Effects of Firm-specific and Country-specific Advantages on Relative Acquisition Size in Service Sector Cross-Border Acquisitions: An Empirical Examination

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Abstract

Using a sample of 348 service sector cross-border acquisitions by U.S. firms in 44 countries during 1990–2006, our study seeks to identify factors that influence relative acquisition size (acquisition transaction value as a percentage of acquiring firm's asset value). Our findings indicate that firm-specific advantages (FSAs) in the form of available financial slack and target industry knowledge were positively associated with relative acquisition size. However, contrary to expectations, we observed a negative relationship between cross-border acquisition experience and relative acquisition size. In addition, our results suggest that country-specific advantages (CSAs) associated with higher market potential, lower political risk, and greater cultural similarity contributed to increased relative acquisition size in service industry cross-border acquisitions. Finally, our analysis reveals that the relationship between available financial slack and relative acquisition size is contingent on cultural similarity with the relationship being more pronounced when cultural similarity is high.

Introduction

With multinational enterprises (MNEs) increasingly relying on cross-border acquisitions for expansion into foreign markets, we have witnessed a dramatic upsurge in both the number and total value of such acquisitions over the past 25 years. Data compiled by the United Nations Conference on Trade and Development (UNCTAD) indicates that between 1990 and 2007 the total value of such acquisitions increased ten-fold from approximately $100 billion to over $1 trillion. While the immediate aftermath of the global recession of 2008 witnessed a significant drop in cross-border acquisition activity, the value of such acquisitions had, by 2016, climbed back to $869 billion (UNCTAD World Investment Report, 2017).

Not surprisingly, this increased popularity of cross-border acquisitions has motivated multiple studies on such acquisitions in disciplines such as international business, accounting, finance and strategic management. Bulk of this research has focused on the assessment of cross-border acquisition performance, with performance generally assessed as wealth effects (abnormal gains) accruing to acquiring and acquired firm shareholders around the acquisition announcement date. Findings, from the perspective of acquiring firm shareholder value creation have been equivocal. While some (e.g., Dutta et al., 2013; Kiymaz, 2009; Starks and Wei, 2013; Zhu, 2011) indicate that cross-border acquisitions do indeed create value for the shareholders of acquiring firms, others suggest that such transactions result in either shareholder value destruction (Aw and Chatterjee, 2004; Datta and Puia, 1995; Karolyi and Taboada, 2015) or no statistically significant performance outcomes (Basuil and Datta, 2015; De Beule and Sels, 2016; Starks and Wei, 2013). Additionally a related body of research, scholars have sought to identify the factors that influence value creation in cross-border acquisitions. Studies involve the effects of, environmental (Benou et al., 2007; Datta and Puia, 1995; Kiymaz, 2009), country (Chakrabarti et al., 2009; Martynova and Renneboog, 2008; Schweizer et al., 2017), acquisition (Arena and Dewally, 2017; Dutta et al., 2013) and firm effects (Barbopoulos et al., 2012; Basuil and Datta, 2015; Gregory and O'Donohoe, 2014; Markides and Oyon, 1998) impact the level of value creation in cross-border acquisitions. Again, findings have been equivocal. Other studies on cross-border acquisitions have chosen to examine the organizational and environmental antecedents of acquisition activity (e.g., Alimov, 2015; Dikova et al., 2010; Ferreira et al., 2009; Nadolska and Barkema, 2007) and the choice of cross-border acquisitions in foreign market entry (e.g., Balakrishnan and Koza, 1993; Datta et al., 2015; Datta et al., 2009; Dikova and Brouthers, 2009; Hennart and Reddy, 1997; López-Duarte and García-Canal, 2002; Slangen, 2013; Slangen and Hennart, 2008).

Our review of the extant literature on cross-border acquisitions also highlighted the fact that most studies pertain to transactions in the manufacturing sector (i.e., firms engaged in the production of tangible goods). In contrast, research on cross-border acquisitions in service industries (e.g., banking, communications, wholesale and retail trade, computer software development, and professional services in areas such as engineering, finance and consulting) has been limited. Yet, UNCTAD data (World Investment Report, 2017) indicates that much of the global growth in cross-border acquisitions in recent years has taken place in the service sector. In 2016, the total worldwide value of service sector cross-border acquisitions (led by transactions in the financial, business, and retail services) exceeded that in the combined manufacturing and primary sectors. This phenomenon can be largely attributed to the increased globalization of service industries which saw a growing number of firms seeking to offer their services in foreign markets. Many of them favor cross-border acquisitions that provide quick entry into international markets (e.g., vis-à-vis greenfield investments) without the need to sacrifice control (e.g., in strategic alliances). In addition to providing an immediate presence in foreign markets, cross-border acquisitions also provide service sector acquiring firms the opportunity to tap into the tangible and intangible resources of target firms (Lahiri et al., 2014). The ability to do so can be very important in overcoming the liability of newness and putting in place strategies that help create competitive advantage in foreign markets.

Unfortunately, with the paucity of research on service sector cross-border acquisitions, we currently have a very limited understanding of such acquisitions. The distinctions between acquisitions in the manufacturing and service sectors stem from the fact that these two sectors are different along several dimensions. As such, conditions underlying the strategic initiatives (including, cross-border acquisitions) of service sector firms are often different from those in the manufacturing sector. First, unlike the manufacturing industry, firm offerings in the service sector are often intangible and often directly related to organizational human capital (Capar and Kotabe, 2003; Cloninger, 2004). Second, service industry “products” are often “perishable” and cannot be easily inventoried (Baltacioglu et al., 2007; Ochel, 2002). In other words, inefficient utilization of resources (e.g., from changing demand conditions for specific services) can have a significant negative impact on profitability. Third, the service sector is generally characterized by simultaneous production and consumption of outputs (Elango et al., 2013). Given this inseparability, firms in the service sector stand to benefit from having a physical presence in the host country which allows them to be more response to local requirements (Berthon et al., 1999). Finally, service industries tend to be more knowledge intensive than manufacturing industries (Brouthers and Brouthers, 2003; von Nordenflycht, 2010), with the knowledge base of employees often being central to value creation. While manufacturing sector acquisitions are generally characterized by post-acquisition integration of operations (to achieve scale economies and operational synergies), it is less common in acquisitions undertaken in the service sector. Since human capital related competencies directly impact performance in service industries, extensive post-acquisition integration can be counterproductive in such industries. As Zhu et al. (2015) point out, acquiring firms in the service sector are often more successful in creating acquisition-related shareholder value when they provide greater autonomy to acquired firms. In sum, there are important differences between manufacturing and service industries and acquisitions therein and as we discuss later in this paper, these differences have important implications for the research question addressed in our study.

In addition to partially filling the void left by the limited research on service sector cross-border acquisitions our objective in the current study is to develop an understanding of the factors that influence decisions related to the relative size of such transactions by acquiring firms. Relative acquisition size (i.e., transaction value relative to the acquiring firm's asset value) represents an important strategic decision in the undertaking of cross-border acquisitions. A relatively large acquisition has the benefit of signaling greater strategic commitment to the host country and communicates to potential customers that the acquiring firm is in the market for the “long haul.” However, it must be remembered, that relatively large acquisitions also represents greater investment risks for acquiring firms. Given the difficult-to-reverse nature of cross-border acquisitions and their high failure rates (e.g., Basuil and Datta, 2015; Datta and Puia, 1995; Hopkins et al., 1999; Karolyi and Taboada, 2015), relatively large transactions can embody significant risk – something that firms need to carefully consider in making acquisitions. In sum, service industry firms must examine the benefits accruing from a relatively larger acquisition in the host country with the attendant risks. As we discuss in the following pages, several firm and country specific factors related to cross-border acquisitions play a key role in the decision making process.

Relative acquisition size has been featured in several studies on the performance of cross-border acquisitions, albeit, as a predictor or control variable. The findings have been equivocal – while a positive relationship has been observed in some studies (e.g., Bae et al., 2013; Barbopoulos et al., 2012; Colombage et al., 2014; Dutta et al., 2013; Feito-Ruiz and Menéndez-Requejo, 2011; Markides and Ittner, 1994), others (e.g., Cakici et al., 1996; Danbolt and Maciver, 2012; Gupta and Misra, 2007; Reus and Lamont, 2009; Steigner and Sutton, 2011) have found either a negative or no significant relationship between relative acquisition size and acquisition performance. However, to the best of our knowledge, no study so far has specifically examined the determinants of relative acquisition size in cross-border acquisitions. Given the significant differences that exist in the relative size of acquisitions, it raises an interesting question, “What factors motivate service sector firms to pursue relatively large acquisitions in foreign markets?” or, “When is a service sector firm more likely to pursue a relatively large foreign acquisition?” Our study was driven by our desire to address this important question towards furthering our understanding of cross-border acquisitions in the service sector.

Our study utilizes Dunning's (1980) eclectic paradigm and Rugman's (1981) FSA/CSA framework to offer theoretically grounded arguments on potential factors that influence service sector acquiring firms to choose relatively large foreign acquisitions. We argue that service sector firms are better placed and more motivated to engage in relatively large cross-border acquisitions when firm resources are favorable for such acquisitions. For example, ceteris paribus, we can expect acquiring firms to pursue relatively larger acquisitions when resources and capabilities at their disposal provide them the ability and the confidence to overcome the greater risks associated with such acquisitions. As such, one aspect of our research seeks to address how firm-specific advantages (FSAs) influence an acquiring firm's decision on the relative size of the acquisition to be undertaken in foreign markets. Second, given the importance of country factors in any foreign investment decision, we examine how country-specific advantages (CSAs) associated with host country impact an acquiring firm's willingness to undertake a relatively large acquisition.

By developing arguments on how firm-specific and country-specific advantages influence decisions by acquiring firms on relative acquisition size, we seek to contribute to the theoretical and empirical literature on cross-border acquisitions. Our arguments linking FSAs and CSAs to relative acquisition size augments the theoretical literature on factors that influence cross-border acquisition decisions. From an empirical standpoint, our study sheds light on the factors that help determine the relative size of cross-border acquisitions undertaken by U.S. service sector firms. Our findings also contributes to the growing body of research on the internationalization efforts of service sector firms. From the perspective of managers involved in service sector cross-border acquisitions, we expect our study findings to provide valuable guidance on the factors they ought to consider in choosing the size of the deal they wish to pursue.

Section snippets

Theoretical overview and research hypotheses

As mentioned above, our study is about factors that influence the relative size of cross-border acquisitions in service industries. Certainly, relatively large acquisitions provide acquiring firms with important benefits in the host country under the right set of conditions. At the same time, such acquisitions involve higher levels of investment risk forcing acquiring firms to exercise greater prudence when engaging in such acquisitions. This inherent dilemma underlies the research question

Sample

Cross-border acquisitions reported in Thompson Financial's SDC Platinum database was the starting point for our sample. We included completed transactions by U.S. firms in the service sector (SIC >4000) during the seventeen-year period (1990–2006) prior to the 2007 recession. Since our study relates to service sector acquisitions, we only considered acquisitions of foreign firms in the service sector by U.S. service industry firms. In addition, to be included in the sample, an acquisition had

Data analyses and results

A year-wise breakup of the 348 service sector cross-border acquisitions in our sample is provided in Table 1. Our sample covers seventeen years and the data presented in Table 1 indicates that 63% of the acquisitions in our sample was undertaken in the period 1999–2006 versus 37% in the first 8 years (1991–1998). It is reflective of the increased popularity of such acquisitions in recent years. There were a total number of 44 host countries associated with the 348 acquisitions in our sample.

Discussion, study contributions and conclusions

Cross-border acquisitions that provide a pathway for rapid internationalization of service sector firms have become increasingly common in recent years (Boateng et al., 2008; Lynch, 2006). This study was motivated by our desire to address two critical gaps. First, the paucity of prior research on service industry cross-border acquisitions which has limited our understanding of such acquisitions. Second, the lack of theoretical and empirical attention provided to the study of factors that

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    The authors wish to thank Dr. Masaaki Kotabe and two anonymous reviewers for their comments and suggestions on the paper. An earlier version of the paper was presented at the Annual Academy of International Business Meetings, 2015. The authors also thank Dr. Ankita Agarwal and Deepyaman Datta for their help in data collection and preparation of the manuscript.

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