Aurora Borealis
1 March 2018 CFA Institute Journal Review

The Value-Added Role of Industry Specialist Advisors in M&As (Digest Summary)

  1. Nicholas Tan, CFA
The use of advisers specializing in the target industry during merger and acquisition transactions explains some of the variances in acquirer cumulative abnormal returns (CARs), where advisers with specialized knowledge of the target industry aid acquirers in achieving higher CARs. The positive effect on acquirer CARs becomes greater as the target-firm information asymmetry becomes larger.

How Is This Research Useful to Practitioners?

Specialization enables advisers to focus their learning efforts on a narrow range of industries, accelerating the acquisition industry–specific knowledge and skills and enabling a deeper understanding of regulatory requirements, financial skills, and industry growth opportunities. The choice of an adviser specializing in the target’s industry increases acquirer cumulative abnormal returns (CARs) by 2.26% in cross-industry deals compared with choosing a nonspecialist adviser, which equates to $184.83 million incremental shareholder value for a mean-sized acquirer in the authors’ sample of US merger and acquisition (M&A) transactions announced over 1985–2010.

No significant difference is found in acquirer CARs when comparing specialist and nonspecialist advisers in the acquirer’s industry, which lends credence to the idea that an adviser’s knowledge of the target industry is more important to acquirer CAR than knowledge of the acquirer’s industry.

Advisers specializing in the target industry help acquirers garner higher CAR when target firms have relatively high idiosyncratic return volatility and when acquiring firms lack recent acquisition experience in the target’s industry.

In the cases of advisers specializing in the target industry, the difference in acquisition synergy gain appears insignificant, and hence, the superior acquirer CAR appears to come from specialist advisers being able to accurately estimate the value of target firms. The takeover premiums associated with specialist advisors are significantly lower than those associated with non-industry specialists.

How Did the Authors Conduct This Research?

The measure the authors use in proxying adviser industry specialization is the Additive Revealed Comparative Advantage (ARCA) index, which captures specialization as the extent to which an investment bank’s overall M&A advisory activities are concentrated in a specific industry. The ARCA index, in simplified terms, is the differential between the investment bank’s portfolio share in a certain industry and the average investment bank’s portfolio share in that same industry. An ARCA of more than zero would mean an investment bank is specializing in that particular industry, whereas an ARCA of less than zero would mean it does not specialize in the industry.

Two ARCA indexes are constructed, one for M&A transactions that each acquirer adviser has advised in the target’s industry and another in the acquirer’s industry. A two-stage least-squares procedure is used in the data regression study because the choice of a specialist adviser is usually endogenously determined and a simple ordinary least-squares regression could thus result in inconsistent and biased estimates.

The sample data on US M&A transactions are from the Thomson Reuters Securities Data Company Platinum database. All successful and unsuccessful deals announced from 1985 to 2010 are taken into account if the acquirer is a US public firm, the payment method is disclosed, the transaction value is greater than $1 million, at least one investment bank is advising the acquirer, and the acquiring firm owns less than 10% of the target initially and seeks to own more than 50% after the transaction. The final sample consists of 6,269 M&A transactions.

Abstractor’s Viewpoint

The authors do a succinct job of separating the effects on acquirer returns from advisers’ specialization. It would be interesting to see whether this effect is as pronounced in other markets or in a different geographical region than the authors’ sample based in the United States. Different sets of regulations of market maturities in other countries may give rise to different information asymmetry conditions, which could lead to further discoveries regarding the effects on acquirer returns. Exploring whether such market phases in the US economy as the 1990 oil price shock, the 2000 dot-com crash, and the 2007 crisis after Lehman Brothers affected acquirer returns as a function of adviser specialization may also be worthwhile.

Client/bank relationships have always been an important centerpiece in investment banking. Although the degree of specialization of an M&A adviser in transactions is shown to contribute positively to acquirer returns, the presence of these client/bank relationships could still lead to little or no value creation in the general markets if the relationship holds more weight to the acquirer than the adviser’s degree of specialization of the adviser.

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