The Value of Control in Emerging Markets

Foreign acquisitions extend the boundaries of the firm across national borders. In the context of emerging markets, these boundaries are extended across countries with vast asymmetries in institutions and property rights protection. If developed-market firms can extend the benefits associated with superior institutions to their operations in emerging markets by acquiring control, the stock price of the acquiring firms should reflect these value gains. In our forthcoming Review of Financial Studies paper, The Value of Control in Emerging Markets, we examine the returns to shareholders of developed-market firms that undertook acquisitions in emerging markets.

We find that when developed-market acquirers gain control of emerging-market targets, they experience positive and significant abnormal returns of 1.16%, on average, over a three-day event window. In the context of the well-documented underperformance of acquiring firms in U.S. mergers and acquisitions (M&A) transactions, this return is somewhat anomalous. It is also fairly substantial when viewed in relation to the size of acquiring firms in these transactions. The acquirer stock price reaction suggests a median (mean) dollar value gain of $4.07 ($30.15) million for the acquirer. In comparison, the median (mean) transaction value in an emerging-market acquisition where control is acquired is $42.41 ($308.57) million. In contrast, acquisitions of minority stakes do not deliver significant acquirer returns.

Positive acquirer returns and dollar value gains appear unique to the transfer of control in emerging-market M&A. The findings are not replicated when we examine acquisitions of developed-market targets by the same set of developed-market acquirers. While emerging-market acquirers also realize positive returns in transactions involving control of emerging-market targets, the magnitude of the gain realized by developed-market acquirers is significantly higher.

Evidence suggests that emerging markets have weak contracting institutions that make it difficult for firms to write enforceable contracts. We claim that by allowing developed-market firms to extend the boundaries of the firm across borders, acquiring control can help overcome problems of incomplete contracting, to increase firm value. Two predictions follow. First, with control, acquirers can improve the target value by sharing better institutional and corporate governance practices such as legal and accounting standards. Second, the importance of contract enforceability is likely to matter more in contract-intensive activities such as R&D or other intangible asset production. We find evidence consistent with both of these predictions. The magnitude of the acquirer stock price increase is more pronounced (a) the weaker the contracting environment in the emerging market and (b) for acquirer industries with high asset intangibility.

We conduct a number of tests to ensure the robustness of our results. First, we confirm that our results are not driven by survivorship bias at the level of the target country. Survivorship bias could arise if developed-country acquirers only make acquisitions in markets where previous transactions have proven profitable. Second, we establish that 50% is the critical threshold that drives the positive acquirer returns. Third, we conduct additional tests that exclude alternative explanations of our results based on asymmetric information and control for deal characteristics such as whether or not the acquisition was diversifying and method of payment effects.

The full paper is available for download here.