Industry Expertise, Information Leakage and the Choice of M&A Advisors

DOIhttp://doi.org/10.1111/jbfa.12165
Published date01 January 2016
Date01 January 2016
Journal of Business Finance & Accounting
Journal of Business Finance & Accounting, 43(1) & (2), 191–225, January/February 2016, 0306-686X
doi: 10.1111/jbfa.12165
Industry Expertise, Information Leakage
and the Choice of M&A Advisors
XIN CHANG,CHANDER SHEKHAR,LEWIS H. K. TAM AND JIAQUAN YAO
Abstract: This paper examines the impacts of M&A advisors’ industry expertise on firms’
choice of advisors in mergers and acquisitions. We show that an investment bank’s expertise
in merger parties’ industries increases its likelihood of being chosen as an advisor, especially
when the acquisition is more complex, and when a firm in M&A has less information about
the merger counterparty. However, due to the concerns about information leakage to industry
rivals through M&A advisors, acquirers are reluctant to share advisors with rival firms in the
same industry, and they are more likely to switch to new advisors if their former advisors
have advisory relationship with their industry rivals. In addition, we document that advisors
with more industry expertise earn higher advisory fees and increase the likelihood of deal
completion.
Keywords: investment banking, mergers and acquisitions, advisory fees, advisory services,
industry expertise
The first author is from Cambridge Judge Business School of the University of Cambridge, and Nanyang
Business School of Nanyang Technological University. He is also a distinguished visiting professor at Jilin
University of Finance and Economics and Central University of Finance and Economics. The second
author is from the Department of Finance, Faculty of Economics and Commerce, University of Melbourne,
Australia. The third author is from the Department of Finance and Business Economics, Faculty of Business
Administration, University of Macau, Macau. The fourth author is at Wang Yanan Institute for Studies
in Economics and School of Economics, Xiamen University, China. The authors are grateful for the
valuable comments and suggestions from an anonymous referee, the editor (Ronan G. Powell), Ying
Fang, Lily Qiu, Cong Wang and George Wong. They also thank participants at the Asian FA 2011, SFM
Conference 2011, Australasian Finance and Banking Conference 2011 and seminar participants at the
Monash University for helpful comments. They also thank Yuanfang Chu for excellent research assistance.
Chang acknowledges financial support from Rega Capital Management Limited and Academic Research
Fund Tier 1 provided by the Singapore Ministry of Education. Shekhar acknowledges funding provided
under the Faculty Research Grant scheme of the Faculty of Economics and Commerce, the University of
Melbourne. Tam acknowledges research funding (MYRG074(Y1-L2)-FBA11-THK) provided by University
of Macau. Yao acknowledges research funding supported by the Fundamental Research Funds for the
Central Universities (#20720151145) and the National Natural Science Foundation of China (#71502152).
All remaining errors are the responsibility of the authors. (Paper received February 2015, revised version
accepted October 2015)
Address for correspondence: Jiaquan Yao, Wang Yanan Institute for Studies in Economics and School of
Economics, Xiamen University, 361005, China.
e-mail: jiaquanyao@gmail.com
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192 CHANG, SHEKHAR, TAM AND YAO
1. INTRODUCTION
A major source of revenue for investment banks comes from the provision of corporate
mergers and acquisitions (M&A hereafter) advisory services.1According to Golubov
et al. (2012), financial advisors were involved in global merger transactions worth
around US$4.2 trillion in 2007 (representing more than 85% of all transactions by
value) and the provision of these services earned the investment banks advisory fees
of about US$40 billion. Given the economic magnitude and rapidly evolving nature of
merger advisory business, there has been an increasing effort by academic researchers
to identify the key driving forces behind the advisor–firm relationship. Among others,
financial advisor reputation, acquirer experience, deal complexity, and target business
structure have been shown by prior studies to be the important factors for firms in
M&A when choosing their financial advisors.2
In this paper,we examine the economic causes and implications of choosing merger
advisors. In particular, we focus on the aspects that have been largely underexplored
in prior studies, namely the advisor’s industry expertise and the firm’s concerns about
information leakage to their product-market rivals through M&A advisors.
In M&A, investment banks advise acquiring and target firms by evaluating firms’
assets and providing technical and tactical assistance throughout the takeover process
(Bodnaruk et al., 2009). Through repeated participation in M&A transactions in
a certain industry, advisors can accumulate industry-specific merger expertise that
enables them to better assess firm value and synergies, execute complex deals, and
reduce transaction costs. Moreover, by advising different firms in an industry and
employing experienced industry analysts, advisors can become privy to crucial legal
and regulatory issues, important industry developments, and firm-level information,
so that they can leverage their domain expertise to provide tailored advisory service
for firms in the industry. When choosing advisors amongst all candidate banks, firms
in M&A may therefore attach importance to a bank’s expertise in industries that
are of interest to them. Although Benveniste et al. (2002) have documented some
causal evidence that banks use their industry expertise to develop unique underwriting
capacity in certain industries, the effects of banks’ industry expertise on advisor choice
and merger outcomes have largely remained unexplored.3In addition, as a merger
transaction involves both an acquirer and a target, it is an empirical question whether
the two firms value industry expertise differently.
On the other hand, advisors’ industry expertise may also heighten firms’ concerns
about leakage of sensitive information to industry (product-market) rivals.4A firm’s
strategically sensitive information (e.g., operational efficiency, customer/supplier
relationships, progress on research and development projects, etc.) is amongst its
most valuable intangible assets. Investment banks can gain access to the sensitive
information through due diligence undertaken before the execution of a deal and/or
1 Throughout the paper, we use the terms mergers, acquisitions, takeovers and M&A interchangeably. We
also use the terms advisor, financial advisor, bank and investment bank interchangeably.
2 See, among others, Servaes and Zenner (1996), Rau (2000) and Kale et al. (2003).
3 For instance, in context of IPOs, Benveniste et al. (2002) find that, of the 15 IPOs completed between
1990 and 1994 in the trucking industry, nine were lead-managed by one bank (Alex. Brown), suggesting
that banks’ industry expertise influences the likelihood of banks winning underwriting mandates.
4 See Rajan and Zingales (2001), Zabojnik (2002) and Baccara and Razin (2004) for analyses on the
information leakage concern in situations where the crucial information is leaked outside of a firm through
its current or former employees.
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INDUSTRY EXPERTISE AND CHOICE OF M&A ADVISORS 193
information certification when selling securities to investors. Leaking firm-specific
value-relevant information to a product-market rival is detrimental and such a concern
may inhibit sharing of advisors between firms in an industry. In general, large firms that
have significant market share and can affect the market equilibrium should be more
sensitive to the effects of information leakage than small firms (Asker and Ljungqvist,
2010). Therefore, they should be more concerned to protect private information
and inhibit information leakage to rival firms through M&A advisors. In addition,
the concerns about information leakage to industry rivals may also vary between
acquirers and targets. Target firms normally cease to exist as standalone companies
if the mergers succeed, whilst acquiring firms continue competing against their rivals
in product markets after acquisitions. This implies that, other things being equal,
acquirers should be more concerned about information leakage than target firms
when selecting M&A advisors.
Taken together, we conjecture that a bank’s industry expertise has both positive
and negative effects on firms’ choice of M&A advisors. On one hand, a bank’s strong
industry expertise can enable it to efficiently collect and process information in
the industry, effectively facilitate deals, reduce transaction costs and develop unique
capacity in the industry. On the other hand, its potential clients may be concerned
about the likelihood of it (the bank) leaking sensitive information to product-market
rivals. As a result, firms in M&A may trade off advisors’ industry expertise garnered
from dealing with industry peers against the chance that advisors may leak sensitive
information to firms’ product-market competitors.
Against this background, we examine how investment banks are chosen as merger
financial advisors for a sample of 12,996 mergers announced between 1985 and 2008.
We utilize the conditional logit model of McFadden (1973) and Morrison et al. (2013)
to examine jointly the effects of banks’ industry merger expertise and firms’ concern
about information leakage on the banks’ likelihood of being chosen for a transaction,
while controlling for prior bank–firm relationships, banks’ market share and other
bank-specific characteristics. Our empirical models examine advisor choices of both
acquirers and targets. This setup recognizes that although all firms involved in a
merger may consider similar factors in choosing an advisor, the influence of these
factors on advisor choice may be different for acquirers and targets.
Our results show that banks’ expertise in both firms’ own industries and their
counterparties’ industries – when measured as prior merger advisory experience in
those industries – are strong determinants of advisor choice for firms in M&A. In
addition, we find that the impact of banks’ industry expertise on advisor choice
is contingent on the nature of deal provisions. Specifically, banks’ industry merger
expertise becomes more important for advisor choice when firms in M&A have
less information about the counterparties as characterized by higher R&D, a higher
fraction of intangible assets, and a higher Tobin’s Q. Banks’ industry expertise is also
more important in more complicated transactions, such as mergers of equals and
mergers with termination fee provisions. Additionally, the existence of poison pills
in targets’ corporate charters also makes banks’ industry expertise more valuable to
acquirers.
Furthermore, consistent with our prediction that firms may avoid sharing invest-
ment banks with major product-market rivals, a bank is less likely to be chosen by
a firm if it (the bank) has had a past relationship with the firm’s major product-
market rivals. To further investigate firms’ concerns about information leakage to
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2016 John Wiley & Sons Ltd

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