The Role of Sovereign Ratings in M&A Markets: Empirical Evidence from Latin America and South East Asia

• Published date: 01 January 2016
• Date: 01 January 2016
• DOI: http://doi.org/10.1111/fmii.12034

The Role of Sovereign Ratings in M&A Markets:

Empirical Evidence from Latin America and

South East Asia

BYJANNA MAI NGUYEN AND DODO ZU KNYPHAUSEN-AUFSEß

Sovereign ratings have not only been regarded as an indicator of country risk for foreign

investors, but also as a determining factor for capital market conditions of domestic firms.

Although they have attracted growing interest in academic research, the extant literature

has so far rendered only minor attention to their role in corporate strategic investment

decisions. This paper focuses on the influence of sovereign ratings on domestic and cross-

border M&A decisions in a sample of Latin American and South East Asian countries. The

empirical results lend support to the proposition that sovereign ratings condition the levelof

activityin domestic M&A markets as well as the attractiveness of domestic M&A targets for

foreign acquirers. Moreover,the foreign bidders’ choice of ownership stakes in acquisitions

appears to be affected. The paper thus highlights the relevance of sovereign ratings as a

country-level factor to be considered in studies of corporate investmentbehavior.

I. INTRODUCTION AND MOTIVATION

Since the 1990s companies have shown increasing interest in mergers and acquisi-

tions (M&A) as a competitive means to grow, enter new markets, or seize strategic

assets. Apart from the development of domestic M&A markets, the growing im-

portance of international reach in globalized markets has contributed in particular

to the popularity of cross-border mergers whose value has risen strongly despite

dampening effects after the dot-com bubble collapse in the early 2000s and the

recent financial market crisis. In line with this development, a growing body of

academic research has evolved on a variety of subjects surrounding corporate

M&A, including, amongst others, the study of factors influencing M&A activity

and flows (for literature reviews see, e.g., Haleblian et al., 2009, Martynova and

Renneboog, 2008, or, specifically in the international management context,

Shimizu et al., 2004). Whereas a range of studies have discussed industry- or

firm-levelfactors in this regard, the importance of macroeconomic factors has only

lately come to the attention of scholars (Neto et al., 2009; Uddin and Boateng,

2011).

Interestingly however,despite the current sovereign debt crisis unsettling global

financial markets, there is a paucity of insights on the role of sovereign credit-

worthiness in M&A activity. This appears quite surprising given that sovereign

creditworthiness, as reflected in sovereign ratings, has been shown to affect not

only sovereigns themselves, but the companies operating within those countries as

well, for instance in the form of access to capital (e.g., Chuhan et al., 1998; Durbin

Corresponding author: Prof. Dr. Dodo zu Knyphausen-Aufseß, Technische Universit¨

at Berlin, Phone: +49 (0) 30

314–28744, E-mail: knyphausen@strategie.tu-berlin.de.

C2016 New YorkUniversity Salomon Center and Wiley Periodicals, Inc.

6Janna Mai Nguyen and Dodo zu Knyphausen-Aufseß

and Ng, 2005; Eichengreen and Mody, 2000). Furthermore, researchers havehigh-

lighted the growing pervasiveness and concurrent importance of sovereignratings

in international capital markets over the last years with according ramifications

for the corporate sector (Bruner and Abdelal, 2005). As such, sovereign ratings

have not only come to increased public, but also managerial significance. In

particular for decision-making processes of strategic managers, it has been recog-

nized that risk ratings (including sovereign ratings) play a vital role (Foster, 2000;

Oetzel et al., 2001). Rendering academic interest to this subject hence appears as

a worthwhile endeavor.

Against this background, this paper intends to connect M&A literature with the

discussion on the role and influence of sovereign ratings, thereby making a three-

fold contribution to the rich literature on M&A as a major form of foreign direct

investment (FDI) in the international management context (see, e.g., Chakrabarti

et al., 2009; Di Giovanni, 2005; Girma et al., 2006). First, by examining a cross-

section of countries, this paper offers results on the relevance of country-level

factors (with a specific focus on sovereign ratings) for corporate M&A activity.

While the study of macroeconomic factors is not new in this research area, their

importance may have increased in recent times. Since existing studies often take

a microeconomic view by focusing on firm-level factors, insights in this regard

are limited (Globerman and Shapiro, 2004; Neto et al., 2009; Uddin and Boateng,

2011). Second, this paper provides insights on the role of sovereign ratings for a

specific form of (often capital-intensive) corporate investment in a domestic and

international setting. Regarding the international context, Neto et al. (2009) note

that studies on the macroeconomic drivers of corporate FDI are often of an aggre-

gate nature and consequently fail to provide discrete insights for a specific FDI

mode. For those studies that in fact discuss the effect of country characteristics

for certain FDI modes, Hyun and Kim (2010) observe that greenfield investments

have caught the primary academic attention, while M&A have lagged behind.

Apart from complementing the extant research in this respect, the results of this

paper simultaneously enrich the so far sparse literature body on the direct impact

of credit ratings on corporations (Lagner and zu Knyphausen-Aufseß, 2012). Here,

the insights will be of particular interest to acquisitive companies or prospective

targets, especially in countries with instable rating situations. Third, the study

provides cross-sectional insights for countries that have so far not constituted a

major subject of analysis in this context. Usually due to reasons of data avail-

ability, research on M&A typically relates to mature markets, such as the United

States (US) or United Kingdom (UK), and often focuses on a single country, while

neglecting a broader perspective as well as less developed countries (Goergenand

Renneboog, 2004; Kamaly, 2007). The increasing importance of these countries

calls, however, for an expansion of the research focus to their markets (Bhagat

et al., 2011). Thus, this paper focuses in particular on a cross-section of mostly

emerging countries in Latin America and South East Asia.

In addition, a better understanding of the potential impact of sovereign ratings

on M&A markets appears particularly relevantfor managers operating in countries

Empirical Evidence from Latin America and South East Asia 7

with imminent rating changes. Moreover, the insights contribute to the ongoing

political discussion about the influence of the major rating agencies, which in turn

has fuelled advances for better controls of their power. Although the European

Union (EU) has recently decided to further tighten regulation for rating agencies

(Norman and Robinson, 2013), the calls for even stricter rules have not ceased,

given the presumably still far-reaching power of these institutions. This paper

sheds particular light on the question how these agencies may influence domestic

and international M&A markets.

The remainder of this paper is structured as follows: In Section II, related lit-

erature on M&A activity and sovereign ratings is discussed and hypotheses are

developed. Section III describes the data and methodology used in the empiri-

cal test. In the following section, the results of the analysis are presented and

discussed. Lastly, Section V concludes, identifies the study’s limitations, and pro-

vides suggestions for future research.

II. RELATED LITERATURE AND DEVELOPMENT OF HYPOTHESES

Regarding the theoretical background of studies on M&A activity, a broad dis-

tinction can be made between neoclassical and behavioral frameworks (Harford,

2005; Very et al., 2012). While the former generally takes regulatory, technolog-

ical, or economic disturbances, at the country or industry level, as the driver for

M&A activity, the latter considers such activity as the outcome of managerial

behaviors, for instance in response to market valuations.1By examining the role

of sovereign ratings in M&A markets, this paper mainly relies on the neoclassical

framework and enriches existing research on country-level M&A determinants.

Therein, some factors have commonly emerged as relevant in the literature across

different time periods and geographies (Martynova and Renneboog, 2008). As a

background, related studies in this respect will be briefly addressed before review-

ing in particular the role of sovereign ratings in corporate investment activities.

Based on this discussion, hypotheses will be developed.

COMMONLY IDENTIFIED DETERMINANTS OF M&A

As Shimizu et al. (2004) note, cross-border and domestic M&A appear quite

similar in their dynamics, although certain issues or strategic motives naturally

apply only in particular settings. Usually, a country’s gross domestic product

(GDP) (e.g., Ahern et al., 2015; Hyun and Kim, 2010; Uddin and Boateng, 2011)

and GDP growth rates (e.g., Ferreira et al., 2010; Rossi and Volpin, 2004; Shen and

Lin, 2011), reflecting an economy’s size and potential, an efficientand liquid stock

market (e.g., Globerman and Shapiro, 2004; Neto et al., 2009), the availability

1Martynova and Renneboog (2008) choose slightly different levels of differentiationand define four

categories for the theoretical explanations of M&A activity: business environment shocks, agency

problems and corporate governance, managerial hubris and herding, and market timing.