and Ferrell, 2014). Our
evidence demonstrates that an important channel through which shareholder rights enhance firm
value is the better incentive for managers to invest cash holdings optimally.
39
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45
Figure 1
The Relation between Optimal Cash Savings and the Value of a Future Project
This figure illustrates why greater cash savings are associated with higher future project values. The vertical axis indicates the marginal return to investments, and the horizontal axis indicates the amount invested in the current (period 0) or future (period 1) project. BB' represents the marginal return curve of the period 0 project. AB, A'B', and A''B' are the marginal return curves of the period 1 projects. E(C1) is the expected cash flow in period 1 from the assets in place, which is given. C is the cash savings out of the period 0 cash flow, which is carried forward into period 1. A higher C implies more investment in the period 1 project and less in the period 0 project, and the
marginal return curve of the period 0 project (BB') has its horizontal axis reversed (i.e., less investment occurs as one moves to the right of BB'). Optimal cash savings (C* or C'*) occur when the marginal return to the period 0 project equals the marginal return to the period 1 project (i.e., B or B'). According to Almeida et al. (2004) and Han and Qiu (2007), higher optimal cash savings (C'*) are associated with higher marginal returns to the period 1 project (B'). The concavity of the production function is constant (as is assumed in Almeida et al., 2004, and Han and Qiu, 2007). That is, A'B' and AB have the same slope for any given value of E(C1)+C, higher optimal cash savings (e.g., C'*, which is greater than C*) is associated with a higher value period 1 project (i.e., the area defined by A'B'IK is greater than the area defined by ABIJ). The assumption of constant production function concavity is necessary. To see this, suppose the slope of the marginal return curve is less negative (curve A''B'). In other words, the second derivative of the production function is less negative. In such a case, higher cash savings C'* is associated with a higher value period 1 project if and only if the area of A"AL is less than LBJKB'. Nonetheless, to the extent that most new production technologies are incremental to the existing technologies during the tenure of a company’s management rather than revolutionary, the assumption of constant production function concavity is reasonable.
I KJ
Marginal Return
E(C1) + C C=0 C* C'*
A'
B'
A
B
A''
L
0
46
Figure 2
Predicted and Unpredicted Acquirers
Probability density functions (PDF) of being an acquirer, pr(acquirer), are plotted for acquirer firm-years
and non-acquirer firm-years separately. These curves cross at 0.06 (0.045) for the U.K. (U.S.) sample, which is the
threshold we use to determine whether an acquirer is predicted or not. To generate the distributions, we first estimate
a logistic model based on all firm-years to predict acquirers and then estimate the fitted probabilities of being an
acquirer. We then plot the distributions of pr(acquirer) for acquirer firm-years and non-acquirer firm-years. An
acquirer in a year whose pr(acquirer) falls to the right (left) of the threshold is predicted (unpredicted). This method
is similar to that used by Palepu (1986) and Harford (1999).
0%
5%
10%
15%
20%
25%
30%
35%
0.01 0.06 0.11 0.16 0.21 0.26 0.31 0.36 0.41 0.46
Perc
enta
ge of
firm
s (%
)
Pr (Bidder)
Bidder Non-Bidder
0%
5%
10%
15%
20%
25%
30%
35%
0.01 0.06 0.11 0.16 0.21 0.26 0.31 0.36 0.41 0.46
Perc
enta
ge of
firm
s (%
)
Pr (Bidder)
Bidder Non-bidder
U.K.
U.S.
47
Appendix A: Shareholder rights in the U.K.
In this appendix, we discuss the U.K. institutional background in relation to shareholder
rights to contextualize our hypotheses about U.K. acquirer cash holdings. Although the two
countries are similar on several dimensions of shareholder rights (La Porta, Lopez-De-Silanes,
Shleifer, and Vishny, 1997), a closer examination reveals that U.K institutions give more rights
to shareholders than those of the U.S. on many other dimensions. As Bebchuk (2005) notes, U.S.
corporations are “representative democracies” in which members of the polity act through their
representatives (i.e., company directors and officers) but not directly. In the U.K., firms are not
“purely representative” and shareholders more actively intervene in company decisions. Bebchuk
(2005) (Section B) posits that U.K. laws grant shareholders greater power to influence board
decisions than U.S. laws do. Djankov, La Porta, Lopez-de-Silanes, Shleifer (2008) conclude that
minority shareholders are better protected in the U.K. compared with those in the U.S.9 Nenova
(2006) also postulates that incumbent shareholders are better protected from disruptive takeovers
in the U.K. than those in the U.S. Table A1 provides a summary of the differences in shareholder
rights between the U.K. and U.S. Our brief discussions below are based on this summary. For
detailed accounts of the differences, see Armour and Skeel (2007), Black and Coffee (1994), and
Bebchuk (2005).
First, shareholder rights to set and change the basic governance scheme and be
represented at general meetings differ between these two countries. U.S. shareholders cannot
9 Both countries offer good protection to minority shareholders compared to many other countries.
48
initiate changes to a company’s constitutional documents (called the articles of association in the
U.K.); however, in the U.K., shareholders can initiate such changes, which require a “special
resolution” approved by a supermajority of 75%. Shareholders of 10% or more of the paid-up
voting capital can call an Extraordinary General Meeting (EGM). The articles of association and
company bylaws cannot deprive shareholders of this right. By contrast, U.S. company bylaws
can deprive shareholders of such rights. Moreover, it is easier for U.K. shareholders to make
proposals than for their U.S. counterparts. Second, it is easier for British shareholders to appoint
or remove directors. In principle, a director of a U.K. company can always be removed by a
special meeting called for such a purpose. In the U.S., to remove the board, the shareholders
much reach unanimous consent in writing. Therefore, the motion can be vetoed by any director
who holds shares. Moreover, the popular adoption of staggered boards makes a board even more
difficult to remove. Third, U.K. shareholders have greater rights in the event of receiving a
takeover offer. The U.K. Takeover Code prohibits management from blocking a takeover bid in
the absence of shareholder consent. There is no such rule in the U.S. Moreover, embedded
defense devices, such as poison pills, dual-class voting shares, and staggered boards, are nearly
absent in the U.K. (Armour and Skeel, 2007) but prevalent in the U.S. As is discussed in the
introduction, strong shareholder rights in the U.K. are illustrated by Kraft’s takeover of Cadbury
in 2009. Despite objections from Cadbury management, the deal was completed without much
resistance. Finally, U.S. corporate law treats distribution policies as business decisions delegated
entirely to management. In the U.K., however, these decisions are subject to instructions dictated
by special shareholder resolutions.
49
Beyond law and regulation, Black and Coffee (1994) postulate that the expectation of
oversight is embedded in British culture, and managers in the U.K. thus have never been able to
become as entrenched as their counterparts have in the U.S.
Strong shareholder rights are well represented by the active role played by institutional
investors in monitoring firm decisions. Black and Coffee (1994) note that U.K. financial
institutions are much more active in engaging their portfolio companies than their U.S.
counterparts. They also note that U.K. insurance companies are the most active institutional
investors because of their substantial share holdings and long investment horizons. Similarly,
Florence (1961) and Scott (1986) note that shareholder intervention is more frequent in the U.K.
than in the U.S. For example, Prudential (a major insurance companies in the U.K.) aims to meet
its portfolio companies at least twice a year; M&G, the asset management company acquired by
Prudential in 1999, states that its investment philosophy is to focus on investing in companies
rather than chasing share prices. Becht, Franks, Mayer, and Rossi (2009) use proprietary data and
observe that Hermes, the fund manager of the British Telecom Pension Scheme, outperforms its
benchmarks by engaging their portfolio companies via regular private meetings and conference
calls. Short and Keasey (1999) also posit that U.K. managers must hold more shares than their
U.S. counterparts to entrench themselves, suggesting shareholders have stronger power in the
U.K.
The regulatory environment in the U.K. is also more conducive for institutional investors
to intervene (Black and Coffee, 1994; Roe, 1994; Armour and Skeel, 2007). For example, for a
50
long time, the U.K. had no counterpart to the Glass-Steagall Act to restrict the size and power of
banks. In the U.K., there were historically no restrictions on the percentage of shares held by
insurance companies or rules concerning collective shareholder actions (Black and Coffee,
1994). The Cadbury Report of 1992 prepared by a committee chaired by Adrian Cadbury
provided recommendations for company boards and accounting systems to mitigate
governance risks and minimize corporate failures. These recommendations represent the U.K.
regulatory authority’s position of encouraging institutional interventions, “because of their
collective stake, we look to the institutions in particular, with the backing of Institutional
Shareholders’ Committee, to use their influence as owners to ensure that the companies in which
they have invested comply with the code” (Section 6.16 of the Cadbury Report).
Note that it can be less costly for U.K. institutional investors to jointly monitor company
managers. Most financial institutions are located in the so-called City of London, a one-square-
mile area in which the London business community is concentrated (Black and Coffee, 1994;
Crespi and Renneboog, 2010), which substantially facilitates interaction and communication.
The legal barriers to collective action against companies are also considerably lower in the U.K.
Company managers face considerable pressure of collective intervention when worries arise that
they may fail their fiduciary duties. Furthermore, because bad reputations diffuse quickly among
actual and potential investors, even at lower levels of share-holding, institutional shareholdings
can affect company decisions. This pattern motivates our use of the non-trivial institutional
holdings dummy in the U.K. analysis.
51
Appendix B: Measuring excess cash reserves
We estimate a company’s target cash reserve ratio following Opler et al. (1999). The
residuals from the regression are the excess cash reserve ratios. In particular, we estimate a
pooled time series cross-sectional ordinary least squares (OLS) regression with year dummies
(Model 2 in Table IV of Opler et al., 1999, p. 25). The sample used for the estimation includes
all firm-years during the period 1984–2007 utilizing data available from Datastream (for the
U.K.) or Compustat (for the U.S.). The specification is as follows:
1 2 3 4
5 6 7
8 9 10&
it it it it it
it it it
it it it t it
Cash Reserve Ratio MTB Size CFAST NWCAST
CAPEXAST LEV INDSIGMA
R D DIVDUM REGDUM YDUM
, (B.1)
where i and t index firms and years, respectively; Cash reserve ratio is cash and short-term
investments over total assets; MTB is market-to-book ratio of assets; Size is the logarithm of total
assets in millions of 1994 pound; CFAST is the income before depreciation and amortization
over total assets; NWCAST is net working capital over total assets; CAPEXAST is capital
expenditure over total assets; LEV is total debt over total assets; INDSIGMA is the mean cash-
flow standard deviation of the firms in the same 2-digit SIC code industry (cash flow is deflated
by total assets and standard deviation is estimated over the previous 20 years); R&D is the
expenditure on research and development normalized by net sales; DIVDUM is a dummy
variable set to one if a firm pays dividends in a year and zero otherwise; REGDUM is a dummy
variable set to one if a firm is in a regulated industry in a year and zero otherwise; and YDUM is
52
a vector of year dummies. We also estimate Equation (C.1) by industry. Our results are robust to
this variation. According to Dittmar and Mahrt-Smith (2007) and Fresard and Salva (2010), the
market-to-book ratio can be reversely affected by cash holdings. We use sales growth over the
past three years as an instrument for the market-to-book ratio and re-estimate Equation (C.1).
The historical sales growth is exogenous because current cash holdings are unlikely to affect past
sales growth. Our results are robust to this alternative estimation. We also verify the robustness
of our results to the alternative calculation of the excess cash reserve ratio used by DeAngelo,
DeAngelo, and Stulz (2010) (footnote 5 on page 287). Specifically, in each year, we
simultaneously sort all non-financial firms that meet our sampling criteria into three equal-sized
groups based on total assets and three equal-sized groups based on market-to-book ratio of
assets. An acquirer is then allocated to one of these nine groups based on its size and market-to-
book ratio. Within each group, the target cash reserve ratio is measured by the median of all
firms in the same 2-digit SIC industry. Our results are broadly consistent using this alternative
measure. These estimation results are not reported here; however, the tables are available upon
request.
Appendix C: The mechanism underlying the positive cash holdings effect at
announcement
In the introduction, we briefly mention that the update to acquisition probability promotes
the positive cash holdings effect. Essential to this argument is the ex ante relation that E(VH) >
53
E(VL), i.e., holding the concavity of the production function constant (as assumed in Almeida et
al., 2004), greater cash holdings are associated with a higher value of a future project. Figure 1
illustrates why, and we elaborate below.
The vertical axis represents the marginal return on investments and the horizontal axis
represents the amount of investment in the current (period 0) or future (period 1) project. In the
framework developed by Almeida et al (2004), C0 (not shown in the figure) is the period 0 cash
flow from assets in place. C is the cash saved out of C0 and carried over to period 1 to invest.
E(C1) is the expected cash flow from the assets in place in period 1, which is given. When
choosing the optimal C, a company faces a trade-off between a current project (in period 0) and a
future project (in period 1). The company invests C0−C in the current project and E(C1) + C in
the future project. The optimal cash savings (C*, C'*) occur when the marginal return to the
period 0 project (represented by curve BB') equals the marginal return to the period 1 project
(curves AB, A'B' or A"B') (Equation 4 of Almeida et al., 2004).10 For a period 1 project with the
marginal return curve AB, C* is the optimal cash savings, and the expected value of the project
is represented by the area of ABIJ. When the period 1 project is more profitable (Almeida et al.,
2004) or the cash flows from the assets in place are more volatile (Han and Qiu, 2007), the
marginal return to the period 1 project increases, which in turn induces the company to invest
more in period 1 by saving more in period 0. Therefore, C'* > C*, where C'* is the updated
10 Since a higher C means more investment in the period 1 project and less investment in the period 0 project, the
marginal return curve for the period 0 project (BB') has its horizontal axis reversed (i.e., there is less investment as one moves to the right of BB'). C=0 is the point at which no cash from period 0 is carried forward and at which the marginal return to the period 0 project is the lowest.
54
optimal cash savings. When the concavity of production function remains constant, the updated
marginal return curve of the period 1 project is A'B', i.e., AB moves outwards. Note that with
constant concavity of the production function, as is the case here, the slopes of AB and A'B' are
the same at any given value of E(C1) + C. In other words, the marginal returns on investments
diminish at the same rate for AB and A'B'. Almeida et al. (2004) do not require AB and A'B' to
be convex, i.e., AB and A'B' can be straight lines. Han and Qiu (2007), however, require that the
marginal return (i.e., AB and A'B') to be convex and the cash flow volatility not be fully hedged,
which generates a positive relation between cash flow volatility and optimal cash savings. In
both Almeida et al. (2004) and Han and Qiu (2007), the area of A'B'IK (i.e., the value of the
period 1 project corresponding to C'*) is greater than the area of ABIJ (i.e., the value of the
period 1 project corresponding to C*).
[FIGURE 1]
The conclusion above may change if the assumption of constant concavity is violated. In
Figure 1, the marginal return curve A"B' has a less negative slope than AB, i.e., the marginal
return diminishes at a lower rate for A"B' than for AB. In this case, when the optimal cash
savings are C'*, the area of A"B'IK is not necessarily greater than that of ABIJ. The area of
A"B'IK is greater than that of ABIJ if and only if the size of area A"AL < LBJKB'. Nonetheless,
to the extent that most new production technologies are incremental to the existing technologies
during the tenure of a company’s management rather than revolutionary, the assumption of
invariant production function concavity is reasonable. This assumption implies that the speeds at
55
which the marginal returns diminish are similar across different future investments (A'B' and AB
in Figure 1). To take further precaution against possible confounding effects of varying
production function concavity, we control for industry effects in our regression analyses.
Production technologies available to the same industry are more similar to one another compared
to technologies available to different industries. Our results are robust to the effects of both the
Fama-French 12 industries and Fama-French 49 industries. We report only the results of
regressions estimated using the Fama-French 12 industries for the sake of brevity, but the results
using the Fama-French 49 industries are available upon request.
Appendix D: Predicted and unpredicted acquirers
We follow a two-step procedure to separate the sample into predicted and unpredicted
acquirers. In the first step, we estimate the probability of being an acquirer using the following
logistic model for both the U.K. and U.S. for the period 1984–2007:
, 1 , 1 , 1 , ,i t i t i t i t it i tAcquirer Excash Controls YDUM INDDUM , (D.1)
where i and t index companies and years, respectively; Acquirer is a dummy variable that equals
1 for a firm-year if a company announces at least one acquisition in this year and 0 otherwise;
Excash is log (1 + excess cash reserve ratio); YDUM is a vector of year dummy variables from
1984 to 2007; INDDUM is a vector of industry dummy variables; and Controls is a vector of
control variables. The control variables include the logarithm of total assets, leverage, logarithm
of the market-to-book ratio of equity, return on assets, mean abnormal returns over the past 3
56
years, standard deviations of daily stock returns over the past 3 years, and non-cash working
capital, defined as net working capital (i.e., current assets – current liabilities) minus cash and
marketable securities, then divided by total assets.11 The estimates are available upon request.
Next, we estimate the fitted probabilities of being an acquirer for each firm-year. We then
plot the distribution of the fitted probabilities for the acquirer firm-years and non-acquirer firm-
years in Figure 2. The figure indicates that these distributions cross at 0.06 for the U.K. sample
and at 0.045 for the U.S. sample. An acquirer that falls to the right (left) of the crossover point is
predicted (unpredicted).
[FIGURE 2]
11 The mean abnormal returns are computed as the daily abnormal returns averaged over the 3 years prior to the
announcement. Abnormal returns are estimated using a market model. The estimation period is a window of 250 trading days that ends 16 trading days prior to the day for which abnormal returns are calculated.
High cash Low cash Z-statistic Mean Median STD Median Median Diff.
CAR (-2,+2) −0.010 −0.008 0.085 −0.006 −0.008 −0.115Excess cash reserve ratio 0.002 −0.023 0.155 0.002 −0.049 −11.112***Total assets (Mil.) 3868.533 1272.543 548.512 1511.450 1032.960 −3.017***Leverage 0.533 0.360 9.023 0.378 0.342 1.010Market to book ratio (M/B) 2.067 1.396 2.111 1.205 1.429 0.517Return on assets (%) 0.017 0.050 0.236 0.048 0.051 0.011Asset tangibility 0.858 0.928 0.174 0.933 0.927 −1.115Average pre-acquisition sales growth 0.498 0.120 1.191 0.132 0.107 −2.269**Relative deal value 0.443 0.149 0.765 0.158 0.141 −1.185Cash payment (%) 63.740 52.629 46.684 68.155 37.049 −2.593**Pre-acquisition operating performance (%) 4.760 4.100 23.600 4.875 3.321 1.987**Post-acquisition operating performance (%) 6.600 5.000 12.600 6.691 3.325 2.012**Whited-Wu Index 1.878 0.334 0.770 0.262 0.425 −1.970**E-index (509 observations) 1.961 2.000 1.388 2.000 2.000 0.450OBS 2196 2196 1098 1098
Yes/No Yes/NoFriendly deal dummy 1040/58 852/246Tender offer dummy 148/950 383/715Diversifying deal dummy 189/909 517/581Unpredicted acquirer dummy 630/468 261/837No bond rating dummy 326/772 778/320Separated leadership dummy 983/115 698/400
706/1490891/13051104/10921681/515
Panel A: The U.S. sample
Yes (1)/No(0)1892/304531/1665
Table 1: Descriptive statistics
This table reports the descriptive statistics for both the U.K. (panel B) and the U.S. (panel A) sample. The sample include all deals completed during 1984–2007 in the U.K. and 1990–2007 in the U.S. that satisfy our selection requirements. CAR (−2,+2) is the acquirers' cumulative abnormal returns (market-model adjusted) from 2 days before to 2 days after the deal announcement day. Excess cash reserve ratio is the difference between the actual cash reserve ratio and the target cash reserve ratio estimated using a pooled time-series cross-sectional OLS regression with year dummies, following Opler et al. (1999). Actual cash reserve ratio is defined as cash and marketablesecurities over total assets. Size is measured by total assets in millions of pounds or dollars. Leverage is the book value of debt over total assets. Market to book ratio (M/B) is the sum of market value of equity and book value of long-term liabilities divided by the sum of book value of equity and book value of long term liabilities. Return on assets is operating income over total assets. Asset tangibility is the ratio of tangible assets to total assets. Average pre-acquisition sales growth is the average annual sales growth measured over 2 years prior to year of announcement. Relative deal value is deal value divided by bidder market value of equity. Payout ratio is the ratio of total distributions (i.e. dividends and stock repurchases) to operating income. Cash payment (%) is the percentage of cash paid in the consideration. We measure operating performance in percentage using the difference between the operating cash flow and the change in working capital scaled by total assets, and adjusted by the median performance of those firms in the same industry, size decile, and operating performance decile (call it the adjusted operating performance). Post-acquisition operating performance is the combined firm's adjusted operating performance averaged over the 3 years next to deal completion. Pre-acquisition operating performance is the value-weighted (using market value of assets) combination of the acquirer's and target's adjusted operating performance, averaged over the three years prior to deal announcement. Whited-Wu index is the financial constraint index of Whited and Wu (2006) estimated using the U.K. or the U.S. data. Grand total institutional holdings are holdings by all institutional investors. Insurance company holdings are holdings by insurance companies. E-index is the entrenchment index of Bebchuk, Cohen, and Ferrell (2009). Friendly deal dummy equals 1 for friendly deals and 0 otherwise. Tender offer dummy equals 1 for tender offers and 0 otherwise. Diversifying deal dummy equals 1 if the target and the bidder are in different 2-digit SIC code industries and 0 otherwise. Unpredicted acquirer dummy is defined according to the procedure described in Appendix D. No Bond rating dummy is 1 if a bidder has never been assigned a rating to its bond(s) and 0 otherwise. Separated leadership dummy is 1 if a bidder's chairman and CEO are taken by two different persons and 0 otherwise. z-test is based on Wilcoxon rank sum test for median differences. All continuous variables are winsorized at the 1st and 99th percentile, except CAR. All variables are measured at the end of the fiscal year prior to deal announcement unless otherwise mentioned.
High cash Low cash Z-statistic Mean Median STD Median Median Diff.
CAR (-2,+2) −0.004 −0.003 0.060 −0.003 −0.003 −0.751Excess cash reserve ratio −0.053 −0.034 0.521 0.038 −0.106 −12.554***Total assets (Mil.) 183.110 131.130 8.642 164.152 98.122 −2.881**Leverage 0.148 0.075 0.281 0.064 0.088 1.991**Market to book ratio (M/B) 2.961 1.413 6.624 1.586 1.257 −1.981**Return on assets 0.055 0.076 0.144 0.082 0.073 −1.115Asset tangibility 0.634 0.496 1.004 0.486 0.506 0.617Average pre-acquisition sales growth 0.325 0.133 0.590 0.136 0.128 −1.105Relative deal value 0.129 0.032 0.410 0.022 0.039 2.874**Cash payment (%) 69.000 55.169 45.980 77.409 32.729 −2.845**Pre-acquisition operating performance (%) 5.176 1.443 14.977 1.869 1.017 −1.987**Post-acquisition operating performance (%) 6.719 2.408 17.730 3.094 1.739 −3.014**Whited-Wu Index 0.886 0.573 0.082 0.456 0.688 2.011**Grand total institutional holdings (%) 46.321 12.162 12.451 14.214 10.115 −1.661*Insurance company holdings (%) 15.902 7.484 5.493 8.883 6.105 −1.798*OBS 185 185 92 93
Yes/No Yes/NoFriendly deal dummy 83/9 55/38Tender offer dummy 38/54 23/70Diversifying deal dummy 32/60 9/84Unpredicted acquirer dummy 39/53 14/79No bond rating dummy 11/81 68/25Grand total institutional holdings non-trivial (> 3%) 39/53 14/79Insurance company holdings non-trivial (> 3%) 31/61 7/86
41/14453/13279/10653/13238/147
Panel B: the U.K. sampleAll
Yes (1)/No (0)138/4761/124
Table2, U.S. evidence: shareholder power, financial constraints and the effect of excess cash holdings on acquirer announcement returns
This table reports the robust regression estimates of our baseline models (1) and (2), and how financial constraints and shareholder power affect the cash reserve effect on bidder announcement returns. The regressions are estimated on two U.S. samples from 1990 to 2007. For the first sample (models 1–5) we require the E-index to be available and for the second sample (models 6–11) we do not. The dependent variables are the acquirers' CAR (-2,+2). Models 4 (5) is estimated using the sub-sample where the acquirers' E-index are below (above) the sample median. Model 9(10) is estimated using the sub-sample where the CEO and the Chairman are different persons (the same person). Model 11 is estimated on the data during 1980–1993. In Panel A, we measure financial constraints using the acquirers' Whited-Wu index. High Whited-Wu index dummy is 1 if the acquirers' Whited-Wu index is above the sample median and 0 otherwise. In Panel B, we measure financial constraints using the No bond rating dummy. All other variables are defined in table 1 and 2. p-values are in parentheses. *,**,*** indicate significance at 10%, 5% and 1% respectively. Standard errors are corrected for heteroskedasticity.
All All All Low E-index High E-index All All AllSeparated Leadership
Combined Leadership
All 1980–1993
Model 1 Model 2 Model 3 Model 4 Model 5 Model 6 Model 7 Model 8 Model 9 Model 10 Model 11log(1+ excess cash reserve ratio) −0.076*** −0.193***
(0.001) (0.000) Predicted acquirer dummy × log(1+ excess cash reserve ratio) 0.004 0.019 −0.012 −0.044 −0.154* −0.188*** −0.158** −0.28*** 0.047
(0.273) (0.605) (0.243) (0.210) '(0.065) (0.000) (0.037) (0.000) '(0.128)Unpredicted acquirer dummy × log(1+excess cash reserve ratio) 0.142** 0.208* 0.319*** 0.053 0.121*** 0.071*** 0.129** −0.207*** −0.203***
(0.039) (0.067) (0.000) (0.200) '(0.000) (0.000) (0.035) (0.000) '(0.000)Unpredicted acquirer dummy × High Whited-Wu index dummy × log(1+excess cash reserve ratio) 0.376*** 0.510*** 0.165* 0.341*** 0.250*** 0.351**
(0.001) (0.004) (0.067) (0.002) (0.001) (0.022)High Whited-Wu index dummy 0.009 0.018 −0.008 −0.006 −0.003 −0.003
(0.252) (0.146) (0.155) (0.456) (0.252) (0.124)Unpredicted acquirer dummy −0.005 −0.018 −0.013 −0.005 −0.005 −0.012 −0.008 −0.005 0.0017
(0.616) (0.114) (0.407) (0.128) '(0.523) (0.177) (0.114) (0.774) '(0.157)Probability of being an acquirer −0.028 0.164 0.227 0.303* −0.101 −0.270** 0.0080 0.0054 −0.267** −0.022 0.188*
(0.249) (0.299) (0.115) (0.081) (0.354) '(0.030) '(0.949) (0.252) (0.025) (0.555) '(0.081)Log (1+total assets) 0.061 −0.052* −0.081 −0.079 −0.041 0.081** −0.026 −0.0168 0.031 −0.007 −0.057**
(0.235) (0.058) (0.186) (0.199) (0.389) '(0.035) '(0.702) (0.138) (0.186) (0.479) '(0.035)Asset tangibility 0.0021 −0.031 −0.021 −0.029 −0.0121 0.014 −0.025 −0.025 −0.061* −0.041*** 0.054*
(0.475) (0.295) (0.473) (0.463) (0.517) '(0.514) '(0.238) (0.256) (0.057) (0.000) '(0.063)Return on assets 0.043** 0.044* 0.063** 0.064 0.124 −0.035 0.049* 0.064** 0.075* 0.081*** 0.141**
(0.040) (0.056) (0.039) (0.360) (0.165) '(0.248) '(0.072) (0.040) (0.09) (0.000) '(0.035)Log (1+average sales growth) 0.001 0.003 0.001 0.002 0.002 0.004** −0.001 −0.001 −0.007* 0.003 0.002
(0.954) (0.497) (0.882) (0.776) (0.770) '(0.041) '(0.887) (0.799) (0.082) (0.644) '(0.215)Log (1+M/B) −0.013** −0.013* −0.0011* −0.004 −0.018* −0.013** −0.017** −0.009* −0.004 −0.014*** −0.003
(0.036) (0.077) (0.097) (0.249) (0.081) '(0.029) '(0.039) (0.087) (0.676) (0.000) '(0.233)Leverage −0.022* −0.004 −0.008 −0.008 0.003 −0.002 0.0140 0.008 −0.008 0.006 −0.029
(0.069) (0.270) (0.622) (0.359) (0.483) '(0.215) '(0.233) (0.492) (0.622) (0.826) '(0.110)Relative deal value −0.021** −0.050** −0.032** −0.026** −0.042*** −0.035*** −0.032*** −0.021*** −0.07* −0.013** −0.012*
(0.038) (0.046) (0.026) (0.034) (0.003) '(0.001) '(0.001) (0.000) (0.066) (0.015) '(0.086)Cash propotion 0.016* 0.016* 0.015* 0.024** 0.033*** 0.024*** 0.022*** 0.023*** 0.0154* 0.030** 0.025***
(0.059) (0.065) (0.082) (0.047) (0.001) (0.001) '(0.001) (0.001) (0.082) (0.012) '(0.001)Tender offer dummy 0.005 0.005 0.006 0.013 −0.001 0.003 0.0010 0.006* 0.006 0.009 −0.028**
(0.529) (0.515) (0.494) (0.166) (0.894) '(0.936) '(0.898) (0.083) (0.494) (0.505) '(0.011)Diversifying deal dummy −0.002 −0.012 −0.002 0.008 −0.016 −0.028** 0.0070 0.006 −0.012* 0.016 −0.018*
(0.796) (0.243) (0.604) (0.461) (0.242) '(0.041) '(0.254) (0.349) (0.080) (0.196) '(0.062)Friendly deal dummy 0.020** −0.010 −0.017* −0.024** 0.008 0.020** −0.008 −0.009 −0.021** −0.013 −0.012
(0.039) (0.159) (0.069) (0.024) (0.054) '(0.030) '(0.305) (0.308) (0.049) (0.486) '(0.253)Constant 0.165** 0.187* 0.178* 0.194 0.083 0.188** 0.119** 0.067** 0.058 0.061 0.002
(0.027) (0.062) (0.072) (0.208) (0.509) '(0.046) '(0.032) (0.031) (0.212) (0.362) '(0.172)Year effect Y Y Y Y Y Y Y Y Y Y YIndustry effect Y Y Y Y Y Y Y Y Y Y YNo obs 509 509 509 328 181 2196 2196 2196 769 1427 1063Pseudo R-squared 0.181 0.173 0.166 0.141 0.131 0.322 0.301 0.191 0.133 0.171 0.155
Leadership StructurePalel A: financial constraint measured by Whited-Wu index
E-index
All Low E-index High E-index All Separated LeadershipCombined Leadership
Model 1 Model 2 Model 3 Model 4 Model 5 Model 6Predicted acquirer dummy × log(1+ excess cash reserve ratio) 0.0050 −0.022 −0.097 −0.091*** −0.39 −0.230***
'(0.178) '(0.150) '(0.301) '(0.001) '(0.224) '(0.000)Unpredicted acquirer dummy × log(1+excess cash reserve ratio) 0.0460 −0.002 0.0200 0.042** 0.470* −0.343***
'(0.214) '(0.200) '(0.224) '(0.016) '(0.060) '(0.000)Unpredicted acquirer dummy× No bond rating dummy × log(1+excess cash reserve ratio) 0.304*** 0.479*** 0.301*** 0.157*** 0.405*** 0.171***
'(0.000) '(0.000) '(0.000) '(0.000) '(0.000) '(0.002)No bond rating dummy 0.0020 0.0030 0.0020 0.0050 −0.014 −0.002
'(0.830) '(0.791) '(0.521) '(0.491) '(0.678) '(0.224)Unpredicted acquirer dummy 0.0020 0.0050 0.0080 0.0010 −0.025* −0.011*
'(0.799) '(0.432) '(0.217) '(0.907) '(0.081) '(0.070)Probability of being an acquirer −0.041101 0.1180 −0.423 0.0070 0.221* 0.0640
'(0.444) '(0.692) '(0.197) '(0.838) '(0.078) '(0.977)Log (1+total assets) 0.0155 −0.032 0.1160 −0.013 −0.091** −0.016
'(0.209) '(0.650) '(0.314) '(0.261) '(0.029) '(0.243)Asset tangibility −0.023 −0.046 0.031 −0.011 −0.093** −0.027**
'(0.116) '(0.290) '(0.114) '(0.297) '(0.021) '(0.032)Return on assets 0.065** 0.0612 0.1180 0.064** 0.0580 0.056**
'(0.039) '(0.126) '(0.137) '(0.032) '(0.146) '(0.029)Log (1+average sales growth) 0.0010 0.0020 0.0010 0.0001 −0.012* −0.001
'(0.880) '(0.687) '(0.901) '(0.762) '(0.062) '(0.758)Log (1+M/B) −0.006 0.0061 −0.0011 −0.006** −0.008 −0.011**
'(0.326) '(0.132) '(0.235) '(0.042) '(0.334) '(0.016)Leverage −0.012 −0.014 −0.003 0.0110 0.0060 0.0040
'(0.408) '(0.472) '(0.850) '(0.156) '(0.281) '(0.287)Relative deal value −0.029*** −0.023** −0.048** −0.026*** −0.007 −0.023***
'(0.000) '(0.021) '(0.018) '(0.000) '(0.135) '(0.000)Cash propotion 0.021*** 0.026** 0.036*** 0.019*** 0.016** 0.031***
'(0.002) '(0.028) '(0.000) '(0.002) '(0.036) '(0.000)Tender offer dummy 0.0070 0.0070 −0.002 0.005* 0.0010 0.0030
'(0.842) '(0.497) '(0.387) '(0.098) '(0.725) '(0.686)Diversifying deal dummy −0.007 0.0060 −0.012 0.0070 −0.002 0.0030
'(0.271) '(0.444) '(0.288) '(0.265) '(0.753) '(0.667)Friendly deal dummy −0.013* −0.023** −0.0061 −0.011 −0.019 −0.011
'(0.076) '(0.029) '(0.298) '(0.102) '(0.138) '(0.245)Constant −0.0061 0.0620 −0.193 0.059* 0.237** 0.0340
'(0.128) '(0.511) '(0.339) '(0.081) '(0.038) '(0.222)Year effect Y Y Y Y Y YIndustry effect Y Y Y Y Y YNo obs 509 328 181 2196 769 1427Pseudo R-squared 0.167 0.153 0.131 0.211 0.161 0.177
Palel B: financial constraint measured by the No bond rating dummyLeadership StructureE-index
Panel A:financial constraints measured by Whited-Wu index
All All Low E-index High E-index All AllSeparated
LeadershipCombined Leadership
Model 1 Model 2 Model 3 Model 4 Model 5 Model 6 Model 7 Model 8Pre-acquisition operating performance 0.2453*** 0.1913*** 0.1034** 0.1882*** 0.2330*** 0.1811*** 0.2013*** 0.1621***
(0.000) (0.000) (0.012) (0.000) (0.000) (0.000) (0.000) (0.000)CAR (−2,+2) 0.0720** 0.0531 0.2250*** 0.0220 0.0436*** 0.0420 0.0450 0.0560
(0.021) (0.221) (0.000) (0.725) (0.000) (0.310) (0.362) (0.460)High excash dummy 0.0551*** 0.0761*** 0.0310 0.0482*** 0.0522*** −0.0322***
(0.000) (0.000) (0.316) (0.000) (0.000) (0.000)High exccash dummy × High Whited-Wu index dummy 0.0571*** 0.0721*** −0.0362 0.0481*** 0.0652*** 0.0371***
(0.003) (0.006) (0.257) (0.000) (0.000) (0.000)High Whited-Wu index dummy 0.0292*** 0.0341*** 0.0011 −0.0261 0.0030 0.0020
(0.000) (0.000) (0.859) (0.642) (0.244) (0.514)Constant 0.0985** 0.0950** 0.1091** 0.0280 0.0795** 0.0491*** 0.0551*** 0.0410
(0.010) (0.016) (0.043) (0.529) (0.021) (0.000) (0.000) (0.687)No obs 509 509 328 181 2196 2196 769 1427Pseudo R-squared 0.384 0.416 0.441 0.444 0.551 0.591 0.471 0.551
E-index Leadership Structure
Table 3, U.S. evidence: shareholder power, financial constraints and the effect of excess cash holdings on acquirer post-acquisition operating performance
This table reports the robust regression estimates of the effect of excess cash reserve on the acquirers' post-acquisition operating performance, and how this effect varies according to shareholder rights and financial constraints. The regressions are estimated using two U.S. samples from 1990 to 2007. For the first sub-sample (models 1–3), we require the E-index to be available and for the second sample (models 4–6) we do not. The dependent variables are the acquirers' post-acquisition operating performance in decimals. Model 2(3) is estimated using the sub-sample where the acquirer's E-index is below (above) median. Models 5 (6) is estimated using the sub-sample where the CEO and the Chairman are different persons (the same person). In Panel A, we measure financial constraints using the acquirers' Whited-Wu index. High Whited-Wu index dummy is 1 if the acquirers' Whited-Wu index is above sample median and 0 otherwise. In Panel B, we measure financial constraints using the No bond rating dummy. All other variables are defined in table 1. p-values are in parentheses. *,**,*** indicate significance at 10%, 5% and 1% respectively. Standard errors are corrected for heteroskedasticity.
Panel B:financial constraints measured by the No bond rating dummy
All Low E-index High E-index AllSeparated
LeadershipCombined Leadership
Model 1 Model 2 Model 3 Model 4 Model 5 Model 6Pre-acquisition operating performance 0.2121*** 0.1230*** 0.2121*** 0.2101*** 0.1902*** 0.2030***
(0.000) (0.005) (0.000) (0.000) (0.000) (0.000)CAR (-2,+2) 0.0821* 0.2661** −0.1552 0.0911** 0.0650 0.0630
(0.069) (0.021) (0.112) (0.041) −0.195 (0.362)High excess cash dummy 0.0030 0.0080 −0.0330 0.0452*** 0.0421*** −0.0491***
(0.870) (0.717) (0.145) (0.000) (0.001) (0.000)High excash dummy x No bond rating dummy 0.0361* 0.0681*** 0.0370 0.1280*** 0.1211*** 0.1372***
(0.072) (0.004) (0.128) (0.000) (0.000) (0.000)No bond rating dummy 0.0281*** 0.0160 0.0262** 0.0021 0.0070 0.0050
(0.006) (0.309) (0.032) (0.739) (0.226) (0.294)Constant 0.0270 0.0670 0.0450 0.0721* 0.0371* 0.0230
(0.412) (0.177) (0.517) (0.098) (0.082) (0.357)No obs 509 328 181 2196 769 1427Pseudo R-square 0.420 0.417 0.466 0.561 0.411 0.470
E-index Leadership Structure
Model 1 Model 2 Model 3 Model 4Log ( 1+ excess cash reserve ratio) 0.024***
(0.000) Predicted acquirer dummy × log(1+ excess cash reserve ratio) −0.008 −0.009 −0.004
(0.761) (0.687) (0.854) Unpredicted acquirer dummy × log(1+excess cash reserve ratio) 0.030*** 0.019** 0.021**
(0.002) (0.045) (0.040) Unpredicted acquirer dummy × Nontrivial grand total institutional holdings dummy × log(1+excess cash reserve ratio) 0.077***
(0.000) Nontrivial grand total institutional holdings dummy 0.009
(0.237) Unpredicted acquirer dummy × Nontrivial insurance company holdings dummy × log(1+excess cash reserve ratio) 0.081***
(0.002) Nontrivial insurance company holdings dummy 0.011
(0.147) Unpredicted acquirer dummy −0.005 0.005 0.006
(0.578) (0.543) (0.463) Probability of being an acquirer 0.014 0.001 0.004 0.006
(0.136) (0.981) (0.932) (0.892) Log (1+total assets) 0.001 0.001 0.002 0.001
(0.508) (0.713) (0.933) (0.621) Asset tangibility −0.003** −0.003* −0.002* −0.002*
(0.038) (0.087) (0.090) (0.081) Return on assets 0.026*** 0.023*** 0.006 0.004
(0.000) (0.008) (0.528) (0.674) Log (1+average sales growth) 0.012*** 0.007* 0.011*** 0.010***
(0.000) (0.062) (0.005) (0.005) Log (1+M/B) −0.008** −0.014*** −0.019*** −0.017***
(0.013) (0.001) (0.000) (0.000) Leverage 0.012 −0.012 −0.021 0.023
(0.460) (0.593) (0.319) (0.268) Relative deal value −0.019*** −0.018** −0.024*** −0.022***
(0.001) (0.024) (0.002) (0.004) Cash percentage (%) 0.015*** 0.009* 0.012* 0.013**
(0.001) (0.088) (0.062) (0.042) Tender offer dummy −0.022*** −0.020*** −0.015** −0.016***
(0.000) (0.001) (0.013) (0.005) Diversifying deal dummy 0.001 0.001 0.001 0.003
(0.756) (0.901) (0.896) (0.643) Friendly deal dummy 0.011** 0.008 0.005 0.005
(0.024) (0.278) (0.454) (0.439) Constant 0.027 0.014 0.024 0.009
(0.103) (0.674) (0.445) (0.757) Yeare effects Y Y Y YIndustry effects Y Y Y YNo of obs 185 185 185 185Pseudo R-squared 0.371 0.517 0.444 0.471
Full sample 1984–2007
Table 4, U.K. evidence: the acquirer excess cash holdings and announcement returns
This table reports the robust regression estimates for our models (1) and (2). The dependent variable is the acquirers' CAR (−2,+2). Probability of being an acquirer is estimated according to equation (D.1) in Appendix D. Nontrivial grand total institutional holdings dummy is 1 if the grand total institutional holdings is no less than 3% and 0 otherwise. Nontrivial insurance company holdings dummy is 1 if the insurance company holdings is no less than 3% and 0 otherwise. All other variables are defined in table 1. p-values are in parentheses. *,**,*** indicate significance level at 10%, 5% and 1% respectively. Standard errors are corrected for heteroskedasticity. Models are estimated with year and industry effects.
model 1 Model 2Predicted acquirer dummy × log(1+ excess cash reserve ratio) −0.004 −0.044
(0.929) (0.309) Unpredicted acquirer dummy × log(1+excess cash reserve ratio) 0.032 0.002
(0.318) (0.943) High Whited-Wu index dummy 0.022*
(0.060) Unpredicted acquirer dummy × High Whited-Wu index dummy × log(1 + excess cash reserve ratio) 0.266***
(0.000) No bond rating dummy 0.004
(0.688) Unpredicted acquirer dummy × No bond rating dummy × log(1 + excess cash reserve ratio) 0.144**
(0.047) Unpredicted acquirer dummy 0.025** 0.008
(0.029) (0.513) Probability of being an acquirer 0.098 0.077
(0.108) (0.256) Log (1+ total assets) −0.001 −0.002
(0.874) (0.637) Asset tangibility −0.005* 0.02
(0.061) (0.323) Return on assets 0.021 0.02
(0.245) (0.378) Log (1+average sales growth) 0.008 0.019
(0.510) (0.140) Log (1+M/B) −0.003 −0.001
(0.129) (0.835) Leverage 0.014 −0.004
(0.696) (0.924) Relative Deal Value −0.02 −0.026*
(0.135) (0.087) Cash propotion 0.007 0.017*
(0.418) (0.098) Tender offer dummy −0.026*** −0.017*
(0.002) (0.068) Diversifying deal dummy 0.018** 0.021**
(0.029) (0.024) Friendly deal dummy 0.017* 0.013
(0.081) (0.219) Constant −0.015 −0.035
(0.743) (0.529) Year effects Y YIndustry effects Y YNo of obs 185 185Pseudo R-squared 0.661 0.567
Table 5, U.K. evidence: financial constraints and the effect of excess cash holdings on acquirer announcement returns
This table reports the robust regression estimates of how the degree of acquirer financial constraints affects the cash reserve effect on acquirer announcement abnormal returns. The dependent variable is the acquirers' CAR (−2,+2). All other variables are defined in table 1 and 2. p-values are in parentheses. *,**,*** indicate significance levels at 10%, 5% and 1% respectively. Standard errors are corrected for heteroskedasticity. Models are estimated with year and industry effects.
results no change if CAR is dropped
(1) (2) (3) (4) (5) (6)Pre-acquisition operating performance (%) 0.0383*** 0.0382*** 0.0363*** 0.0364*** 0.0353*** 0.0344***
(0.000) (0.000) (0.000) (0.000) (0.000) (0.000)
CAR (−2,+2) 0.0102** 0.0086 0.0098 0.0091 0.0059 0.0010
(0.049) (0.122) (0.148) (0.160) (0.380) (0.143)
High excash dummy 0.0020** 0.0024** 0.0025** 0.0038*** 0.0030***(0.017) (0.024) (0.015) (0.000) (0.000)
High excash dummy × Non-trivial grand total institutional holdings dummy 0.0098**
(0.021)Non-trivial institutional holding dummy 0.0003
(0.800)High excash dummy × Non-trivial insurance company holdings dummy 0.0088**
(0.030) Non-trivial insurance holdings dummy 0.0015
(0.313)High excash dummy × High White-Wu index dummy 0.0035***
(0.000)High White-Wu index dummy 0.0023***
(0.000)High excash dummy × No bond rating dummy 0.0051***
(0.000)No bond rating dummy 0.0047***
(0.000)Constant 0.0027*** 0.0019*** 0.0024*** 0.0022*** 0.0088*** 0.0026***
(0.000) (0.000) (0.000) (0.000) (0.000) (0.000)No of obs 185 185 185 185 185 185Pseudo R-squared 0.191 0.184 0.214 0.193 0.133 0.157
Table 6, U.K. evidence: the excess cash holdings and post-acquisition acquirer operating performance
This table reports the robust regression estimates of how excess cash reserve affect the acquirers' post-acquisition operating performance. Model 1 and 2 estimate the baseline model of equation (3). Models 3 and 4 estimate how institutional holdings impact the cash holdings effect on acquirer operating performance. Models 5 and 6 estimate how financial constraints impact the cash reserve effect on acquirer operating performance. In all specifications, the dependent variable is the acquirers' post-acquisition operating performance in decimals. High excess cash reserve dummy is 1 if anacquirer's excess cash reserve is above the sample median and 0 otherwise. All other variables are defined in table 1, 2 and 3. p-values are in parentheses. *,**,*** indicate significance at 10%, 5% and 1% respectively. Standard errors are corrected for heteroskedasticity.
U.K. U.S.Model 1 Model 2
Predicted acquirer dummy × log(1+ excess cash reserve ratio) −0.002 0.079*(0.921) (0.084)
Unpredicted acquirer dummy × log(1+excess cash reserve ratio) 0.063*** 0.100***(0.000) (0.000)
Unpredicted acquirer dummy × all stock offer dummy x log(1+excess cash reserve ratio) −0.049** −0.121***
(0.023) (0.003) Unpredicted acquirer dummy × all cash offer dummy x log(1+ excess cash reserve ratio) −0.007 0.029
(0.671) (0.677) Unpredicted acquirer dummy −0.003 0.001
(0.802) (0.775) Probability of being an acquirer 0.002 0.053
(0.968) (0.276) Log (1+total assets) 0.002 0.012
(0.661) (0.292) Asset tangibility −0.002 −0.012
(0.154) (0.290) Return on assets 0.012 0.115***
(0.182) (0.000) Log (1+average sales growth) 0.009** 0.001
(0.027) (0.357) Log (1+M/B) −0.015*** −0.002
(0.000) (0.241) Leverage −0.019 −0.012**
(0.374) (0.014) Relative deal value −0.018** −0.008***
(0.028) (0.000) Tender offer dummy −0.017*** −0.012
(0.005) (0.218) Diversifying deal dummy 0.002 0.007
(0.801) (0.848) Friendly deal dummy 0.007 0.005
(0.304) (0.365) All cash offer dummy 0.005 0.013**
(0.491) (0.030)All stock offer dummy 0.001 −0.003
(0.981) (0.470) Constant 0.011 0.019
(0.742) (0.478) Yeare effects Y YIndustry effects Y YNo of obs 185 2196Prob>F 0.00*** 0.00**Pseudo R-squared 0.516 0.218
Panel A
Table 7: means of payment and the effect of acquirer cash holdings on acquirer announcement returns and operating performance
This table reports robust regression estimates of how the effect of excess cash reserve on acquirer announcement returns (panel A) and acquirer operating performance (panel B) varies according to the means of payment. The regressions are estimated using both the U.K. sample (model 1) and the U.S. sample (model 2). The dependent variables are acquirer CAR (−2,+2) for panel A and adjusted post operating performance in panel B. All stock (cash) offer dummy is a dummy variable equals 1 if all considerations are paid in stock (cash) and 0 otherwise. All other variables are defined in table 1. p-values are in parentheses. *,**,*** indicate significance level at 10%, 5% and 1% respectively. Models in panel A are estimated with year and industry effects. Standard errors are corrected for heteroskedasticity.
U.K. U.S.Model 1 Model 2
Pre-acquisition operating performance 0.0410*** 0.2852***(0.000) (0.000)
CAR (-2,+2) 0.0095 0.0474(0.114) (0.379)
High excash dummy 0.0038** 0.0078(0.041) (0.245)
High excash dummy × all cash offer dummy 0.0014 0.0521***(0.117) (0.000)
High excash dummy × all stock offer dummy −0.0017** −0.0426**(0.044) (0.041)
Cash offer dummy 0.0011 0.0171**(0.109) (0.010)
Stock offer dummy −0.0018* −0.0637**(0.094) (0.032)
Constant 0.0024*** 0.0646**(0.000) (0.013)
No obs 185 2196R-square 0.117 0.604
Panel B
Shareholder power United Kingdom United StatesShareholder power related to general meetingsChanging basic governance arrangements Shareholders can intitiate changes to company memorandum and the articles of association —
the constitutional documents of UK firms. Changes can be made by a "special resolution" that requires a supermajority approval of 75% of casted votes at shareholder meeting (Companies Act, 1985, c. 6, section 9(1), 378(2)).
Only the board can initiate changes to corporate charters and the state of incorporation. Shareholders only have veto power (Delaware Code Annotated, Title 8, section 141(a) ; Model Business Corporation Act section 8.01(b)).
Calling extraordinary general meeting (EGM) Shareholders of 10% or more of the paid-up voting capital have the right to call an EGM, which cannot be removed by the company's article of association (Companies Act, 1985, c. 6, section 368).
Shareholders cannot call these meetings, unless stated otherwise in the corporate charter or bylaws (Delaware Code Annotated, Title 8, section 211(d)).
Making shareholder proposals At ordinary annual meetings, shareholder(s) holding no less than 5% of the voting rights or at least 100 shareholders (each has paid no less than £100 of paid-up capital) can force the company to put a resolution to the meeting, and to circulate a statement less than 1000 words before the meeting (Companies Act, 1985, c. 6, section 376).
Shareholders can request the board to add a proposal to the proxy statement but these proposals should not be related to the election (SEC Rule 14a-8). Even when the proposal receives a majority of votes, it is not binding on the board. Related costs go to the company. The shareholders can also launch a full proxy fight (SEC Rule 14a). The shareholders bear the costs of proxy fight which is normally very high.
Shareholder power related to director appointment/removalAppointing/removing directors via election in the annual general meetings (AGM)
There must be a separate resolution for each director (Companies Act, 1985, c.6, section 292). Cumulative majority votings applies.
State laws and company bylaws apply. Under Delaware Law, plurality voting is the default practice, i.e. candidates that receive the most votes (not necessarily a majority votes) win (Delaware Code Annotated, Title 8, section 216).
Appointing/removing directors by other procedures other than the AGM
A director can always be removed by a special meeting called for such purposes (Companies Act, 1985, c.6, section 303).
Shareholders can appoint/remove the directors by a unanimous consent in writing; If the consent is not unanimous, appointing/removal can only be made when all the directorships are vacant andall such vacancies are to be filled by such consent (Delaware Code Annotated, Title 8, section 211(b)).
Shareholder power related to takeoversStaggered board But shareholders can always remove a director by a special resolution (see above). The terms of directors can be staggered, which ensures only one-third can be elected each
year(Delaware Code Annotated, Title 8, section 141(d)).
Shareholder rights plans (poison pills) Shareholder rights plans (poison pills) are largely absent. Delaware courts support the shareholder rights plans which constraints the ability of an acquring shareholder to take her voting power above a certain threshold (usually 10-15%).
Restrictions on management frustrating takeover bids
The Takeover Code does not allow the managers to block a takeover bid. Shareholders have the power to decide whether to accept a bid (Takeover Code, Rule 21).
No such restrictions.
Embedded takeove defences Embedded takeove defenses are largely absent, which make it difficult for the directors to entrench themselves (Armour and Skeel, 2007; also see above on staggered board and poison ill )
Various types of "enbeded takeover defenses" exists (Armour and Skeel, 2007).
Shareholder power related to cash distributionDistribution to shareholders Under the default of UK law, the board is subject to "any directions given by special resolution"
of the shareholders(Companies Act appendix, Table A, provision 70 ).Under state corporate law, the authority to determine distribution (in cash or in kinds) rests fully with the board (Model Business Corporation Act, section 6.40).
Table A1: Comparing shareholder powers in the U.K. and the U.S.