Research Volumes

Copies can be ordered from the University of Calgary Press.

Contents

• Recent Trends in Merger and Acquisition Activity in Canada and Selected Countries
  R.S. Khemani

• Canadian Acquisitions Abroad: Patterns and Motivations
  John Knubley, William Krause and Zulfi Sadeque

• Foreign Ownership and Corporate Strategy
  Alan M. Rugman and Leonard Waverman

• Foreign Multinational Enterprises and Merger Activity in Canada
  John R. Baldwin and Richard E. Caves

• Hostile Takeovers: The Canadian Evidence
  Michel Patry and Michel Poitevin

• Taxation and Canada-United States Cross-Border Acquisitions
  Paul Halpern and Jack Mintz

• Mergers and Acquisitions and the Public Interest: Don't Shoot the Messenger
  Ron Daniels

• Rapporteur's Comments
  A.E. Safarian

Summary

The Foreign Investment Review Agency (FIRA) was established in 1975 to review whether the acquisition of Canadian companies and the establishment of new businesses by foreign investors were of value to Canada. At the time, Canada held nearly one quarter of the world's total stock of foreign direct investment (FDI) and foreign investors (principally Americans) controlled the majority of assets related to petroleum and natural gas, mining and manufacturing. FIRA was succeeded in June 1985 by Investment Canada, whose task was both to encourage FDI and to continue to monitor foreign acquisitions of Canadian businesses to ensure that transactions were of "net benefit" to Canada. During FIRA's regime, foreign control of Canadian business fell sharply. Part of this reduction in foreign ownership was due to FIRA, but part was also due to other Government policies (such as the various programs designed to increase Canadian control in the petroleum and natural gas sector); part was due to the changing global economic environment and the diminishing role of the United States as the world's economic leader (see Graham and Krugman, 1989); and part was due to the rise of Canada as the home base for a growing tide of multinationals (see Rugman, 1987).

The international environment has continued to change. Domestic capital markets have become much more interconnected; the nature of borrowing has undergone significant transformations (junk bonds and their ilk); and a major merger wave has passed through North America. All this has made "globalization" the new buzzword to describe many business activities.

It is clear that FDI in Canada and Canadian FDI abroad are parts of a larger global issue. One cannot examine inward and outward FDI in Canada without examining the international context and the forces creating these real capital movements. These forces are not well understood or researched. Little data exist on the extent of cross-border merger and acquisition (M&A) activity, and how such activity relates to "globalization". Is M&A activity high in Canada relative to other countries? Are there specific explanations of these phenomena, such as tax differences or general explanations such as "corporate strategy"? Do M&As create "value"? Do cross-border M&As differ significantly from domestic M&As? What public policy concerns, if any, are generated by transborder M&As? There are many, many unanswered questions.

It is to the credit of Investment Canada that the Agency commissioned publishable academic research to examine these forces and all of the authors whose works are contained in this volume are grateful to the Agency.

The final paper by Edward Safarian, the Conference Rapporteur, summarizes the papers and provides his insights on policy; there is, then, no need to summarize the papers in this introduction. What would be useful for the reader, however, is to understand why the topics were chosen and how they fit together. A brief digression is first required to examine the enterprise that engages in FDI, the multinational company.

As soon as a company engages in FDI, it has become a "multi-national" -- a firm operating in more than one country. The forces of corporate globalization are then the forces which make for multi-country firm operations. Why do multinationals (MNEs) exist? Clearly, they are not new. Krugman (1990) argues that they may indeed have been more important in the earlier years of this century than now. Economists have developed a number of hypotheses to explain the growth of MNEs, the sectors in which they will operate, and the countries to which they will be attracted. The most sophisticated of these hypotheses and one addressed by nearly every one of the authors in this volume, is the "transactional/locational" hypothesis (called T-L). This hypothesis is as follows. Firms are collections of specific assets. Some of these assets are priced in markets and provide few spillovers to other activities (say, a knitting machine). However, some of the firm's assets may be intangible and difficult to price in markets -- the value of the firm's patents, its stock of goodwill, the advertising and brand names that spill across national borders, even the talent of highest management.

Some firms have specific intangible assets that they can use in a number of markets -- a patent, for example. If a firm wishes to sell its patented product in another country, it could export its product, but transportation costs or other barriers (tariffs, the need to have localized design) make it more profitable for the firm that owns the patent to produce in the foreign country. The firm could produce overseas by licensing its technology to a foreign entrepreneur, but then the firm (patent holder) is at risk that the licensee will acquire all the information developed by the firm and/or that the licensee will adversely harm the firm's interests (opportunism affecting the patent holder's ability to appropriate the pecuniary gains from the patent). The value of the patent to the patent holder is then maximized when the patent holder becomes an MNE and invests (foreign direct investment in the foreign country through an acquisition or greenfield construction). Therefore, the T-L approach suggests that the MNE form of enterprise -- ownership of assets abroad -- developed so that the parent could appropriate the economic rents on these intangible assets, returns that would be at risk with arm's-length contracts where the rights to these intangible assets were put in third party hands. This T-L approach can also be used to explain vertical cross-border M&As, the purchaser finding transaction costs lower in purchasing assets rather than in engaging in long-term contracts (Gorecki, 1990).

This T-L approach, while at the base of any economic analysis of corporate globalization through mergers and acquisitions, is not the whole story. Acquisitions occur through waves and it is unlikely that the development of firm-specific intangible assets occurs with similar waves. Hence, attention is also placed on other determinants of M&As. One clear potential determinant is inefficient management in the acquired firm, management which is not maximizing shareholders' returns and is thus open to a hostile takeover designed to replace the managers. This move is called the market for "corporate control". (It is unclear, however, that managerial inefficiencies occur in waves as well and thus the "market for corporate control" may not explain merger waves.) It is not evident that foreign managers have the best information on which domestic managers are misbehaving, so that the market for corporate control might be a better explanation for domestic rather than foreign takeovers (of course, if foreign acquiring firms are already operating in the market, they may have a high degree of knowledge about the operations of domestic companies).

Another management story explaining M&As is the notion that it is the managers of the acquiring firm (rather than of the acquired firm) who are inefficient, using their power to acquire assets. These acquisition bound managers receive enjoyment from driving their firms larger even when such acquisitions are not to the benefit of the owner shareholders. Many observers suggest that the conglomerate merger wave of the 1970s, a wave that eventually saw most such mergers redivided, was driven by ambitions of acquiring firms' managers. Other explanations for M&As exist. One plausible story is that acquirers take advantage of underpriced assets in the acquired firm. This story could explain merger waves, since assets could become undervalued across a broad spectrum of companies. A more recent hypothesis is that some M&As occur in order for management to break contracts (explicit or implicit) with labour, this ability being unavailable to incumbent managers. Numerous specific reasons such as the benefit of tax losses which decrease income taxes to the acquiring firm exist for M&As as well. Other explanations that have been advanced for trans border M&As utilize differential tax regimes in the two countries that make it profitable to cross the border, differential costs of capital, differential move ments in exchange rates (making assets in one country relatively cheap), and differential movements in stock market prices.

As the reader can see, the list of potential explanations is long and with each explanation lies a potentially different public policy story. For example, the notion that some M&As can serve to break implicit contracts with workers suggests that M&As may create winners and losers and the losers may have to depend on the government for assistance. If M&As are driven by management whims that are not coincident with the maximization of shareholder value, that is another public policy story. If cross-border M&As are generated by differential taxation, implications for tax policy are evident.

The papers in this volume do not examine all these issues, nor do they provide many answers. They do, however, provide significant new information and analyses which shed light on the process of corporate globalization through mergers and acquisitions. The first two papers (Khemani; Knubley, Krause and Sadeque) examine recent history to provide data on inward and outward FDI (in Canada) in a global context. These papers add to our knowledge of the extent of M&As in Canada, the growth of Canadian multinational activity abroad, and how these developments relate to M&A activity in other industrialized nations. Rugman and Waverman analyze the cases examined by FIRA and Investment Canada according to some recent general corporate strategy theories of MNEs. Baldwin and Caves examine foreign and domestic Canadian M&As to determine if and how they differ in their effects on important issues such as productivity. Patry and Poitevin analyze ten recent hostile takeovers in Canada and examine the sources of gains -- is value created for shareholders and if so, at whose expense? Halpern and Mintz examine whether tax issues can explain Canada-United States cross-border M&As. Daniels analyzes the public policy issues of the various motivations for M&As and discusses whether a new M&A specific policy is required. Safarian, as noted, summarizes the studies and provides his policy guide.

Together these eight papers provide significant new research on the important topics of the extent of M&A activity in Canada, its similarity across countries, and the determinants and impacts of mergers and acquisitions. This research will whet the appetite of the reader to consider new questions and engage in more research on the topic.

Research Volumes