Managerial Ownership Proposition
The choice of financing alternatives in M&As must be related to the managerial ownership fraction of both parties – acquirer and target. Generally speaking, managerial ownership refers to the percentage of equity held by management and insiders in the acquiring and target firms. It is often viewed that the greater the management’s share of acquiring or target firms, the more likely cash financing is adopted. One explanation of this strategy in M&A deals is that the managers of both parties offer (or accept) cash as the medium of exchange in order not to dilute their already existing control after the acquisition.
Stulz (1988) examines the relationship between the choice of payment methods and the managerial ownership of acquiring firms. His study shows that the larger the fraction of the ownership held by the acquiring firms, the less likely an acquisition is financed by using share exchange. Under such a circumstance, the management of the bidder is reluctant to offer share as the payment medium in order not to dilute their original control after the acquisition. Meanwhile, Stulz finds in his study that if the fraction of target managerial control of voting rights is high, the probability of a hostile takeover is low since the target with a higher fraction of ownership will want more rights before the deal is completed.
Amihud, Lev and Travlos (1990) use a sample of 209 US acquisitions during the years 1981 – 1983 to investigate whether there exists a relationship between insider ownership and financing methods. They find that in cash financing deals the top five officers and directors of the firm hold about 11% of the company’s shares, while for the share financing, there are less than 7% held by them. This result indicates that managers with relatively higher share holdings in their firms prefer financing acquisitions with use of cash to share. In the explanation of this phenomenon, they point out that the reason for the use of cash rather than share financing by the acquiring firms is that they do not want to increase the risk of losing control after the acquisitions.
Song and Walkling (1993) study a sample of 153 target firms and 153 non-target firms containing all acquisition-related announcements in the US from 1977 to 1986 to explore: (1) the relation between managerial ownership and the probability of becoming a target; and (2) the effect of managerial ownership on target shareholders’ returns.
Initially, Song and Walkling calculate separately the mean and median of the managerial ownership for the target firms, industry-matched non-targets, and randomly selected non-targets in the sample. They find that target managerial ownership is significantly lower than industry-matched non-targets, which implies that the firm with a lower managerial ownership is more likely to be an acquisition target. Their study also shows that, in contested offers, the average level of managerial ownership is just 6.4%, which is significantly different from the corresponding average level of 18.7% for industry non-targets. This result indicates that a target with a lower level of managerial ownership has a higher probability to be contested by bidders. With reference to the relationship between managerial ownership and the forms of acquisition (contested or uncontested), their findings show that in uncontested acquisitions, the average level of managerial ownership for successful cases is 15.2%, which is significantly higher than the 8.6% level of unsuccessful cases. They conclude that a target with high level of managerial ownership is more likely to be attempted by the uncontested acquisition.
Furthermore, they employ a logistic regression analysis to examine the impact of target managerial ownership on the likelihood of an acquisition attempt. They find that the probability of being a target is inversely related to managerial ownership, which means that firms with a high level of managerial ownership are less likely to be attacked by the outsiders.
Finally, inspecting the relation between managerial ownership and target shareholders’ daily abnormal returns surrounding the first announcement date (from day –5 to +5), their results show that, in a successful acquisition where the target’s managerial ownership is low, the average abnormal returns are 29.5%; while in an unsuccessful case where the target’s management holds a high level of shares, the average abnormal returns are only 5.2%. To explain this phenomenon, Song and Walkling regress CAARs on managerial ownership and other variables. The regression results indicate that there is a highly positive relationship between target managerial ownership and abnormal returns in contested and ultimately successful acquisitions. As for all uncontested offers and in contested but not ultimately successful acquisitions, this relationship seems insignificant.
In summary, the findings by Song and Walkling suggest that the likelihood of being a target and the accomplishment of the deal is associated with the level of target managerial ownership.
A more recent study by Ghosh and Ruland (1998) has also confirmed the proposition concerning the positive relationship between the acquirer’s managerial ownership and cash financing. Ghosh and Ruland examine a sample of 212 successful US acquisitions for the period 1981 – 1988. They group the entire sample into three categories – offer by cash, share and the combination of cash and share. The data panel in their study clearly reveals that, with share exchange financing, the target firms’ average managerial ownership is significantly higher; while with cash financing, the acquirers’ managerial ownership is relatively high. The initial findings by them suggest that acquirers would prefer cash financing for acquisitions rather than share financing when their managerial ownership is relatively high. As for targets, they are more preferable to be financed by share if the management of the target still has a desire to possess voting influence in the combined firm.
Furthermore, Ghosh and Ruland apply multinomial logistic regression analysis to explore the impact of managerial ownership on the likelihood of share financing. They divide the acquirers’ percentage of managerial ownership into three segments in order to adjust their multinomial logistic model. These segments are 0-3%, 4-25%, and above 25%, respectively. As for the target, they employ the same method to cut off and categorize the managerial ownership but limit the cut-off point at 3%. The results from multinomial logistic regression has confirmed their propositions, that is, the managers with large percentage ownership in target firms prefer receiving share payment in order to maintain their job in the combined firm; while managers with large percentage ownership in acquiring firms are more preferable to use cash as means of payment in order not to dilute their ownership in the combined firm.
The Growth Opportunity Proposition
The alternatives for payment methods used in M&A deals, to some extent, depend upon the acquiring firm’s growth opportunities. A most detailed study in this respect has been done by Martin (1996), who attempts to explore the relationship between the means of exchange used in M&A transactions and the firm’s growth opportunities.
Initially, Martin exams a sample data covering 846 US acquisitions for the period from 1979 to 1988 by applying the traditional market model to calculate the mean values of data variables which are grouped by the three payment methods. The findings show that the CAARs obtained from using variables such as institutional ownership of ordinary shares and some other leading economic indicators are not statistically different at 10% level. This result suggests that the medium of exchange in acquisitions is not significantly affected by these variables.
Furthermore, Martin employs multinomial logit regression analysis to examine the growth opportunity proposition in acquisition financing. He uses Tobin’s q-ratio, the ratio of the market value of a company’s debt and equity to the current replacement cost of its assets, to measure the firm’s growth opportunity. It is often thought that firms have an incentive to invest when q is greater than 1, and they will stop their investment when q is less than 1. The results show that the coefficients on q are positive and highly significant in his model, which is regressed by testing the relationship between growth opportunity and share financing. The findings, therefore, have confirmed his proposition that acquiring firms with greater growth opportunities are more likely to use share exchange as the payment method in acquisitions. A possible interpretation of this is that the acquiring firms would need more cash (if available) under such a circumstance to satisfy their growth opportunities.
The Relative Size Proposition
The previous studies on the impact of the relative size of target to bidder on payment methods are not consistently confirmed. It is viewed by some researchers that the bigger the size of the target firm will lead to the acquirer more likely to use share financing in M&A deals; while for some other studies, this hypothesis has been rejected.
In the study by Grullon, Michaely and Swary (1997), this theory is tested in great detail. They examine 146 US bank mergers for the period between 1981 and 1990 by applying a multinomial logit model to explore the determinants of payment methods. The variables to be tested in a logit regression include the capital position of the merged banks, the relative size of targets, and the return on equity of both parties. They find that share exchange or a combination of share and cash financing is more likely to be used in mergers where targets have high capital adequacy relative to the bidders as indicated by higher log odds ratio of share-to-cash and the combination-to-cash which are 2.12% and 1.87%, respectively. With regard to the relative size effects on the choice of payment methods, Grullon, Michaely and Swary find that the bigger the relative size of the target to the acquirer, the more likely the merger is financed by share or the combination but not cash only. This result has confirmed their hypothesis that the relative size of the target to the acquirer is positively related to the choice of share financing in M&A deals.
However, in conflict with the findings by Grullon, Michaely and Swary, Martin’s (1996) results show that the target’s relative size, which is measured by the ratio of the amount paid for the acquisition to the sum of the market value of equity as of 20 trading days just before the announcement date and the amount paid for the acquisition, is not significant at the 5% level in any of his regressions. He draws the conclusion that the target’s relative size does not differ significantly between the methods of payment used in acquisitions. This result suggests that there is no clear and close association between relative size and acquisition financing in mergers and acquisitions.
A study by Ghosh and Ruland (1998) present the same results as Martin’s (1996), regarding the relationship between the relative size and the choice of acquisition financing. Similar to Martin (1996), Ghosh and Ruland also analyze the impact of relative size as well as other factors on the likelihood of a particular payment method used in acquisitions. Their findings show that the target’s relative size does not differ significantly for the payment alternatives in their logit model. The possible interpretation of their results is, according to the authors, that when target size is relative large compared with the acquirer’s, the target management would prefer negotiating for share financing in order to maintain their interest and influence in the combined company. Meanwhile, the acquiring firm’s managers prefer paying cash in order not to dilute their existing ownership in the firm. The payment alternatives are, therefore, offset by those two different motivations between the counterparts. As a result, there is no clear sign indicating the linkage between the relative size of the two parties and payment methods chosen in M&A transactions.
Business Cycle Proposition
In the study by Martin (1996) described earlier, he has also attempted to analyse the impact of business cycle conditions on the methods of payment used in acquisitions. The business cycle variables in his study include changes in the Standard and Poor’s 500, index changes in Moody’s BAA bond yield, changes in the index of 11 leading economic indicators and changes in industrial production. The results of his logit regression analysis show that only the variable of Standard and Poor’s 500 is consistently significant with predicted positive sign, with regard to share financing. As for the other variables studied in the model, they are all not in line with the predicted signs in terms of their relationship with acquisition financing. As a result, based on Martin’s findings, the good performance in overall stock market gives rise to share financing more preferably.
As we have seen there is much literature on the issue of payment methods in corporate acquisitions. However, nearly all of the previous research focused mainly on US takeovers; little analysis in this respect has been made on the UK market. In search of the relevant articles dealing with the UK, we find that the studies, which have been involved systematically in investigating the choice of payment methods based on the UK market are quite few. Among those excellent UK studies, the post-acquisition performance for bidders as well as targets has been examined extensively. Few analyse the specific area of the determinants of the payment methods except for one by Harris, Franks and Mayer (1988). As reviewed above, in their study, Harris, Franks and Mayer made a comprehensive comparison in terms of means of payment in takeovers between the US and the UK. They attempted to explore the impact of taxation and asymmetric information on the choice of payment methods. The authors found no satisfactory explanation for their findings in terms of the tax effects on payment methods used in M&As.
Theories of acquisition financing present some propositions in terms of the payment methods. Some of them appear to have been confirmed while the others are far from being conclusive. Taking the relative size hypothesis as an example, the inconsistent results in respect of methods of payment studies motivate us for further scrutiny. Meanwhile, based on the study of the UK market, in this paper we attempt to illustrate the issue further on the determinants of payment methods in M&A.
3. Testable Hypotheses
As outlined above, a number of hypotheses have been advanced to explain the choice of payment methods, given some alternatives in M&A deals. The suggestions presented by these previous empirical studies indicate that the payment methods chosen in M&A transactions might be related to information asymmetry, taxation, M&A regulations, accounting treatment, and some other factors in terms of both acquirer and target’s financial performance. However, these key elements, on which payment methods are generally considered dependent, do not hold in any circumstances. Moreover, empirical results from testing the hypotheses are quite different among the previous studies. The inclusiveness in this respect, therefore, provides support for further scrutiny in this paper – some key elements will also constitute the foundation for related studies. Summarising the literature and considering the current state of research in the area, we propose to test the following set of hypotheses with specific reference to the choice of payment methods in M&A. We feel that to organise and test the hypotheses in a systematic way will help achieve consistent results.
Hypothesis 1. The Relative Size Hypothesis – The bigger the size of the target relative to the acquirer, the more likely the share financing is used.
This hypothesis is based on the proposition of Martin (1996), Ghosh and Ruland (1998) and Grullon, Michaely and Swary (1998). In view of the inconsistent results among them, this study proposes further investigation into the exchange mediums chosen in M&A deals with regard to the relative size hypothesis. The relative size in this study is measured as the ratio of the target assets (or market value of its equity) to those of acquirer’s. It is a quite popular view that the bigger size of the target relative to the acquirer will make share financing more preferably. The possible interpretation about this viewpoint is that the managers in target firms under such a circumstance have more power to bargain the payment methods with the acquirers; and if they want to retain their job and influence in the combined firm, share exchange must be an ideal choice for them. On the other hand, if the target firm is a relatively bigger one, the acquirer has to choose share financing since there will be no sufficient cash to finance the deals. This is also what our analysis suggests.
Hypothesis 2. The Management Ownership Hypothesis – The greater the share ownership in both parties, the more likely cash financing is used.
The percentage of equity held by management and insiders must be related to the payment methods used in acquisition financing. Stulz (1988), Amihud, Lev and Travlos (1990), and Song and Walkling (1993) have attempted to explore the relationship between the choice of payment methods and management ownership, but their studies in this respect focus either on the target or acquirer but not on both simultaneously. A more detailed study by Ghosh and Ruland (1998) confirmed hypothesis 2, which is based mainly on the US acquisition market. Possible differences concerning M&A activity between the two markets deserve a closer attention on this phenomenon.
Hypothesis 3. The Free Cash Flow (or Cash Availability ) Hypothesis – Sufficient free cash flows in hands by acquiring firms lead to the acquisition deal being financed by cash
This hypothesis is based on the premise that the acquirer has sufficient cash flows in hand but few profitable investment opportunities. Under such a circumstance, with everything else the same, a cash offer tends to be employed in the M&A deals. The acquirer’s free cash flows could be obtained from the Free Cash Flow Account; and it can also be measured and reflected by Dividend Payout ratio – a higher payout might signal the higher level of free cash flows. We employ the latter in this paper to test the hypothesis.
Hypothesis 4. The Target Prior-acquisition Performance Hypothesis – Bad performance in this regard gives rise to cash financing more preferably
Bad pre-acquisition performance of the target firm means that the target is poorly managed. Under such a case, the acquirer is more willing to use the cash financing in order to eliminate the inefficient management of the target firm. For convenience of the analysis, the target firm’s pre-acquisition performance is measured by its Return on Equity (ROE) just before the announcement date.
Hypothesis 5. The Stock Market Performance Hypothesis – Good performance of the acquirer on the stock market makes share exchange more preferable in M&A deals
The booming stock market means the buoyant profitability of the firms. In this situation, the acquirer prefers to use share exchange financing the deals and; on the other hand, the target is also willing to accept the share exchange since it seems extremely attractive when offered as the considerations of the payment methods. We use the Market-to-Book ratio as the measurement of acquirer’s stock performance.
4. Data Sample and Descriptive Statistics
4.1 Description of the Data Sample
The data set and announcement dates used in this study were collected from Excel’s publications on Takeovers, Offers and New Issues and the various issues of Acquisitions Monthly for the period between 1990 and 1999. There were a total of 807 mergers and acquisitions taking place in the UK during this period. We delete a total of 117 lapsed bids and a total of 161 bids unavailable of payment methods in terms of the three alternatives examined in the study. Additional 86 observations in the meantime are removed from the initial sample because they are either non-UK public companies or private ones. That means, to be included in our sample, all takeovers for both the target and acquiring firms must be listed on the London Stock Exchange during the sample period. This restriction allows us to use Datastream and therefore to help ensure sufficient data for both targets and acquirers. Finally, 340 bids have to be dropped due to unavailability of relevant data.
Thus, the final sample contains 103 acquisitions – all targets being matched with acquirers in terms of the explanatory variables in our study. Financial data for the final sample are collected from Datastream. However, since Datastream does not provide all of the financial data required, we have to obtain those from some reference books, such as various issues of Price Waterhouse’s “Corporate Register”, Crawford’s Directory of City Connections, and the Macmillan’s Stock Exchange Yearbook. For some specific financial data, for example, the dividend payout ratio of the acquirers, which is frequently not available on Datastream, we use a formula to calculate the ratio of net dividend to net earnings shown on the company’s Balance Sheet as its payout ratio. Finally, it should be noted that all accounting variables and financial data in our study are selected or calculated for the most recently available financial year immediately prior to the bid announcement. Table 1 provides the final sample consisting of 103 acquisitions which are satisfied with our criteria and grouped by payment methods.
Table 1. Annual Distribution of Corporate Acquisition Bids Available in Terms of Required Financial Information Grouped by the Payment methods (1990 –1999)
Observations in table 1 show that cash financing constitutes 37% of the sample data, share exchange financing and the combination of the two financing account for 41% and 22%, respectively.
4.2 Descriptive Statistics and Interpretations
Table 2.1 presents summary statistics for the payment methods in the sample. As table 2.1 indicates, mean values for the three payment methods – cash offer, share exchange offer and the combination of the two—are quite different in the Relative Size of target to acquirer, the acquirer’s Return on Equity, the Dividend Payout ratio, and its Market-to-Book ratio. In more detail, descriptive statistics in the sample reveal the following characteristics:
- Row 1 in table 2.1 shows that the smaller the relative size of the target to acquirer, the more preferable the deal is financed by cash. By contrast, the bigger the relative size of target to acquirer, the more likely the deal is financed by share exchange. This result is consistent with our hypothesis 1 that the bigger the target, the more likely share exchange is used since there might be no sufficient cash for the acquirer to pay the deal under such a circumstance.
-
As shown in the third row of the table, mean values of acquirer’s return on equity are much higher when using cash financing than that of share and combination financing. As a result, our hypothesis, which says that sufficient cash flows in hand by acquirer will lead to cash financing, was confirmed
- From the fifth row of the table, we can see that the higher the share ownership of the target, the more likely cash financing is used. This point is in line with our hypothesis that higher ownership by the target management will make them have more power when negotiating the payment methods before the deals. Accordingly, cash payment is used in the transactions since this payment method is often preferred by target firms.
- Mean values of the dividend payout ratio of the acquirer show that cash financing and the combination are both higher than those of share financing, but only mean values of cash financing are significantly different from share financing. Clearly, the acquirer is more preferable to finance the M&A deal by using cash offer if the company has sufficient cash flows in hand.
- Summary statistics in the last row show that the higher the ratio of acquirer’s market-to-book value, the more likely share exchange or the combination of the two is used in M&A deals. The results are in line with the hypothesis that good performance of the acquirer’s share on the stock market (measured by the ratio of market-to-book value) makes its share more attractive when offered as consideration in the transaction.
Tables 2.2-2.4 show the differences in means of different variables with regard to the comparisons of cash and share, cash and combination, and share and combination. By comparing cash with share under different variables (as shown in table 2.2), for example, we can see that t values of RSIZE, ROE(A), DIVIDPAY(A), and MARKET-to-BOOK(A) are significant at 5% level. That means these variables are well defined for the classification of the payment methods when cash offer and share exchange is used.
Similarly, when cash and combination of cash and share are compared in this respect (as shown in table 2.3), t values are significant in variables of RSIZE, ROE(A), and MARKET-to-BOOK(A). Therefore, these variables are the dominant factors in classifying payment methods between cash offer and combination exchange.
From table 2.4, we can see that at 5% level of significance t values are insignificant for all the variables. This suggests that there is no clearly defined classification between share exchange and the combination of the two.
Table 2.2 Independent Samples Test (cash and share)
Table 2.3 Independent Samples Test(cash and combination)
Table 2.4 Independent Samples Test(share and combination)
However, the hypothesis which says that cash offer usually takes place in the case that return on equity (ROE) of the target’s is relatively low has not been confirmed in table 2.1. (The second row of table 2.1 shows that the mean values are nearly similar in cash offer and share exchange). The possible interpretation of this result is that the higher ROE of the target makes the target more powerful in negotiating with the acquirer concerning the medium of exchange before the transactions. Accordingly, it is more likely to be financed by cash since cash offer, as is well known, usually gives rise to a higher premium of the bid price due to taxation considerations. As for the result of higher ROE of the acquirer’s leading to a higher probability of using cash financing, it can be interpreted as that good performance of the acquirer implies that it has sufficient cash in hand or it is easier for it to raise funds on the market.
Finally, as shown in table 2.1, the payment methods used in M&A deals do not seem to be influenced by the ownership of the acquirer, at least this phenomenon does not exist in the situation regarding the two payment methods. The lack of such significant differences between cash offer and share exchange offer with reference to the ownership of acquirer indicates that the result is not consistent with previous research, i.e., Martin (1996), documenting the importance of ownership in determining the means of payment.
5. Empirical Results: Determination and Classification
Summary statistics described above show that some of the hypothesised variables have statistically different mean values in M&A deals financed by cash as compared with those financed by share exchange, while some other variables are indifferent with payment methods. Therefore, there is a need to further investigate the determinants of merger finance on the basis of Factor Analysis. Factor analysis groups financial variables into categories with common factors. It is expected that a small number of factors can explain most or the large part of the attributes in financial entities. So factor analysis allows us to concentrate on important factors by reducing a larger number of variables to a smaller number of factors. Moreover, factor analysis reveals the relationship between the variables defined in the study as it classifies variables with similar characteristics into one factor and variables with different features into other orthogonal factors. We further employ discriminant analysis to classify the merger cases by the payment methods used in M&A transactions.
5.1 Factor Analysis and its Results
Table 3 shows the results of principal component analysis, which were conducted on the correlation between the seven variables. Three factors were initially extracted with eigenvalues equal to or greater than 1.00. As shown in the above table, the first factor accounts for 25% of total variance, the second factor for 18%, and the third one accounts for 14%. In total, the three factors account for 57% --- more than half of the total variance. Clearly, there are other remaining factors in our data sample but they are insignificant.
Table 3 Principal Component Analysis Output
Total Variance Explained
Orthogonally rotated factors, which are uncorrelated, are reported in Table 4, The table gives the linear relationship between the variables and the extracted factors as reflected by different loadgings of the seven variables on the two factors.
Table 4 Rotated Component Matrix
It is clear that at least two variables such as return on equity of both acquirer and target are loaded substantially on Factor 1. Some variables such as the relative size of target to acquirer, the acquirer’s dividend payout ratio, and the performance of acquirer’s stock on the stock market loaded significantly on Factor 2. The variables of ownership of the target and acquirer, loaded significantly on Factor 3. Since the first factor is often viewed as the single best summary of linear relationships exhibited in the data, it reveals, combined with the second factor—factor 2, that the variables of return on equity of acquirer and target, relative size of target to acquirer, the acquirer’s dividend payout ratio, and the performance of acquirer’s stock on the stock market are relatively more decisively defined in our sample in analyzing the payment methods.
5.2 Discriminant Analysis and its Results
The above factor analysis indicates that there are three factors in our data sample which can explain 57.30% of total variance. We further employ discriminant analysis to distinguish the cases listed in our sample. The purpose of discriminant analysis is to make it possible to identify those variables that significantly contribute to the predictive process and thereafter drop the others from the discriminant function. By applying stepwise type of discriminant analysis, we obtain the following results:
Table 5 Results of discriminant analysis
5.1 Eigenvalues
First 2 canonical discriminant functions were used in the analysis.
5.2 Structure Matrix
Pooled within-groups correlations between discriminating variables and standardized canonical discriminant functions Variables ordered by absolute size of correlation within function.
5.3 Classification Results
61.2% of original grouped cases correctly classified.
5.4 Functions at Group Centroids
Unstandardized canonical discriminant functions evaluated at group means
5.5 Classification Function Coefficients
Fisher’s linear discriminant functions
*PM is payment methods in which 1.00 = cash, 2.00 = share, and 3.00 = the combination,respectively.
- Output listing in table 5.1 shows the percentage of total variance accounted for by each discriminant function. Generally, the function with the largest eigenvalue is the most powerful discriminator. Accordingly, function 1 may highlight the combination of variables that best discriminates between the three groups.
- Following the interpretation of table 5.1, the output listing in table 5.2 shows that the first discriminant function (the most powerful discriminator) is based on MARK-BOOK(A), ROE(T), RSIZE, and DIVPAY(A). These variables are also viewed as the main predicting variables in the function.
- Table 5.3 provides an indication of the success rate for predictions of membership of the grouping variable’s categories. As shown in table 5.3, over 70% cases in the two major categories, i.e., share exchange and cash offer, can be correctly classified using this method. Nevertheless, discriminant analysis does not have any prediction power for the third payment method, i.e., the combination of cash and share exchange, with more than two thirds being wrongly classified as cash or share exchange. This results in a relatively low overall success rate of 61.2%. Clearly, the mixed attributes of cash and share exchange offers make the classification rather difficult for this group which shares the characteristics of either cash offer or share exchange.
- Table 5.4 gives the means for each of the groups. These means are based on values of the two functions, or the linear combinations of seven prediction variables in our sample, and they are standardised. The means are also called centroids and are used to interpret the differences between the groups.
The comparisons show that there is a significant difference between cash and share exchange financing with centroids are –0.616 and 0.323, respectively. Clearly, the difference between cash and combination is also quite remarkable. However, the difference between share and combination is much less clearly defined on function 1.
- The discriminant analysis output produces Fisher’s classification function coefficients as showed in table 5.5. These coefficients can be used directly for classification – an activity in which either the discriminating variables or the canonical discriminant functions are used to predict the group to which a case most likely belongs. We hereby derive the relevant classification functions for each group based on table 5.5:
Ci = -4.56 + 0.088*DIVIDPAY(A) + 0.072*OWNSHIP(A)
• 0.068*OWNSHIP(T) + 0.026*ROE(A) + 0.035*ROE(T)
• 0.017*RSIZE + 0.16*MARK-BOOK(A)
where i = 1,…,38
Sj = -3.93 + 0.069*DIVIDPAY(A) + 0.064*OWNSHIP(A)
• 0.056*OWNSHIP(T) + 0.015*ROE(A) + 0.051*ROE(T)
• 0.32*RSIZE + 0.29*MARK-BOOK(A)
where j = 1,…,42
(C+S)k = -4.24 + 0.08*DIVIDPAY(A) + 0.11*OWNSHIP(A)
• 0.03*OWNSHIP(T) + 0.002*ROE(A) + 0.05*ROE(T)
• 0.13 RSIZE + 0.31*MARK-BOOK(A),
where k = 1,…, 23
From the above classification functions we can see that there is a clear difference between Ci and Sj in terms of the following variables, namely MARK-BOOK(A), RSIZE, ROE(A), and DIVIDPAY(A). While considering the variables in function (C+S)k, we can see that the difference between (C+S)k and Sj is not clear with regard to the variables of MARK-BOOK(A) and DIVIDPAY(A), but there is a difference in the other variables. Similarly, we can find the difference between (C+S)j and Ci. However, the similarity as well as the difference is difficult to be observed from these functions. This implies that the characteristics of M&A deals are quite different between the payment methods of cash financing and share exchange, but those of cash and share combination are less clearly defined.
In summary, results obtained from the discriminant analysis indicate that four of the seven variables, namely the stock market performance of the acquirer which is measured by the ratio of market-to-book value, return on equity of the target, relative size of the target to acquirer, and the ratio of the acquiring firm’s dividend payout are selected as being part of the dominant factors. These results are in line with those obtained from the previous Factor Analysis except for the variable of return on equity of the acquirer, which is not thought to be one of the main factors in discriminant analysis.
6. Concluding Remarks and Suggestions for Further Research
This paper examines the determinants of financing methods in M&A transactions, using a sample set of acquisitions in the U.K. for the period of 1990 – 1999. We find that the choice of methods of payment in acquisitions is dependent upon a number of financial variables. In this respect, the overall results obtained in the study are consistent with those found by other researchers. However, a few propositions concerning the determinants of payment methods cannot receive strong support in this study.
The empirical results in this paper are consistent with the hypothesis that the larger the size of the target relative to the acquirer, the more likely the acquisition is financed by share. In addition, the results also confirm the hypotheses that: (1) The higher the dividend payout of the acquirer, the more preferable cash offer will be used in the deals; (2). The higher the return on equity of acquirer’s, the more likely cash is used to finance the deal; and (3) The better performance of the acquirer’s share on the stock market, the more likely the deal will be financed by share exchange.
Factor analysis and discriminant analysis confirm that the relative size of target to acquirer, the acquirer’s dividend payout, and its share performance on the stock exchange are relatively more important in explaining the variations. Meanwhile, these variables are the main factors in segregating cash financing from share exchange. We have found that neither target nor acquirer’s share ownership is important in analysing the choice of payment methods in M&A activities.
Some findings in the study, however, contradict those of previous studies. For example, the results in terms of the ownership variable are not confirmed in the study. Results indicate that there is no clear evidence showing that the payment method is closely related to the fractions of ownership held by the two participants – acquirer and target. It seems difficult to explain this result that the ownership variables of the acquirer as well as the target do not have meaningful explanatory power in determining the payment methods in M&A deals.
The empirical results in the study suggest at least two directions for further study in this respect. First, future research on the determinants of payment methods could benefit from applying econometric models, e.g., the multinomial logit model, to explore the close relationship between payment methods and the financial variables, thereby deciding which payment alternative is preferable in M&A transactions under particular circumstances. Second, post-acquisition performance with regard to the choice of payment methods deserves attention in order to uncover whether a particular exchange medium is rationally chosen by the two parties and is justifiable in the long run.
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