Industry competition, Innovation and Cross-border M&A: East versus West

1. Importance and Key contribution Globalization has brought many opportunities for businesses and entrepreneurs. Globalization allows firms to conduct business activities outside of their national boundaries, which includes... [ view full abstract ]

1. Importance and Key contribution
Globalization has brought many opportunities for businesses and entrepreneurs. Globalization allows firms to conduct business activities outside of their national boundaries, which includes acquiring international targets. The M&A markets are no longer limited to domestic deals, and as a result, the number of cross border M&A deals has been increasing significantly over time. In 2012, cross border M&A accounted for 36% of all M&A activities (Huang et.al 2013), rising from 25% in 1990s (Erel et al., 2012). The magnitude of the increase in cross border M&As has created a significant demand for research. Prior studies in cross border M&As have looked at factors that affect cross borders M&A such as culture, geography, innovation acquisitions, bi-lateral trade level, corporate international diversification. However, none of the research has looked at the effect of industry competition on cross border M&As. As firms face more intensive competition, they will need to find a growth strategy to escape competition, either grow internally through investing in innovation or grow externally through undertaking M&As. Therefore, we argue that competition is an important driver of M&A, especially cross border M&A, and this relationship requires further research.
This paper contributes to the literature in that aspect. First, this is the first paper that empirically examines the relationship between industry competition and M&As with special focus on cross border M&As. Second, the paper contributes to the product market competition literature by showing the impact of industry competition (both domestic and international) on the managerial decision to engage in M&A activities. We also show the moderating impact of innovation in the relationship between competition and M&As.
Finally, we contribute to the understanding of the differences between business and entrepreneurship thinking between Eastern firms and the Western firms. Specifically, what factors may drive Western and Eastern managers to undertake M&A, and how globalization (through cross border M&A) has impacted differently the Eastern businesses and Western businesses in term of innovation growth (R&D and patent growth).

2. Theoretical Base
The increase in cross-border M&A transactions has motivated several studies, with the primary focus on firm and country factors that stimulate cross border M&A. These include geography, quality of accounting disclosure, bilateral trade level between two countries (Erel et al., 2012), corporate international diversification (Santos et al., 2008), and culture (Chakrabarti et al., 2009). More recently, Huang et al. (2013) and Bena and Li (2014) show that innovation is an important determinant of cross-border deals.
There is also a growing body of M&A literature with a strong management perspective. Parvinen and Tikkanen (2007) show that incentive asymmetry (risk antecedent, information antecedent and pure self-interest) can significantly impact on the M&A process, including biased financial valuations, post M&A integration plans and acquisition price acceleration. The differences in the cost of domestic deals and international deals can be largely explained by information asymmetry, arising from greater information gathering costs as bidders attempt to increase transparency (Boeh, 2011). The choice of M&As versus strategic alliances has also been examined (Hagedoorn, and Duysters 2002), and can largely be explained by industry (i.e., high tech versus low tech), and type of business (i.e., core business versus non-core business) factors.
The focus of this paper is on what role, if any, does industry competition play in motivating firms to grow through domestic and/or cross-border M&As, and more importantly, whether traditional Western theories of competition (e.g., Schumpeter 1942, Aghion 2005) help explain differences in activity across countries, broadly classified as Western or Eastern. This analysis will then be extended to examine the relation between competition and the acquisition of innovation as a key driver in motivating M&A deals. Prior literature has examined innovation (Huang et al. 2013 and Bena and Li 2014) in motivating cross-border deals, but is silent on the relation, if any, between industry competition and innovation in driving deals.
3. Research questions & Method
The following three key research questions are examined:
- What is the relationship between industry competition (both from domestic rivals and foreign competitors) on the level of M&As, especially cross border M&A deals (in term of the number of deals, deal value, deal mood- hostile or friendly, deal completion rate)
- Does industry competition play a role in motivating innovation-type M&A deals, and are these deals more likely to be cross-border than domestic?
- Do M&A activities change firms’ entrepreneurial behaviour? Specifically, how do firms involved in cross-border deals perform relative to domestic in term of R&D and patent growth, and what role does industry competition play ex-ante and ex-post in achieving better innovation outcomes?
Methodology
Data
The data includes information for M&A deals initiated by public bidders from 1990-2010, and is obtained from SDC Platinum’s Mergers and Acquisitions database. Accounting information for the bidder is from World Scope. Country-level risk measures (ADI, ICRG, Common law, Transparency index, and the CGRI), gravity measures (distance and language), and relative stock market returns are obtained from various sources (see Huang, Officer and Powell (2014); Huang et.al, 2013). Data on patents are taken from NBER patent database.
Models
In this paper we use industry-level model, in which we extend the model proposed by Mitchel and Mulherin (1996). However, I take into account the impact of industry competition to the level of M&A. In this ever increasing global world, competition in an industry can come from different sources, including from rivals in domestic markets or international competitors. Following Mitchell and Mulherin (1996), foreign competition is measured using the import intensity ratio. Domestic competition arising from domestic rivals is captured using the Lerner and Herfindahl Indices (Aghion 2005).
4. Findings
First, we find a positive relationship between competition and M&A, indicating that managers when they face more intense competition, they will engage more in M&As as a tool to escape competition. Second, we find a moderating effect of innovation in the relationship between competition and innovation. Further, we show that there is a difference in the behaviours of Eastern and Western managers when they face the same level of competition increase. Eastern managers are more likely to undertake M&A whereas Western managers will think of investing more in innovation to stand out from the crowd. In addition, we find an evidence that Western initiated deals are more hostile than Eastern deals and completion or success rate of Western initiated deals are higher than that of Eastern initiated deals. Finally, we find that M&As have positive impact on firms’ performance in term of innovation growth

5. Implications
This study has an important implication in demonstrating the link between industry competition and M&As. The study also points out how innovation plays a moderating role in the competition- M&As relationship.
The study also promotes an understanding of the difference in managerial behaviours of the Western and Eastern managers. Under the same competition pressures, Eastern and Western managers will react differently. While Western managers will be putting more effort in innovation investment, Eastern managers will look for potential M&A partners to merge/ acquire.
6. References
Aghion, P., Bloom, N., Blundell, R., Griffith, R., & Howitt, P. (2002). Competition and innovation: An inverted U relationship (No. w9269). National Bureau of Economic Research.
Bena, J., & Li, K. (2014). Corporate innovations and mergers and acquisitions.The Journal of Finance, 69(5), 1923-1960.
Boeh, K. K. (2011). Contracting Costs and Information Asymmetry Reduction in Cross‐Border M&A. Journal of Management Studies, 48(3), 568-590.
Chakrabarti, R., Gupta-Mukherjee, S., & Jayaraman, N. (2009). Mars–Venus marriages: Culture and cross-border M&A. Journal of International Business Studies, 40(2), 216-236.
Dos Santos, M. B., Errunza, V. R., & Miller, D. P. (2008). Does corporate international diversification destroy value? Evidence from cross-border mergers and acquisitions. Journal of Banking & Finance, 32(12), 2716-2724.
Erel, I., Liao, R. C., & Weisbach, M. S. (2012). Determinants of cross‐border mergers and acquisitions. The Journal of Finance, 67(3), 1045-1082.
Ferreira, M. A., Massa, M., & Matos, P. (2009). Shareholders at the gate? Institutional investors and cross-border mergers and acquisitions. Review of Financial Studies, hhp070.
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Hagedoorn, J., & Duysters, G. (2002). External sources of innovative capabilities: the preferences for strategic alliances or mergers and acquisitions. Journal of management studies, 39, 167-188.
Huang, P., Humphery-Jenner, M., & Powell, R. (2013). Innovation and Cross-border Mergers and Acquisitions. 26th Australasian Finance and Banking Conference 2013
Huang, P., Officer, M. S., & Powell, R. (2014, August). The Choice of Method of Payment in Cross-Border and Domestic Mergers and Acquisitions. In Asian Finance Association (AsianFA) 2014 Conference Paper.
Mitchell, M. L., & Mulherin, J. H. (1996). The impact of industry shocks on takeover and restructuring activity. Journal of financial economics, 41(2), 193-229.
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Competition, Innovation, M&A, Cross border M&A [ view full abstract ]

Competition, Innovation, M&A, Cross border M&A