Academic journal article IUP Journal of Applied Economics

Pre-Acquisition Performance Analysis of Indian Target Firms

Academic journal article IUP Journal of Applied Economics

Pre-Acquisition Performance Analysis of Indian Target Firms

Article excerpt


Acquisitions are categorized as domestic acquisitions or cross-border acquisitions. Acquisitions where the acquirer and target firm operate in the same country are called domestic acquisitions, whereas cross-border acquisitions are those where the acquirer belongs to a foreign country and the target firm belongs to the home country.

There are two main competing motivations behind acquisitions:

1. Corporate Control Hypothesis: According to this hypothesis, poorly-performing companies often become takeover targets for synergy gains.

2. Market Entry Hypothesis: According to this hypothesis, companies enter into new market through acquisition in order to tap the significant market potential.

Usually, the modes of entering a market can be either equity-based (e.g., acquisition, greenfield, joint ventures) or non-equity-based (e.g., export, debt funding, alliance), as the decision to acquire a firm is essentially an investment decision in case of capital budgeting process. According to Ernst and Young (1994), the three major components of the analytical structure for Mergers and Acquisitions (M&A) evaluation criteria are industry competitive factors, operating strategy and target firms' competitive position. The most preferred entry mode choice for entering any foreign market was found to be the acquisition of an existing local high technology firm, thus forming a duopoly with a local low technology firm (Gorg, 2000). Therefore, it is seen that existing operating characteristics of a company play a vital role in the acquisition decision-making process.

While pursuing a cross-border acquisition, firms consider various country, industry and firm-level factors. Past studies show that cross-border acquisitions are motivated by the Market Entry Hypothesis (foreign company acquires efficient domestic firms) and domestic acquisitions in emerging markets serve as a market for Corporate Control Hypothesis (domestic acquirers invest in poorly performing local firms with a view to improving their productivity and competence). According to Zhu et al. (2010), target firms of domestic acquisitions in emerging markets underperform target firms of cross-border acquisitions in the pre-acquisition period. Fukao et al. (2008) conducted a firm-level study in Japan and found that in case of domestic acquisitions, Japanese firms tend to target inefficient domestic firms with high leverage ratio, whereas in case of cross-border acquisitions, foreign firms prefer well performing Japanese firms. According to Zou and Simpson (2008), industry size and profitability are among the key determinates of cross-border M&A over the past few decades in China. Moreover, intangible resources and intellectual capability favor more of crossborder acquisition activities into China. Blonigen et al. (2013) found that foreign acquirers prefer such targets in the domestic country that have maintained high efficiency and competency levels for several years prior to acquisition.

Foreign markets are characterized by high information asymmetry and foreign acquirer usually has little knowledge and experience in doing business in the local domestic markets. Thus, foreign acquirers have less information about the valuation and business profile of the target firm. Differences in language, cultural, political, and financial systems make it more difficult for foreign firms to start new businesses in overseas markets. Therefore, foreign firms prefer large, competent and well-organized domestic firms. On the other hand, domestic acquirers have networking, intellectual and communication advantages and are also familiar with the governance system and legal framework of the country as against the foreign acquirer. As a result, it is relatively easier for domestic acquirers to identify efficient firms in the local market in order to acquire them at a lower valuation. Zhan (2014) conducted firmlevel study on banking sector and found that efficient banks have a higher chance to be acquired by foreign firms. …

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