INVESTMENT BANKS IN DUAL ROLES: ACQUIRER M&A ADVISORS AS UNDERWRITERS

• Published date: 01 June 2014
• DOI: http://doi.org/10.1111/jfir.12033
• Author: Mine Ertugrul,Karthik Krishnan
• Date: 01 June 2014

INVESTMENT BANKS IN DUAL ROLES:

ACQUIRER M&A ADVISORS AS UNDERWRITERS

Mine Ertugrul

University of Massachusetts

Karthik Krishnan

Northeastern University

Abstract

We analyze the dual role of investment banks that provide advice to acquiring firms and

act as underwriters on the securities issued to finance the acquisition. We find that the dual

role of acquirer advisors is associated with lower acquirer announcement returns, higher

target announcement returns, higher acquisition premiums, faster completion speeds, and

higher divestiture rates. The dual role of the acquirer advisor does not lead to lower

underwriting fees or issue costs. Our results are robust to controlling for the endogeneity

of selection of the acquirer advisor as underwriter on the security issue used to finance the

acquisition.

JEL Classification: G24, G30, G34

I. Introduction

Acquisitions are an important part of corporate investment activity and there is a large

literature that analyzes value addition and mechanisms related to acquisition transactions.

Many corporations enlist the support of investment banks as advisors on acquisitions.

Managers of firms rely on these banks for advice and execution of acquisitions. In

addition to advising firms, investment banks may also take the role of underwriters of

public securities issued by the acquiring firm to finance the deal. Such arrangements can

substantially alter the nature of the relationship between the investment bank and the

acquirer. In particular, the role of the investment bank changes from an advisor to an

arranger of financing. Clearly, such a change in the role of the investment bank can

potentially alter their incentives (in terms of providing objective advice) and may have an

impact on deal outcomes. However, there is little empirical evidence on how such “dual

roles”of investment banks may affect the value of the acquisition to the acquirer and the

target as well as other deal outcomes such as completion time, underwriting fees, and

issuance costs.

We would like to thank the associate editor, James Ligon, and the referee, Jin Jeon, for their valuable

comments and suggestions. We would also like to thank Thomas Chemmanur, Basak Tanyeri, Chi Wan, session

participants at the 2010 Financial Management Association annual meetings, 2012 Eastern Finance Association

meetings, and 2012 Financial Management Association European meetings for many helpful comments.

The Journal of Financial Research Vol. XXXVII, No. 2 Pages 159–189 Summer 2014

159

© 2014 The Southern Finance Association and the Southwestern Finance Association

RAWLS COLLEGE OF BUSINESS, TEXAS TECH UNIVERSITY

PUBLISHED FOR THE SOUTHERN AND SOUTHWESTERN

FINANCE ASSOCIATIONS BY WILEY-BLACKWELL PUBLISHING

Our article fills this gap in the literature by analyzing how an investment bank’s

dual role as the acquirer’s advisor and as the underwriter on the public security issue used

to finance the acquisition affects deal outcomes. In particular, we address the following

questions related to the dual role of acquirer advisors using hand‐collected data on

acquisition‐related public security issues. First, how does the choice of the acquirer’s

advisor as underwriter for the public issue used to finance the deal affect the

announcement‐period returns of the acquirer and the target? Second, how does the dual

role of the acquirer advisor affect the premium that the acquirer pays for the target? Third,

are acquisitions in which the acquirer advisor plays a dual role more or less likely to be

successful in the long run? Fourth, does the use of a dual‐role advisor and underwriter by

the acquirer lead to faster deal completion? Finally, does hiring the advisor as an

underwriter benefit the acquirer in terms of reduction in investment banking fees or

financing costs related to the security issue used to finance the acquisition?

We expect the following effects to drive the relation between acquisition

outcomes and dual advisor‐underwriter roles played by an investment bank. First, the

prospect of additional fees from the underwriting business should make it more profitable

for the investment bank to support the completion of the deal and payment of higher

premiums to the target firm, even if the acquisition is value reducing for the acquirer

(conflict of interest hypothesis). Thus, this conjecture predicts that using advisors as

underwriters on the associated financing issue will lead to lower acquirer value, higher

target value, higher target premiums, and lower long‐term success rates for acquisitions. It

is possible that concerns of moral hazard may be offset by potential costs of reputational

loss faced by investment banks when acquisitions advised by them perform poorly (e.g.,

Chemmanur and Fulghieri 1994). However, empirical evidence (e.g., Chemmanur and

Krishnan 2012) and anecdotal evidence from the recent financial crisis suggest that

financial institutions may not be necessarily concerned about their reputation. Media

articles (e.g., see “As Wall Street Firms Grow, Their Reputations Are Dying,”S. M.

Davidoff, New York Times, April 26, 2011) also indicate that in recent years, many

financial institutions do not seem to be concerned about reputation loss. Thus, whether the

above trade‐off works in favor of moral hazard (which increases short‐term profits) or

long‐term reputation preservation is an empirical question.

Second, the acquirer may be able to obtain shorter deal completion times by

expediting the financing process through the use of the same investment bank as advisor

and underwriter (expedited acquisition hypothesis).

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Finally, acquirers may benefit from

lower investment banking fees and lower financing costs if the investment bank achieves

significant economies of scope by both advising an acquisition and underwriting a public

security issue related to the acquisition (reduced transaction cost hypothesis). In

particular, the investment bank may face lower costs of information production when

underwriting the acquisition‐related security issue because of information already

obtained in the process of providing advice to the acquirer. The investment bank may

share some of the cost savings with the acquirer through lower underwriting fees

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Acquirers may want shorter deal completion times to prevent competing bids and to ensure that current

market conditions do not change substantially and make it costlier to acquire the target firm.

160 The Journal of Financial Research