The Value of Strategic Alliances in Acquisitions and IPOs

• Author: Jianping Qi,Ninon K. Sutton,Qiancheng Zheng
• Published date: 01 June 2015
• DOI: http://doi.org/10.1111/fima.12040
• Date: 01 June 2015

The Value of Strategic Alliances

in Acquisitions and IPOs

Jianping Qi, Ninon K. Sutton, and Qiancheng Zheng∗

This paper investigates how firms’ strategicalliance experience affects their valuations as acqui-

sition targets or in initial public offerings (IPOs). We propose that alliance experience serves as

a valuable signaling device for opaque firms. The results showthat takeover targets with alliance

experience receive higher premiums than those without such experience. More recent alliance

experience as well as alliances in the same industry also contributes to a larger target gain.

Similarly,IPO firms that have alliance experience obtain higher valuations than those without the

experience. Finally, alliance experience increases the likelihood that private firms exit by going

public rather than being acquired.

The information asymmetry surrounding f irms presents a valuation challenge to potential

outside investors. This valuation challenge is particularly daunting for unlisted (private or sub-

sidiary) firms. Faced with significant valuation difficulty, potential acquirers or initial public

offering (IPO) investors may discount the amount that they are willing to pay for the firm. For

example, Officer (2007) notes that the premiums paid for unlisted targets are significantly lower

than those paid for comparable public targets.Although unlisted f irms are generally more difficult

to value, those that have a history of collaboration with other firms may have reduced levels of

information asymmetry. In particular, the previous alliances that these firms have had with other

firms can send positive signals about their value and reduce the asymmetric information problem

for outside investors. According to a recent Wall Street Journal article, industry giants, such as

General Mills and Procter & Gamble, are using their partnerships with a “crowdfunding” site to

get to know more about certain start-ups and “ . . . CircleUp’s partnerships with big conglomerates

could be ‘a good thing for a business that’s looking to get acquired, eventually’...”

1

Indeed, several studies have demonstrated that strategic alliances are common forms of

collaboration that create value for the firms involved (Chan et al., 1997; Bodnaruk, Massa,

and Simonov, 2013). In examining alliances between biotech and pharmaceutical companies,

Nicholson, Danzon, and McCullough (2005) find that the valuations of biotech firms increase

after they have formed their first alliance, suggesting that the alliance sends a positive signal

to investors. Furthermore, Ivanov and Lewis (2008) determine that IPO firms with alliances

obtain higher valuations on the day of the offering and have greater positive long-run return

We thank RaghuRau (Editor) and an anonymous referee for insightful suggestions that greatly improved the paper. We

also thank the participants at the SFA2012 Annual Meeting, Daniel Bradley, Christos Pantzalis, and DelroyHunter for

valuable and helpful comments. All remaining errorsare our own.

∗Jianping Qi is a Professor of Financeand Bank of America Professor in the Muma College of Business at the University

of South Florida, in Tampa, FL. Ninon K. Sutton is a Professor of Finance and Bank of America Professor in the Muma

College of Business at the University of South Florida, in Tampa,FL. Qiancheng Zheng is a Visiting Assistant Professor

in the Department of Finance in the Muma College of Business at the University of South Florida, in Tampa, FL.

1See “P&G, General Mills Tap Into Startups,” Wall Street Journal, February 14, 2013. According to this article,

“ .. . Cincinnati-based P&G said it offers the founders of startups listed on CircleUp mentoring as well as help setting up

licensing deals or joint ventures. A P&G spokeswoman also confirmed that P&G may occasionally acquire a startup’s

business or technology.”

Financial Management •Summer 2015 •pages 387 - 430

388 Financial Management rSummer 2015

performance. Thus, if alliances increase the perceived value of a firm by alleviating the asym-

metric information faced by outside investors, alliances mayplay an important role in influencing

the valuation a firm receives as an acquisition target and, in the case of a private firm, in its exit

via either a takeover or an IPO. The exit outcomes of private or, more generally, unlisted fir ms

are of particular interest because of the greater informational asymmetry surrounding these f irms

and, consequently, the greater benefit of strategic alliances as signals.

Building on the literature, this paper examines the value of strategic alliances in mergers and

acquisitions, as well as in initial public offerings. We are interested in examining the signaling

effects of alliances of not just public targets, but also unlisted targets. The latter provide unique

valuation challenges for potential acquirers caused by their lack of publiclyavailable information.

We also compare the value of alliance experience for fir ms with different levels of asymmetric

information (i.e., unlisted, newlypublic, and more mature public targets) to explore the contingent

effect of firm stages on the role of strategic alliances in acquisition premiums. Moreover, we per-

form subsample analyses on different types of alliances, such as horizontal versus nonhorizontal

alliances, strategic alliances versus joint ventures, research and development (R&D) alliances,

and marketing alliances, as certain types of alliance partnerships may be more valuable than

others.

Using a sample of 29,089 completed acquisitions of public and unlisted targets announced from

1990 to 2010, our results indicate that the premiums paid for takeover targets with prior strategic

alliance experience are significantly higher than those without such experience, especially for

targets that are unlisted. Although strategic alliance experienceincreases the premium, on average,

by 3.70% for public targets (7.98% for new IPO targets and 1.37% for mature publictargets), the

increase is 10.38% for unlisted targets. Alliance experience provides a stronger positive signal

for unlisted firms and IPO targets as they have less publicly available information and, as such,

are more difficult to value, consistent with signaling theory. Also consistent is our finding that

alliance experience in the more recent past or that is in a related industry results in a higher

premium, as the signal it provides is more timely or relevant.

Next, we examine whether strategic alliances provide value for entrepreneurial firms that go

public. Using a sample of 3,039 IPOs, we find that the valuation premiums for IPOs with alliance

partners are 2.13 times higher than those without alliance partners. Furthermore, in examining

how alliance experience influences the exit choice of private firms, we confirm that firms with

alliance relationships are more likely to exit via IPOs than bybeing acquired by other f irms. Thus,

strategic alliances appear to provide value to the sellers byalleviating the information asymmetry

challenge faced by outside investors.

The key contribution of our research is to demonstrate that firms’ alliance experience serves as

a signaling device to reduce information asymmetry and increase their valuations. Indeed,alliance

experience positivelyaffects the willingness of acquirers or IPO investors to pay higher premiums

for allied target or IPO firms. By exploring the more nuanced effects of specific types of alliance

ties, this paper also advances our understanding of the various contingencies and boundary

conditions of the role of strategic alliances in acquisitions and IPO valuations. This paper is also

the first, to our knowledge, to combine comprehensive data on acquisitions, strategic alliances,

and IPOs to examine the possible impact of alliance experience on entrepreneurial firms’ choices

of exit.

The rest of the paper proceeds as follows. Section I reviews the related literature and develops

our hypotheses regarding the signaling role of strategic alliances. Section II describes the data

sample for mergers and acquisitions, strategic alliances, and IPOs, as well as the dependent,

independent, and control variables. Section III reports the univariate results and multivariate

regression results that demonstrate the effects of alliance experience on target premiums. Section

Qi, Sutton, & Zheng rStrategic Alliances in Acquisitions and IPOs 389

IV presents evidence concerning the beneficial role of strategic alliance experience on IPO

valuations. Section V examines the impact of alliance experience on private firms’ choices of

exit via IPOs or acquisitions, whereas Section VI provides our conclusions.

I. Related Literature and Hypotheses Development

Researchers in finance have only recentlybegun to investigate the value implications of strategic

alliances. Chan et al. (1997) examine the share price response to the formation of strategic

alliances and find positive stock price reactions and better subsequent operating performance for

firms entering alliances. Allen and Phillips (2000) study corporate equity ownership and f ind

that the largest increases in targets’ stock prices, investment, and profitability occur when block

equity purchases are combined with strategic alliances or other product market relationships.

Robinson (2008) develops and tests a model to address why firms sometimes prefer alliances

over internally organized projects and finds that strategic alliances help to overcome managers’

incentive problems. Palia, Ravid, and Reisel (2008) analyze the motivation of internal project

financing versus funding via outside alliances. They determine that project risk is an important

consideration. In a similar vein, Bodnaruk et al. (2013) argue that alliances help to improve firm

operating flexibility and reduce agency costs related to free cash flows and capital allocation

within the firm. Fang et al. (2012) conclude that firms with alliance experience enjoy a lower

cost of bank debt and are less likely to use collateral and covenants in their loan contracts.

Exploring the role of strategic alliances on IPO performance, Ivanov and Lewis(2008) examine

2,165 IPOs with positiveear nings before interest, taxes,depreciation, and amor tization (EBITDA)

including 280 IPOs with strategic alliance experience. Their findings indicate that IPO firms

with alliance experience receive higher valuations on the offeringday and exhibit better long-run

returns, but these firms also have a higher degree of underpricing. Lindsey (2008) f inds that

strategic alliances improve the probability of exit by venture backed fir ms via either IPOs or

acquisitions. Furthermore, strategic alliances are shown by Ozmel, Robinson, and Stuart (2013)

to serve as an alternative source of funding to venture capital (VC) for early stage high-tech firms.

Reuer, Tong, and Wu (2012) examine the signaling role played by prominent venture capitalists,

underwriters, and alliances in takeovers of IPO targets and find that such associations increase

the acquisition premium for newly public firms.

Although previous research provides useful evidence regarding the value of alliances, the

literature has not addressed the role of alliances for unlisted targets that would likely benefit

more from the signaling effect given their general lack of publicly available information. Also

unexamined is the contingent effect of various types of alliance partners as signals in acquisitions

or IPOs, as well as the differential signaling value of alliance experience between the relatively

more recent and distant past and between related and unrelated industries. Finally, it remains an

open question whether strategic alliance experience influences private firms’ exit choice of IPO

versus takeover.

It is well recognized that participants in the takeover and capital markets possess different in-

formation sets. Thus, acquirers or IPO investors may face the “lemons” problem (Akerlof, 1970)

when offering to buy or invest in another firm. A number of solutions have been suggested to

alleviate this problem. In the so-called market solution, acquirers select targets that are publicly

traded that have much more openly available information for correct valuation. Empirical evi-

dence, however, indicates that the acquisition of public firms often generates negative abnormal

returns for the acquirers around the acquisition announcement (Fuller, Netter, and Stegemoller,

2002). An alternative proposed in the literature is the ownership solution where the acquirer buys