Financial Deepening, Banking Stability and Cross-border M&A Activity-Evidences from Emerging Countries

This study investigates the effect of financial deepening, banking stability and market structure on cross-border M&A activity in 13 emerging countries with data covering the period, 2003-2010. We show the empirical results of panel regression by sub grouping portfolio based on whether the firms are acquirer or target to cross-border M&A activity. For acquiring countries, the results show a significantly positive effect of the deepening indicator in cross-border M&A activity. Moreover, bank stability on the acquiring firms investing in the cross-border M&As shows a significantly positive effect. For targeting countries, the results show a significantly positive impact of the deepening indicator in cross-border M&A activity. A positive relation between the ratio of the amount of credit provided by banks and other financial institutions to the private sector to GDP in cross-border M&A activity is found as well. These findings imply that not only financial depth but also banking stability promotes cross-border M&A activity for emerging economies.


Introduction
For a multinational corporation, there are different modes of foreign direct investment (FDI). It can choose "Greenfield" investment, i.e., invest in new assets or firm in the host country from scratch; or, it can choose merger or acquisition of a local pre-existing firm (mergers and acquisitions, M&A). Since 1990s, there has been merger wave and has become important part of foreign direct investment globally.
Calculating from the Securities Data Corporation (SDC) Mergers and Acquisitions database, Table 1 captures the M&A activity around the world and shows that in 2003 the value of completed M&A deals In traditional literature wisdom, financial development plays a key role in our understanding of sustainable economic development. More deep financial market mainly measured by liquidity could provide firms necessary capital to invest. To a large extent, it supports the view that the development in financial sectors, both of financial institution and financial market, which enhances the investment activity and leads to sustainable development of the whole economy. Thus it implies that the financial market deepening should be encouraged. However, the 2007-2008 financial crises raise the question: whether the financial deepening helps the development of the economy? The cross-border M&A activity, one of the mechanisms that enhance economic growth, needs financial source from the financial market.
Therefore the stability of the financial system with respect to banking sector remains one of important issues. This study illustrates how the financial depth and banking stability might provide further insight into the cross-border M&A activity for the emerging countries. We contribute to the existing literature by investigating whether the increase of financial deepening affect flows of cross-border M&As. The structure of the paper is organized as follows. Section 1 reviews the literature regarding financial deepening and mergers and acquisitions. Section 2 describes the data and depicts the empirical methodology. Section 3 reports econometric results. Section 4 provides some preliminary conclusions and outlines directions for future research.

Literature Review
In the relative financial deepening literature, Beck & Demirguc-Kunt (2006, 2009, 2010 introduce the updated version of the Financial Development and structure Database and depict trends in development of financial markets and financial institutions across countries. They show that financial systems across the world deepened over the past decades with much of the deepening, concentrated in high-income countries though. This financial deepening has taken place as much as in stock market, bond market, and in banking as well. The Financial Development and Structure Database collects many indicators covering several categories: indicators of the size of the financial system, the banking system -size, structure, efficiency and stability, indicators of capital markets and insurance sector, indicators of financial globalization, and indicators of financial structure. Klein & Olivei (2008) examine the impact of the capital account liberalization on financial deepening and economic growth, and they find developed countries which chose opening capital accounts had greater increase in financial deepening and greater economic growth for over the periods 1986-1995 and 1976-1995. In the M&A literature, Harford (2005) uses a sample of industry-lever merger waves in the 1980s and 1990s and compares directly two general classes of viewpoints, the neoclassical model and the behavioral model, in explaining what causes merger waves. Neoclassical hypothesis of M&A waves argue that mergers waves result from economic disturbance, such as technological or industrial change, that leads to industry reorganization and assets reallocation (see, for example, Mitchell & Mulherin, 1996;Jovanovic & Rousseau, 2002;Jovanovic & Rousseau, 2008). Meanwhile, behavioral explanations of M&A waves argue that M&A merger waves are driven mostly by stock market valuations. When managers use timing of market overvaluations of their stock to buy the lower-values firms leads the merger waves (see, for example, Shleifer & Vishny, 2003;Rhodes-Kropf & Viswanathan, 2004;Rhodes-Kropf et al., 2005;Ang & Cheng, 2006;Bouwman et al., 2009). Harford (2005 modifies the neoclassical model with considering a role for capital liquidity, in which this macro-level capital liquidity offering relative low transaction costs to support a large volume of M&A activity. The empirical findings in Harford paper support the neoclassical viewpoints, namely, causes of industry merger waves are economic, technological, or regulatory, rather than market-timing. Alexandridis et al. (2011) depict the sixth merger wave that started in 2003 and came to an end about in mid-2007 by using the U.S. sample. During the sixth merger wave, their empirical results show that acquirers continue to realize significant losses around announcements with cash financed deals no longer create value for acquiring firm shareholders, and stock-swap deals continue to result in extensive losses.
They also find that acquirers are less overvalued relative to the 1990s, with more cash financing rather than equity financing. Thus, they support the drivers of the sixth merger wave are more consistent with neoclassical explanations of merger waves. That is, low financing rate and plenty cash balances result in sufficient capital liquidity to back up the booming period. By examining merger patterns for both listed and unlisted firms in the United Kingdom, the United States and Continental Europe from 1991 to 2004, Gugler et al. (2012 demonstrate that the causes of merger waves are as predicted by behavioral theories.
The mergers wave literature gives fruitful discussion about the causes and characteristics on the mergers activity, and point out the important of capital liquidity, in which that support the industry-lever merger waves.
Another branch of the major mergers and acquisitions literature compare domestic and cross-border M&A activities, especially cross-border M&A involving the capital flow across border and corporate control reallocation at the international level. For example, di Giovanni (2005) raises the question: how financial deepening within a country can aid its firms in investing abroad? He finds that one financial deepening variable, the stock market capitalization to GDP ratio, has a positive significant relationship with domestic firms investing abroad via mergers and acquisitions. His finding highlights the importance of financial market deepening appears to be encouraging. The literature suggests that financial depth seems to play a significant role in outflows of M&As. However, since the global economy hit by the 2007-2008 financial crisis, it raises the important issue of the stability of the financial system, especially of the banking sector. The increasing inflows or outflows of cross-border M&As usually incur with greater financial deepening (for instance, the size of financial markets measured by the stock market capitalization to GDP) might not convey transaction effectively without considering the stability of the financial institution.

Methodology
Data: We retrieve the firm-level mergers and acquisitions data from Securities Data Corporation (SDC) Mergers and Acquisitions database, which provides a more complete coverage on the international M&As activity. Data on financial depth and banking risk are obtained from Financial Development and Structure Database. We also construct the country-level market structure of the banking industry index from Bankscope database. There are four indicators conducted in this paper in measuring financial deepening of the acquiring firm's country in the M&A procedure. The first measure is a traditional indicator of financial depth provided by King & Levine (1993), liquidity liabilities to GDP (LIL). It is the value of the currency plus demand and interest-bearing liabilities of all financial intermediaries divided by GDP. This index is a typical measure of financial deepening because of its reflecting the overall size of the financial intermediary institutions. The second one is a measure of stock market capitalization to GDP (STOCKCA).
It is value of listed shares divided by GDP and captures the size of the stock market relative to the size of the economy. The third measure is stock market total value traded to GDP (STOCKTR), and equals total shares traded on the stock market exchange divided by GDP. In the developing world, the banking sector plays the important role in providing funds for private sector to invest domestically and abroad. Therefore we also employ the forth measure of financial deepening indicator PRICREDIT, which equals the ratio of the amount of credit provided by banks and other financial institutions to the private sector to GDP.
In order to depict the stability of the banking industry, the ZINDEX is employed. It is the ratio of return on assets plus capital-asset-ratio to the standard deviation of return on assets. That is, a higher ZINDEX value means that the banking sector is more stable. These data are from Financial Development and Structure Database, and available at http://econ.worldbank.org/programs/finance. Two measures of M&A activity are the value of the completed M&A deals (MA), and the value of the cross-border M&A (CBMA). These indicators are collected from Securities Data Corporation (SDC) Mergers and Acquisitions database based on the perspective of acquirer firms and target firms respectively. We construct the panel data based on whether the ZINDEX data are completed or not, and then 13 emerging countries meet the requirements.
Additionally, two variables which depict the characters of banking industry are considered. One is Herfindahl-Hirschman index (HHIA) which is defined as 10,000 times the square of the ratio of asset of bank i divided by total amount of assets for all banks in one specific country. The variable HHIA is country-level indicator of bank industry concentration and the higher value the greater market concentration is. The variable CAP denotes the Tier 1 capital ratio which is defined as Tier 1 capital divided by total risk weighted assets and used to measure the financial health of a bank. The 1988 Basle Accord established an international definition of bank capital that divides bank capital into two tiers: Tier 1 capital and Tier 2 capital. In order to conduct more meaningful cross-country comparisons, we here use Tier 1 capital rather than Tier 2 as the analytical basis. Since the measurement of Tier 2 capital across countries is quite different.

Empirical Model Design:
In order to examine the effect of financial deepening on the cross-border M&A activity, we first estimate the model (1) expressed as the following: CBMA_ACQit is outflows of cross-border M&As for acquiring country i in time t. FDit is the financial depth variables for country i at year t. BANKit is the banking stability and market structure variables for country i in time t. This model allows us to investigate how the variables of financial depth, stability and market structure affect M&A activity. Model (2) is expressed in the following. It allows us to examine whether the financial deepening variables and banking stability affect inflows of cross-border M&As.
where the dependent variable CBMA_TARit is transaction value of cross-border M&A deals for targeting firms in country i at year t. With an effort to pool time-series and cross-section data, we utilize the materials to analyze the sample by using the panel data approach. The panel data analysis, involving at

Empirical Results
A summary of total and cross-border M&A transaction value, broken down by the country and year, is shown in the Table 2. We also partition the data into two portfolios for 13 emerging countries:    expected. The stable banking system is likely to matter because the acquiring firm may want to raise funds from the domestic financial system in which the banks play an essential role. A more developed stock market and a more stable banking system facilitate fundraising process and obtain valuable information for the acquiring firm. To sum up, the empirical results show the financial deepening and stability of the banking system significantly influences cross-border M&As in emerging markets.
We now discuss the panel results from targeting country's perspective. The findings given in model 2-1 to model 2-3 in Table 4 show a significantly positive effect of STOCKCA (value of listed shares divided by GDP) on cross-border M&A activity. This suggests that the development of stock market in the targeting country encourages the foreign company's investment domestically via M&A activity. We also find a positive relation between PRICREDIT (ratio of the amount of credit provided by banks and other financial institutions to the private sector to GDP) and cross-border M&As. The result indicates that with more available credit provided by banks and financial institutions in the target countries, the motivation of raising funds with cross-border M&As by taking advantage of reducing the foreign exchange rate exposure is warranted. Therefore, the deepening financial market exerts profound effect. More importantly, as our empirical results show that the stability of banking system inevitably remains an essential ingredient when corporations implement financial activity.

Conclusion
This study investigates the effect of financial deepening, banking stability on cross-border M&A activity in     PRICREDIT is the ratio of the amount of credit provided by banks and other financial institutions to the private sector to GDP. ZINDEX denotes the ratio of return on assets plus capital-asset-ratio to the standard deviation of return on assets. HHIA is the Herfindahl-Hirschman index measured with banks' asset. The variable CAP denotes the Tier 1 capital ratio which is defined as Tier 1 capital divided by total risk weighted assets. The symbols *, **, *** indicates significance at 10%, 5% and 1% confidence level. The numbers in the brackets are t-statistic.