1. Introduction
In the U.S., Gompers, Ishii, and Metrick (2003) use the incidence of 24 governance rules to construct a “Governance Index” to proxy for the level of
shareholder rights at about 1500 large firms during the 1990s. Then Masulis, Wang and Xie (2007) analyze the relationship between the GIM index and the acquisition CARs. They find that there is a significantly negative relation between these two items. In Taiwan, however, there is no such a thing like GIM index which can be a proxy for corporate governance. So in this dissertation, I use internal corporate
mechanisms as my explanatory variables and analyze if there are relationships between internal corporate mechanisms and acquirers’ CARs. After reading this paper,
you will realize what mechanisms have effects on the CARs in Taiwan stock market.
The ultimate goal of Corporate Governance for a company is to maximize the company’s stock price. Denis and McConnell (2003) define corporate governance as
the set of mechanisms － both institutional and market-based － that induce the
self-interested controllers of a company (those that make decisions regarding how the company will be operated) to make decisions that maximize the value of the company to its owners (the suppliers of capital). Shleifer and Vishny (1997) describe that corporate governance deals with the ways in which suppliers of finance to corporations assure themselves of getting a return on their investment.
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Denis and McConnell (2003) state that the internal mechanisms of primary interest are the board of directors and the equity ownership structure of the firm. In Taiwan, the member of the board of directors is elected by the shareholders and it is
the highest authority in the management of the corporation. The number of members of the board is usually specified by the company’s bylaws. The duties of board of
directors include (1) governing the organization, (2) selecting, appointing, and reviewing the performance of the chief executive officer, and (3) approving annual budgets. Board composition is one issue that is often been studied. It includes board size and board structure. Board size means the number of directors that comprise the board and board structure means who comprise the board; independent members or not and if the CEO and chairman is the same person.
Ownership structure is the identities of firm’s equity holders and the size of their positions (Denis and McConnell (2003)). Ownership structure of a company will affect its performance by determining the degree of agency conflicts. A more concentrated ownership structure will minimize agency problems by aligning the interests of owners and managers. Hence, ownership structure is an important corporate governance mechanism.
There are mainly two ways for a company to amplify its scale. One way is through internal expansion which is using a company’s own capital to find investment
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opportunities having positive net present value. The other is by Merger and acquisition (M&A) which is a fiercer and more rapid method than the former to expand a company. These investments also tend to intensify the inherent conflicts of interest between managers and shareholders in large public corporations (Berle and Means (1933) and Jensen and Meckling (1976)). Morck, Shleifer, and Vishny (1990) identify several types of acquisitions (including diversifying acquisitions and acquisitions of high growth targets) that can yield substantial benefits to managers, while at the same time hurting shareholders.
A merger is an activity to combine two companies into one larger company.
These actions are usually voluntary and involve stock swap or cash payment to the target. Stock swap is often used because it allows the shareholders of the two companies to share the risk involved in the deal. An acquisition is an activity for a company to buy another company. This action can be friendly or hostile. In a friendly acquisition, the acquirer (buyer) negotiates the target (seller) before they act. However, in a hostile acquisition, the target may not know that some company is trying to buy it or even the target knows but it does not want to be bought. Acquisition commonly happens in the case that a bigger company purchases a smaller one. Nonetheless, it is still possible for a smaller company to buy a larger one. In an acquisition, an acquirer can purchase the target by stock, cash, or mixed.
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Why do firms have incentives to engage in acquisition activities? There are several reasons:
Synergy: This means that the combined company can often decrease its fixed costs by removing overlapped departments or operation lines, lowering the costs of the company relative to the same revenue stream, thus increasing profits.
Market share: This assumes that the buyer will absorb a major competitor and thus increase its market power by capturing increased market share to set prices.
Cross-selling: For example, a bank buying a stock broker could then sell its banking products to the stock broker's customers, while the broker can sign up the bank's customers for brokerage accounts. Or, a manufacturer can acquire and sell complementary products.
Economy of scale: It is a reduction in long run unit costs which arise from an increase in production. It occurs when larger firms are able to lower their unit costs due to increased order size and associated bulk-buying discounts.
Taxation: A profitable company can purchase a firm which has negative net income and use the target's loss as their advantage by reducing their tax liability.
Geographical or other diversification: This is designed to smooth the earnings results of a company, which over the long term smoothes the stock price of a company, giving conservative investors more confidence in investing in the company. However,
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this does not always deliver value to shareholders.
Vertical integration: Vertical integration occurs when upstream and downstream firms merge. By merging the vertically integrated firm can collect one deadweight loss by setting the upstream firm's output to the competitive level. This increases profits and consumer surplus. A merger that creates a vertically integrated firm can be profitable (Maddigan, Ruth, Zaima, and Janis (1985)).
In the next section, I am going to describe my data source and acquisition sample.
Section 3 presents the empirical results on the influence of internal corporate
governance mechanisms on the profitability of acquisitions. Section 4 concludes this thesis.