Cross-Border Target Selection and Investor Protection Disparity

Underperforming firms in emerging markets have little access to foreign capital is a well-documented but little understood phenomenon. I argue that this phenomenon is due to the gap in the strength of investor protection (IP) between capital exporting and importing countries. An acquirer from a strong-IP country values control premiums less than does a typical controlling shareholder in a weak-IP country. Thus, the acquirer is attracted to better performing companies that have the stronger incentives to practice better corporate governance and demand lower control premiums in acquisition prices. I examine how the passages of corporate governance reforms (CGRs) undertaken by either target or acquirer countries affect the target selection tendency of acquirers from 20 strong-IP countries in 21 weak-IP countries. When a CGR in a target country narrows the IP gap, acquirers exhibit more willingness to pursue underperforming firms. Conversely, acquirers’ tendency to cherry pick increases in response to their own home countries’ CGRs, which increase the IP gap. These findings imply that weak IP prevents poorly performing local firms from gaining access to foreign capital and those CGRs in weak-IP countries help guide international capital flows to companies with more room to improve.http://deepblue.lib.umich.edu/bitstream/2027.42/64017/1/ipc-84-lu-cross-border-target-selection-investor-protection-disparity.pd