(3) Decision Usefullness of Accounting Information_Using Financial Accounting Information in the...

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Using financial accounting information in

the governance of takeovers: An analysis

by type of acquirerJoseph Aharony a,1, Ran Barniv b,*

a Faculty of Management, Tel Aviv University, Israelb Department of Accounting, Graduate School of Management, Kent State

University, P.O. Box 5190, Kent, OH 44242-0001, United States

Abstract

The substantial changes in the corporate governance mechanism of acquired firms

that take place during the periods surrounding corporate acquisitions lead investors

and other corporate financiers to an intensive search for financial accounting inputs

for decision making. We examine whether financial accounting information on takeover

targets provides useful input in the corporate governance mechanisms of US publicly

traded takeovers in these periods. Our analysis is by four different types of acquirers:

foreign firms, publicly traded US firms, private US acquirers, and leverage buyouts

(LBOs). We expect that certain firm-specific financial accounting characteristics of take-

over targets by type of potential acquirer affect valuation. To examine this expectationwe construct a probability summary-value measure, composed of eight financial

accounting variables, based on the type of acquirer. We also expect the probability

0278-4254/$ - see front matter 2004 Elsevier Inc. All rights reserved.

doi:10.1016/j.jaccpubpol.2004.07.002

* Corresponding author. Tel.: +1 330 672 1112; fax: +1 330 672 2548.

E-mail addresses: [email protected], [email protected] (J. Aharony), rbarniv@bsa3.

kent.edu (R. Barniv).1 Visiting professor of Accounting, Singapore Management University.

Journal of Accounting and Public Policy 23 (2004) 321349www.elsevier.com/locate/jaccpubpol
mailto:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]


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summary-value measure to be useful for determining investment strategies in acquired

firms. The empirical results strongly support our expectations.

2004 Elsevier Inc. All rights reserved.

JEL codes: G34; M14; M41Keywords: Corporate acquisitions; Corporate governance; Accounting information; Value rele-

vance; Investment strategy

1. Introduction

During periods surrounding corporate acquisitions, the corporate govern-ance mechanism of acquired firms changes substantially. In particular, new

potential financiers such as the new investors and acquiring firms extensively

scrutinize publicly available information in search of inputs. A major research

question that has been partially ignored in prior literature is how relevant

accounting information is during these periods. In these settings, financial

accounting information may play a more prominent role in corporate govern-

ance mechanisms and should therefore have greater value relevance to inves-

tors and other financiers of the firm, increasing their demand for such

information when making decisions.In this study, we examine the value relevance of information available from

the financial statements of US publicly traded acquired firms prior to the

acquisition. Our focus is on the value relevance of the accounting information

to different types of acquirers and other investors in target firms. We identify

four types of acquirers: foreign firms, publicly traded US firms, private US

acquirers, and leverage buyouts (LBOs). 2 We expect the accounting informa-

tion of the acquired firms to differ across types of acquirers and provide differ-

ent inputs and signals to investors. In addition, we expect that the accounting

information is useful for investment strategy in choosing among acquiredfirms.

Extant accounting studies use earnings and book value of equities to explain

prices and returns. Rather than focusing only on earnings and book values,

which may not provide sufficient information at the end of the firm s life cycle,

we construct a probability summary-value measure (Ou and Penman, 1989),

composed of other components of accounting data. This measure includes spe-

cific characteristics of accounting information used by each type of potential

major financier in the corporate governance of takeovers, and differs, on aver-

age, across acquired firms classified by the four types of acquirers.

2 Bradley et al. (1988), Kim and Lyn (1991), Opler and Titman (1993), Barnes et al. (1996) and

Gonzalez et al. (1998).

322 J. Aharony, R. Barniv / Journal of Accounting and Public Policy 23 (2004) 321349


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We use three methodologies to test our research expectations. First, we em-

ploy logistic regressions to generate the probability measure. While construct-

ing the probability measure, we find that the logistic regression performs welland certain firm-specific financial accounting characteristics of the acquired

firms are useful in identifying the type of acquirer. 3 Second, we employ

OLS price and return regressions. We find that the probability summary-value

measure is value relevant in price and return models. In particular, we show

that the probability summary-value measure is significant while neither earn-

ings nor changes in earnings are significant in return models. Third, we use uni-

variate statistics to examine whether the probability summary-value measure is

useful for investment strategy in choosing among acquired firms. We find that

the probability measure is a very powerful investment instrument. In sum, theempirical results strongly support our expectations.

The remainder of the paper is organized as follows. The next section pro-

vides further empirical background. The third section details the motivation

and incremental contribution of our study, and provides a literature review.

Section 4 deals with the research methods, and Section 5 presents the data.

Section 6 analyzes the results, and Section 7 provides a summary and

conclusions.

2. Further empirical background

We examine the impact of financial accounting information on prices and

returns for investors in takeover firms, classified according to the four types

of acquirers we have defined, from 250 trading days prior to the acquisition

announcement date through the last day of trading. To assess the cross-sec-

tional likelihood of acquisition by a certain type of acquirer, we identify other

firm-specific financial accounting characteristics of takeover targets used in

prior studies (e.g., Palepu, 1986; Hasbrouck, 1999), rather than the earningsand book value of equities used in valuation models. Specifically, eight signif-

icant financial accounting variables are used in a five-group multi-logit regres-

sion to extract the probability summary-value measure. We use the four groups

of acquired firms by type of acquirer and a fifth control group of manufactur-

ing firms not being acquired during the entire sample period. These five groups

are used to construct the probability summary-value measure. Then, prices and

returns are regressed on earnings, book value of equities, and the probability

3 Based on prior literature on the market for corporate control (e.g., DeAngelo et al., 1984;

Gompers et al., 2003), we expect the financial accounting characteristics of acquired firms to differ

across the four types, providing dissimilar signals as inputs for effective operation of the governance

mechanisms of US takeover firms.

J. Aharony, R. Barniv / Journal of Accounting and Public Policy 23 (2004) 321349 323


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measure. Finally, we show that the probability measure is useful for investment

strategies in target firms.

We obtained an initial list of acquired firms fromHall (1990, 1993)and sup-plemented the information using Compustat, the Wall Street Journal Index,

and Mergers & Acquisitions (19782001). Financial accounting and market

data were obtained from the Compustat and CRSP, respectively. Our final

sample consists of 1578 acquired US manufacturing firms that exited the stock

exchanges from 1978 to 2001. The control group consists of a final sample of

932 manufacturing firms with complete data.

We find that investors in firms acquired by either foreign firms or by publicly

traded US firms gain, on the average, about 66% returns, from 250 trading days

prior to the initial takeover announcement date through the last trading day,while investors in firms taken over by private US acquirers gain, on the average,

46% returns, followed by even lower returns of 42% gained, on the average, by

investors in LBOs. 4

Our results provide strong evidence that earnings, book value of equities,

and the probability measure representing the other financial accounting

information are significantly value relevant in explaining prices. Furthermore,

the probability measure is a significant factor in explaining returns for inves-

tors making choices among acquired firms, while, earnings and change in

earnings are insignificant. These specific findings suggest that financial infor-mation other than earnings and book value is increasingly more important to

investors in acquired firms. Finally, the results show that the probability

summary-value measure is very useful for investment strategies, providing

high security returns for investments in acquired firms. In sum, the results

indicate that financial accounting information, in addition to book value of

equity and earnings, provides an important input in the governance mecha-

nisms of US takeovers and has a significant impact on valuation of acquired

firms.

3. Motivation, literature review and incremental contribution

In excellent overviews of the explicit and implicit uses of accounting infor-

mation in corporate governance mechanisms, Bushman and Smith (2001)

andSloan (2001)claim, among other things, that financial accounting systems

provide direct and indirect inputs for corporate control mechanisms and that

4 While demonstrating annual negative gains for investors in many acquiring firms one year

after the acquisition, Henry (2002) documents average excess returns during the two weeks

surround the announcement of 9% over the S&P 500 index for investors in the 15 largest acquired

companies from 1998 to 2000.



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the most important role of accounting information is its implicit use. For

example, Sloan highlights its role in facilitating corporate takeovers, and points

outPalepus (1986)contribution in showing that financial accounting data are

useful in predicting takeovers.

Our study goes a step further in focusing specifically on the issue of whether

financial accounting information provides useful input for the corporate gov-

ernance mechanisms of US publicly traded acquired firms facilitated by four

different types of large acquirers, and the extent to which this information is

instrumental in investment decisions by various financiers.

Jensen (1984, 2000)argues that shareholders benefit most from acquisitions

because of the increase in the value of the acquired shares (the synergy hypoth-

esis). Takeovers protect shareholders from mismanagement of corporationssince they allow alternative managers to compete for the right to manage,

though they are also motivated by the self-interest of the members of the ac-

quirers management, who can use the free cash flows to increase the size of

their firm. We further argue that the input provided by accounting information

turns out to be of the utmost importance under such circumstances, as manag-

ers, investors and other financiers participate in the governance of target firms

and in the search for ways to improve the returns to various stakeholders of

both the acquired firm and the acquirer. 5 When large investors do not have

a clear voting majority on the board, they may have to take more drastic actionsuch as takeover (Sloan, 2001). 6

The corporate governance mechanism changes dramatically during the peri-

ods surrounding corporate acquisition announcements, with a concomitant

increasing demand for financial statement information by the various corpo-

rate stakeholders who evaluate the acquired firms. In such an environment,

earnings and book value may be insufficient for valuation. By using other com-

ponents of financial statements, our probability summary-value measure may

provide incremental value relevance for stakeholders competing in the market

for corporate control; it may also provide relatively costless inputs for effectivecorporate governance in mergers and acquisitions.

Fig. 1, adapted fromSloan (2001), describes the role of both the account-

ing information and the participants in the corporate governance mechanisms

5 Agrawal and Jaffe (2003) find little evidence of underperformance for acquired companies,

even for sub-samples of takeovers where managers are more likely to be disciplined. Bittlingmayer

(1998)shows that if managers of the acquiring firms act on behalf of their shareholders, investors

gain the highest value, but if managers serve their own interests rather than those of shareholders,the market for corporate control determines the means by which managers may be disciplined or

replaced.6 Holmstrom and Kaplan (2001) argue that internal corporate governance mechanisms of

incentive-based compensation and activist boards of directors and shareholders are playing an

increasing role in mergers and acquisitions.



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during the period of acquisition. The right-hand side of the figure lists thefour types of potential acquirers as new players among the financiers, distin-

guishing them from other participants, including new investors seeking short-

term gains and new debt holders who may lend funds to the acquirer for

financing the acquisition. For example, most capital provided for LBOs

usually comes from borrowed funds. Following the final acquisition, the fin-

anciers consist of a single type of acquirer, other remaining minority share-

holders, if any, current creditors, and the new creditors. The management

of the acquired firm may be retained or a new team of executives may be

appointed.Our study focuses on the role of financial accounting information as an in-

put for major financiers during the acquisition period, suggesting that acquirers

use this information to target potential acquisitions. Thus, for example, re-

search and development intensities reported by firms acquired by foreign firms

and by publicly traded US acquirers are about 10 times greater than those re-

ported by firms acquired either by private US acquirers or through LBOs. We

also show that the probability measure, which summarizes the role of the

accounting information in distinguishing the type of acquirer, is useful for

investors in acquired firms.In the process of corporate governance, managers of LBO firms may benefit

at the expense of other shareholders by implementing various techniques, includ-

ing low-ball bidding, altering firm economic decisions, earnings decrease manip-

ulations, and compensation shifts to minimize prices (DeAngelo et al., 1984;

Corporate

Governance

Mechanism

Alternative New Financiers:

1. Foreign Acquirer,

2. US Publicly Traded

Acquirer,

3. US Private Acquirer,

4. LBO.

Other Financiers:

Investors:

Insiders Shareholders,

Outsiders Large Investors,

Small Investors

Creditors:

Current Creditors,

New Creditors providing

borrowed funds to the acquirer.

Financial

Accounting

Input

Managers

Adapted from Sloan (2001).

Fig. 1. Acquired firms corporate governance mechanism during the period of acquisition.



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Perry and Williams, 1994; Wu, 1997; Jensen, 2000). 7 Further studies show that

returns to investors in LBOs are significantly smaller than those for investors in

publicly traded US firms acquired by publicly traded US acquirers (Torabzadehand Bertin, 1992; Barnes et al., 1996). 8

While LBOs and acquisitions by private acquirers are considered alternative

methods of going-private transactions (Opler and Titman, 1993), there is little

empirical evidence on the returns to investors in publicly traded US firms ac-

quired by private acquirers (Lehn and Poulsen, 1989). We conjecture that pri-

vate bidders that acquire publicly traded US firms and transfer them to the

private domain may lack the financial depth to pay high premiums. Hence,

lower returns are expected to investors in publicly traded US takeover targets

acquired by private US acquirers compared to those obtained in takeovers byforeign acquirers or by publicly traded US firms. The perspective of the ac-

quired firms management in this type of acquisition is less clear. On the one

hand, managers of the target firms may resist the takeover, in particular if they

have reason to believe that their compensation or wealth will be reduced and

that a new management team may replace them. On the other hand, they

may support the acquisition if they feel that their wealth and executive position

will remain secure.

Bris and Cabolis (2002) show that when acquiring foreign firms are from

countries with better corporate governance, investors wealth increases, sug-

gesting that cross-border mergers provide an alternative mechanism for the

contractual transfer of corporate governance. 9 While searching for under-

valued firms as targets for their acquisitions, managers of foreign acquirers

have stronger incentives to obtain financial information, and higher wealth

premium for investors is expected (Gonzalez et al., 1998). Indeed, previous

7 Kaplan (1992)shows that, between 1979 and 1986, about 63% of all LBOs remained privately

owned and about one-third either subsisted as public firms or were acquired by other publicly

traded firms.8 LBOs and other going-private modes are manifestations of the new emerging corporations

that may manage resources more efficiently than the publicly traded firms (Jensen, 1997). Further

studies show that LBOs and other going private modes possess financial and market characteristics

which are significantly different from those of other publicly traded firms ( Maupin et al., 1984;

Lehn and Poulsen, 1989; Kim and Lyn, 1991), and that managers of LBOs manipulate

discretionary accrual earnings in the year prior to the announcement (Perry and Williams, 1994).9 Black (2000)argues that the 20th century wave of US takeovers may be considered the last,

and that the growing percentage of cross-border takeovers indicates a future wave of international

mergers.Shleifer and Vishny (2001)present a theoretical model of mergers and acquisitions based

on stock market misvaluation of the firms. Among other things, the model explains who acquireswhom and what are the valuation consequences of the mergers; the model is also consistent with

prior empirical evidence about the characteristics and returns of merging firms. One empirical

prediction is that managers and shareholders of acquired firms are likely to have shorter horizons

than the acquirers. We conjuncture that this prediction indicates that the role of acquirers in the

corporate governance of acquired firms is different than the role of other financiers.



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studies show that managers of foreign acquirers tend to pay higher premi-

ums for publicly traded US takeover targets than do publicly traded

US acquirers (Michel and Shaked, 1986; Shaked et al., 1991; Harris andRavenscraft, 1991; Kang, 1993; Dewenter, 1995; Cheng and Chan, 1995;

Eun et al., 1996; Chen and Su, 1997). Thus, investors and managers of for-

eign acquirers of US firms not only have reason to search for potential

acquisitions with certain attributes reported by the accounting information;

they also have strong incentives to seek and obtain more financial account-

ing information. The probability measure, which is obtainable from publicly

available financial statements at a relatively small cost, may be a useful

instrument for these stakeholders. Since the expected gains from this type

of acquisition is higher than from other types of acquisitions, foreign acquir-ers may have incentives to incur the additional cost involved in obtaining

such information.

4. Research methods

4.1. Univariate statistics and logistic regression

We identify several firm-specific financial accounting attributes of acquiredfirms (other than the earnings per share (EPS) and book value of equities that

are included in the price and return models), which differ across the four

types of acquirers. Several accounting and financial variables suggested in

previous studies (e.g., Harris et al., 1982; Palepu, 1986; Opler and Titman,

1993; Hasbrouck, 1999) are selected for this purpose. These variables are pre-

sumed to be value relevant for the different types of acquirers and indicative

of an increase in value that might be captured in an acquisition. Conse-

quently, we assert that these variables are useful for assessing the likelihood

of a takeover in general, and the likelihood of a takeover by one of the fourdifferent types of acquirers, in particular. Specifically, we assume that acquir-

ers, investors in general, and other financiers of acquired firms use these

financial variables to assess the probability, PROBi,j, that firm j will not be

acquired (designated by i= 0), or that firm jwill be acquired by acquirer type

i (where i= 1, . . .,4). This probability is used as a summary-value measure of

financial accounting information. If differences in firm-specific attributes are

found to be significant in a classification by type of acquiring firm, it may

illuminate the different motivations for acquisition of each type of potential

acquirer in the corporate governance of takeovers prior to the finalconsolidation.

Using both univariate analysis and a two-group logit regression (not tabu-

lated), we identify a final set of eight significant financial variables representing

financial information other than EPS and book value of equities used in value-



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relevance analyses. 10 Then, a five-group logistic regression is performed using

the eight measures as explanatory variables, where the acquired firms are

grouped by the four types of acquirers: foreign, US publicly traded, US private,and LBO, a fifth group of non-acquired firms being used as a control sample.

The following five-group logit model is used:

TDUMi;j a01a02a03a04 a1 RDIja2RSj a3 ADIj

a4LEVja5TQja6 LIQja7LSIZEj

a8GDUMjej; 1

where TDUMi,j is an empirical grouping of both non-acquired and acquired

firms that equals 0, 1, 2, 3, 4, respectively, for the control group and for the

four types of acquirers: foreign, US publicly traded, US private, and LBO;and j= 1, . . ., Ni, where Niis the number of firms in group i= 0, . . ., 4.

11

The independent variables are estimated using the last financial statements

available prior to the initial acquisition announcement date. 12 The economic

hypotheses regarding the characteristics of a target firm that make it attractive

to a particular type of acquirer are articulated in theAppendix A, which dis-

tinguishes target firms in terms of their relative attractiveness to different types

of buyers. Based on the untabulated results reported in footnote 10, we as-

sume that these characteristics are also useful to distinguish among the five

groups. The definitions of the independent variables are as follows (the hypoth-esized expected signs of the independent variables are presented in parentheses,

while a detailed articulation of the reasons is provided inAppendix A):

RDI research and development intensity, measured as research and devel-

opment expenditure/net sales (a negative sign is expected);

RS net income/net sales (a negative sign is expected);

10 Several two-group comparisons are performed. The major purpose of these analyses is to

identify relevant and significant financial variables used in prior studies. The entire research period

is examined to obtain variables that remain relatively stable from 1978 to 2001, and might be used

for the estimation and testing periods examined in the five-group logit model. We use 22 variables

for our sample of 1578 acquired manufacturing firms and a control sample of 1777 manufacturing

firms, with at least three consecutive years of data on Compustat, that were not acquired or listed as

target firms during the research period. The control firms are randomly assigned to each sample

year without repetition, under the restriction that the same proportions of merged and control firms

from the entire samples are kept for each year, and each firm is presented in the analysis no more

than once. The final eight variables used for the final five-group logit regression are those that are

significant in the univariate comparisons between the acquired and control firms or in the two-

group logit regression or in both.11 Similarly, TDUMi,j is a binary (0,1) dependent variable for the respective pair of acquired

and control firms for the two-group logit regression described in footnote 10.12 The averages of the three-year data prior to the acquisition announcement date are also used,

but not tabulated because of missing values for several firms and empirical results for the reduced

sample that resemble the findings based on the last financial statements.

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ADI advertising intensity, measured as advertising expenses/net sales (the

sign is not predictable);

LEV financial leverage, measured as total debt/total assets (a positive sign isexpected);

TQ Tobins Q ratio, measured as (market value of equity + book value of

debt)/total assets 13 (a negative sign is expected);

LIQ liquidity, measured as (cash + marketable securities)/total assets

(a positive sign is expected);

LSIZE firms size, measured as ln (sales) (a negative sign is expected);

GDUM Palepu, 1986) (a positive sign may be expected).

4.2. Value-relevance OLS regressions

We examine whether the probability summary-value measure of the type of

acquirer (PROBi,j) is incrementally value relevant for investors in acquired

firms, given that the impact of both earnings and book value of equities are al-

ready included in the model. We use the following price model (Collins et al.,

1997; Francis and Schipper, 1999):

Pjtb

0b

1BVPS

jt b

2EPS

jt e

jt:

2a

and then add the probability summary-value measure as follows:

Pjtb0b1BVPSjt b2EPSjt b3PROBjt ejt; 2b

where Pjt is the price per share for acquired firm jat specified dates before or

after the initial acquisition announcement datet; BVPSjtis the book value per

share for acquired firm jin the last annual financial statements available prior

to the initial acquisition announcement date t; EPSjt is the earnings per share

for acquired firm j in the last annual financial statements available prior tothe initial acquisition announcement date t; PROBi,j is the probability sum-

mary-value measure, generated by the logit regressions, for a non-target firm

j not being acquired (designated by i= 0), or for a takeover firm j being ac-

quired by acquirer type i (where, i= 1, . . ., 4). PROB = [1/(1 + eax)], where a

is the vector of the estimated coefficients and x is the vector of the eight inde-

pendent variables described in Section 4.1.

Similarly, the return models are:

Rjtc0c1EPSjtc2CEPSjt ejt; 3a

and

13 The Q-theory of mergers suggests that the firms investment rate increases with Q and may

explain and motivate the acquisition (Jovanovic and Rousseau, 2002).



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Rjtc0c1EPSjtc2CEPSjt c3PROBjt ejt; 3b

whereRjtis the returns commencing one year prior to the initial announcement

of the jth acquisition through either one day following the acquisitionannouncement date or through the last trading date prior to the acquisition;

CEPSjtis the change in annual earnings per share for acquired firm jin the last

annual financial statements available prior to the initial acquisition announce-

ment date t.

Other variables are as defined above, and EPS and CEPS in the return mod-

els are deflated by market price per share at the beginning of the period (i.e.,

250 trading days prior to the initial announcement date).

4.3. Using the probability summary-value measure for a simple investmentstrategy among acquired and non-acquired firms

PROBi,j, the probability summary-value measure of financial accounting

information, defined in Section 4.1, may also be used to construct a trading

strategy. For this purpose we use a five-step procedure. First, using the logistic

regression (Eq. (1)), we estimate PROBi,j for each control and for each ac-

quired firm during the estimation period, 197890. Second, the PROB i,jvalues

are ranked and the outcome is divided into three probability regions: (1) low

deciles (30% of the firms, i.e., the lowest three deciles of PROB); (2) medium(the next four deciles, from 30% to 70% of the firms); (3) high (the top three

deciles of PROB). Third, a PROBi,jvalue is calculated for each acquired firm

in the testing period, 19912001. Fourth, we construct three investment portfo-

lios during the testing period. The first portfolio consists of firms with PROB

values in the low region; the second portfolio consists of firms with PROB val-

ues in the medium region; and the third portfolio consists of firms with PROB

values in the high region. Finally, for each portfolio we calculate and report

mean (median) returns resulting from a buy-and-hold strategy for three inter-

vals from 250 trading days prior to the initial acquisition announcementsthrough the final trading date. For the testing period, we report results for

(1) all acquired firms, (2) only for firms correctly classified as acquired, and

(3) for a mixed portfolio of correctly classified acquired firms and non-target

firms misclassified as acquired firms.

5. Data

We obtained our initial list of acquired manufacturing firms from Hall s

Manufacturing Sector Master File Research data (1990 and 1993), and ex-

tended it using information from the Wall Street Journal Index and Mergers

and Acquisitions (19782001). Financial accounting and market data were ob-

tained from the Compustat and CRSP, respectively. The initial sample was



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limited to firms for which acquisitions were successfully completed, that is, the

firms were fully acquired and exited the stock market. Moreover, financial data

were available on Compustat for at least three years prior to the acquisitionannouncement dates, and subsequent to the acquisition announcements prices

were available till the last day of trading. The sample selection of acquired

manufacturing firms is presented inTable 1. After excluding firms with missing

data, our final sample, presented in Panel A, consists of 1578 acquired US

manufacturers that exited the stock exchanges between 1978 and 2001. Of

these, 285 (18%) were acquired by foreign firms, 1053 (67%) by publicly traded

US firms, 164 (10%) by private US acquirers, 14 and 76 (5%) through LBOs.

The initial control group was drawn from the population of US publicly

traded manufacturing firms that were active during the 1980s and remained

Table 1

Sample selection of acquired manufacturing firms by type of acquirer: 1978 through 2001

Type of acquiring firm Totalfirms

acquiredForeign US publicly

traded

US private LBO

Panel A: 19782001

Acquired firms with data available

on Compustata317 1190 217 93 1817

Less: missing firms or data on CRSP 32 137 53 17 239

Firms with data availableon

Compustat and CRSPb285 1053 164 76 1578

Panel B: 19781990

Acquired firms with data available

on Compustata158 543 183 84 968

Less: missing firms or data on CRSP 11 67 50 12 140

Firms with data availableon

Compustat and CRSPb147 476 133 72 828

Panel C: 19912001

Acquired firms with data

available on Compustata159 647 34 9 849

Less: missing firms or data

on CRSP

21 70 3 5 99

Firms with data availableonCompustat and CRSPb

138 577 31 4 750

a Acquired manufacturing firms with data available on Compustat for the financial statement

variables used in our study.b Acquired manufacturing firms with data available on Compustat and CRSP for all variables

used in our study.

14 Private US acquirers include private firms, private investor groups and private investors, but

exclude LBOs.



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active throughout the year 2002. It consists of all firms with some available

data on Compustat from 1980 to 2002. These requirements yielded a control

sample of 1015 manufacturing firms. After excluding firms with missing data,our final control sample consists of 932 manufacturing firms.

We split our sample into two sub-periods: (1) estimation period (19781990)

for estimating the coefficients (Eq.(1)) used to derive the probability summary-

value measure, and (2) test period (19912001) for computing the probability

summary-value measure for each firm. The partition of the 828 (750) firms ac-

quired during the estimation (test) period, among the four types of acquirers, is

presented in Panel B (Panel C). During the test period, the number of acquisi-

tions by US publicly traded firms was considerably larger than during the esti-

mation period, while the opposite is true for going-private acquisitions, eitherby private acquirers or through LBO. 15

6. Results

6.1. Using financial accounting input to determine the likelihood of a takeover by

type of acquirer

6.1.1. Descriptive statistics of financial accounting variablesComparative univariate descriptive statistics of the eight financial variables

used to estimate the probability (PROBi,j) of firm jbeing acquired by an ac-

quirer of type i in the estimation period, 19781990, are presented in Table

2. For each variable, the sample mean and median are presented across take-

over targets by each type of acquirer and separately for the control firms. To

test whether for each variable the four groups and separately the five groups

(including the control group) have equal central distributions (mean and med-

ian), we conducted ANOVA and KruskalWallis tests. Table 2 shows that

RDI, LEV, TQ, LSIZE, and GDUM differ significantly and RS and LIQ differmarginally across the four groups. Our comparison among the five groups

shows significant differences among all variables except for ADI. These results

suggest that the variables differ across the four groups of acquired firms, not

just when the control sample of non-acquired firms is included in a-five group

comparison. We further identify the sources of the difference using t-tests and

Wilcoxon rank-sum tests on pair-wise comparisons (not reported).

The results (including the untabulated pair-wise comparisons) indicate that

both foreign acquirers and publicly traded US acquirers target firms having, on

the average, statistically significant larger research and development intensity

15 Holmstrom and Kaplan (2001)provide evidence that LBOs and other going-private takeovers

significantly decreased during the 1990s. They argue that these modes of acquisitions were no

longer needed due to the changes in corporate governance in the 1990s.



14/29

Table 2

Summary statistics for the explanatory variables of Eq. (1)(estimation period: 19781990)

Explanatory variablea Type of acquirer Co

noForeign US publicly

traded

US private LBOs Four-group p values

(F-test) [Kruskal

Wallis v2]

RDIb 0.1041c 0.1045 0.0107 0.0122 (0.0004) 0

(0.0137)d (0.0151) (0) (0.0003) [0.0001] (0

RSb 0.0112 0.0002 0.0161 0.0262 (0.0489) 0(0.0345) (0.0359) (0.0279) (0.0360) [0.394] (0

ADI 0.0130 0.0129 0.0100 0.0147 (0.6685) 0

(0) (0) (0) (0) [0.3089]

LEV 0.4445 0.4205 0.4903 0.5053 (0.0007) 0

(0.4224) (0.4143) (0.4425) (0.4623) [0.0007] (0

TQ 1.4461 1.6712 0.9332 0.8535 (0.0001)

(1.1581) (1.2021) (0.9233) (0.4619) [0.0001] (LIQ 0.1268 0.1417 0.1108 0.1168 (0.0582) 0

(0.0538) (0.0639) (0.0604) (0.0640) [0.6048] (0

LSIZE 10.11533 9.2198 8.4401 10.4892 (0.0001) 1

(9.7729) (8.9776) (8.3964) (10.5956) [0.0001] (1

GDUM 0.1987 0.2481 0.2824 0.2667 (0.0177) 0

(0) (0) (0) (0) [0.1365]

a Variables are estimated based on the last financial statements prior to the initial acquisition announcemen

active publicly-traded manufacturing firms, obtained from the 2002 Compustat files, that were traded in

development intensity, measured by research and development expenditures/net sales; RS is net income/net sale

by advertising expenses/net sales; LEV is financial leverage, measured by total debt/total assets; TQ is Tobequity + book value of debt)/total assets; LIQ is liquidity, measured by (cash + marketable securities)/total asse

(sales); GDUM is a mismatch growth index, measured as a growth dummy variable (Palepu, 1986).b Because a handful of outliers have a major impact on the means of both RDI and RS, the results re

winsorized at 1% and 99% for all firm-year observations.c Mean.d Median.


15/29

(RDI) and Tobins Q (TQ) compared with firms taken over by private US

acquirers or through LBO. Foreign acquirers and publicly traded US acquirers

target firms having, on the average, statistically significant larger research anddevelopment intensity (RDI) than firms in the control group. In contrast, firms

taken over by private US acquirers or through LBO have, on the average, sta-

tistically significant smaller RDI compared with firms in the control group.

Also, the control firms have statistically significant larger TQ compared with

each of the four acquired groups, where firms acquired by private acquirers

or through LBO have the smallest TQ. The results also suggest that firms ac-

quired through LBO are, on the average, larger and have higher financial lev-

erage than those taken over by the other types of acquirers. LBOs are, on the

average, significantly smaller than the control firms, but have larger financialleverage. Private US acquirers also tend to acquire highly leveraged but smaller

firms relative to those targeted by either foreign acquirers, publicly traded US

acquirers, or by the non-target control firms. Foreign acquirers generally tend

to target larger firms than do publicly traded US acquirers and private US

acquirers. Finally, the mismatch growth index (GDUM) is significantly larger

for firms acquired either by private US acquirers or through LBOs than for

firms acquired by either publicly traded US firms or foreign acquirers. GDUM

is significantly smaller for the control group compared with any of the four

groups of acquired firms.

6.1.2. Five-group logit regressions

Table 3shows the estimated coefficients, the chi-square for log-likelihood,

and the Somers D for the estimation period 19781990. Six estimated coeffi-

cients (RDI, LEV, TQ, LIQ, LSIZE, and GDUM) are statistically significant,

and their signs are in the predicted directions. The overall model is highly sig-

nificant, and has a relatively high explanatory power. Overall, using cutoff

points that minimize the number of misclassifications, the model correctly clas-

sifies 59% of the firms in the five groups significantly more than a randomchance of correctly classifying the outcomes among the five groups. 16 In addi-

tion, the model correctly classifies 70% of the firms as acquired or non-target

in the estimation period (88% of the acquired firms, but only 51% of the

non-target control firms). 17

16 The proportionate random five-group classification criterion is 36.8% (9322 + 1472 + 4762 +

1332 + 722)/1,7602 for the 197890 estimation period.17

A classification of an acquired firm is considered to be correct when it is classified as anacquisition by any of the four types of acquirers. For example, an actual acquisition by a foreign

acquirer is considered a correct classification if the model classifies it as an acquisition by foreign

acquirer, by public US firm, by private US firm or through LBO; it is considered a misclassification

when classified as an observation in the non-target control group. This approach is used in the

analyses reported in Section 6.3 and in Panel C ofTable 6.



16/29

As expected, the estimated coefficients for RDI, RS, TQ, and LSIZE are sta-

tistically significant and negative, and those for LEV, LIQ, and GDUM are sig-

nificant and positive. 18 These results suggest that as research and development

intensity, Tobins Q, and firm size increase, the probability of being acquired by

foreign firms or by publicly traded US firms increases, while the probability of

being acquired by private US acquirers or through LBO decreases. Also, as the

financial leverage, liquidity and the mismatch growth index increase, the prob-

ability of being acquired by private US acquirers or through LBO increases.

6.2. The value-relevance of the probability summary-value measure

Table 4presents pooled cross-sectional regression results of the price model

(Eqs.(2a) and (2b)) using the sample for the test period 19912001. The regres-

sion results are reported for three alternative measures of the dependent vari-

able (Pjt): (1) the price on the 60th trading day prior to the initial takeover

announcement date (Day-60); (2) the price at the initial takeover announce-

Table 3

Five-group logit regression results of Eq. (1)for non-acquired control firms and for acquired firms

classified by the four types of acquirers: 19781990a

Independent variableb Expected signsc Estimated coefficients (19781990)

Intercept 1 4.635**

Intercept 2 4.174*

Intercept 3 2.264*

Intercept 4 0.886**

RDI () 2.988*

RS () 0.995*

ADI (?) 2.317

LEV (+) 2.558*

TQ () 1.211*

LIQ (+) 1.410*

LSIZE () 0.284*

GDUM (+) 0.339*

Chi-square for log likelihood 667.9*

Somers D 0.55

* Significant at p < 0.01.** Significant at p < 0.05.

a The non-acquired control firms and the acquired firms grouped by the four types of acquirers-

foreign, US publicly traded, US private and LBO, take the values of 0, 1, 2, 3, 4, respectively.b The variables are defined inTable 2.

c Expected signs of coefficients.

18 Significant positive estimated coefficients indicate that the probability of acquisition by

private US acquirers (group 3) and through LBO (group 4) increases. Significant negative estimated

coefficients indicate that the probability of acquisition by the control firms (group 0), foreign

acquirers (group 1) and by publicly traded US acquirers (group 2) increases.



17/29

ment date (Day 0), and (3) the price on the last trading date (Last date). Our

focus is on testing the incremental explanatory power of the additional finan-

cial accounting information represented by PROB, the probability summary-

value measure.The results in Panel A indicate that for regression model(2a), the adjusted

R2s vary from 0.317, 60 days prior to the initial takeover announcement dates

to 0.197 on day 0. In comparison, the results in Panel B for the three-variable

model (Eq.(2b)) show greater explanatory power: the adjusted R2s vary from

0.385, 60 days prior to the initial announcement date, to 0.269 on day 0. The

estimated coefficients for BVPS and EPS are positive (as expected) and highly

statistically significant, and the estimated coefficients for PROB are highly

significant and negative (as expected). 19 These results suggest that PROB

Table 4

The value relevance of accounting information: Pooled cross-sectional regressions of price on book

value per share (BVPS), earnings per share (EPS) and the probability of acquisition (PROB): 1991

2001

Trading days relative to

initial takeover announcement

date (day zero)

Estimated coefficientsa AdjustedR2

BVPS EPS PROBb

Panel A: (Eq.(2a)) Model without probability measure

Day60 0.892 3.222 0.317(10.5)* (8.32)*

Day 0 1.193 3.539 0.197

(10.6)* (5.38)*

Last datec 1.307 4.286 0.203

(8.75)* (6.62)*

Panel B: (Eq.(2b)) Model with probability measure

Day60 0.954 3.822 20.102 0.385(11.2)* (8.77)* (4.27)*

Day 0 1.295 4.463 33.222 0.269

(11.4)* (5.57)* (3.02)*

Last datec 1.426 5.338 28.687 0.282(8.79)* (6.32)* (2.84)*

White adjusted t-statistics are in parentheses.* Significant at p < 0.01.

a Intercepts tend to be insignificant and are not reported.b The probability of acquisition, PROB, by type of acquiring firm is estimated based on the

logistic regression reported inTable 3. The lowest (highest) probability suggests an acquisition by

foreign firms (LBOs).c Last date is the last trading date.

19 We use a chi-square test to examine the incremental information of PROB when BVPS and

EPS variables are already included in the model. The significance level is equal to that of a simple

t-test (the square root of the chi-square test with one degree of freedom) for testing the hypothesis

that the estimated coefficient for each variable is equal to zero in the full model.



18/29

provides significant incremental value-relevant information for investors in

general, and for each type of potential major financier in the corporate govern-

ance of takeover targets.

Table 5 presents pooled cross-sectional regression results for the returnmodels (Eqs. (3a) and (3b)) using the testing period, 19912001. The regres-

sions results are reported for two alternative return interval measures of the

dependent variable (Rjt): (1) from trading day 250 to day +1 relative to theinitial takeover announcement date, and (2) from trading day 250 to the lasttrading day. Again, our focus is on testing the incremental explanatory power

of the additional financial accounting information represented by PROB, the

probability summary-value measure, when the variables EPS and CEPS are

already included in the model.

The results in Panel A indicate that for the variables EPS and CEPS inregression model(3a), the estimated coefficients are not statistically significant

and the adjustedR2s are only 0.001. In contrast, the regressions results in Panel

B for the three-variable model show adjusted R2s of 0.059 and 0.021 for the

two return intervals, respectively. Furthermore, the estimated coefficients

Table 5

The value relevance of accounting information: Pooled cross-sectional regressions of returns on

earnings per share (EPS), changes of earnings per share (CEPS)a and the probability of acquisition

(PROB): 19912001

Trading days relative to initial

takeover announcement

date (day zero)

Estimated coefficientsb AdjustedR2

EPS CEPS PROBc

Panel A: (Eq.(3a)) Model without probability measure

250 to +1 0.118 0.558 0.001(0.33) (1.12)

250 to Last dated 0.070 0.623 0.001(0.12) (1.30)

Panel B: (Eq.(3b)) Model with probability measure250 to +1 0.615 0.255 1.390 0.059

(1.88)*** (0.53) (3.71)*

250 to Last dated 0.218 0.433 1.021 0.021(0.34) (0.93) (2.19)**

White adjusted t-statistics are in parentheses.* Significant at p < 0.01.** Significant at p < 0.05.*** Significant at p< 0.10.

a The variables EPS and CEPS are deflated by the market price per share at the beginning of the

returns interval (day

250).b Intercepts tend to be insignificant and are not reported.c The probability of acquisition, PROB, by type of acquiring firm, is estimated based on the


foreign firms (LBOs).d Last date is the last trading date.



19/29

for PROB are negative (as expected) and highly significant for both return

intervals. These results suggest that PROB not only provides significant incre-

mental value-relevant information for each type of potential acquirer, but it isalso essentially the main significant explanatory variable for the returns mod-

els. In summary, the results indicate that while earnings and book value of

equities alone may not provide sufficient information content during the period

surrounding the acquisition, the additional financial accounting input is value

relevant for investors in general and for each type of potential major acquirer.

Thus, the additional financial information provides important input to finan-

ciers participating in the corporate governance of acquired firms and to the

valuation of acquired firms.

6.3. Using the probability summary-value measure for investment strategy

Table 6 presents the mean (median) buy-and-hold returns for each of the

three portfolios resulting from implementing a buy-and-hold investment strat-

egy in the second sample period, 19912001, as described in Section 4.3. The

results are shown for three return intervals: (1) from trading day 250 to1, relative to the initial takeover announcement date; (2) from trading day250 to +1; and (3) from trading day250 to the last trading day. 20 In PanelA we show that all acquired firms classified in the low PROB portfolio (the

three portfolios are defined in Section 4.3) gained, on the average, the highest

buy-and-hold returns for each of the three return intervals; firms classified in

the medium PROB portfolio gained, on the average, lower returns, and firms

in the high PROB portfolio gained, on the average, the lowest returns. Note

that the returns presented in Panel A also include those of acquired firms that

are misclassified as non-target firms.

Panel B shows similar results for the 580 acquired firms correctly classified

in the testing period (19912001) using a cutoff point that minimizes the five-

group logistic misclassification rate in the estimation period. For example, for

the return interval 250 to Last date, the mean (median) returns are 70.3%(48.1%), for the low PROB portfolio, 60.8% (43.2%) for the medium PROB

portfolio, and only 34.1% (38.1 %) for the high PROB portfolio. Panel C

shows similar results for a mixed portfolio of the correctly classified 580 ac-

quired firms and a random 313 non-target control firms. The composition of

firms in this portfolio is based on applying the percentage of both correctly

classified acquired firms and misclassified non-target firms in the estimation

20 We also examine but do not report the mean (median) returns for shorter intervals

commencing on day60. The results across the three portfolios resemble those reported inTable 6,except that the returns are smaller.



20/29

period, 19781990, to the testing sample in 19912001. The returns are sim-

ilar but smaller than those reported in panels A and B because non-targetfirms gain, on average, only 15.6 percent annual return during the 1991

2001 period.

Recall that a relatively low PROB suggests a higher likelihood that a foreign

acquirer will acquire a US publicly traded firm, whereas a high PROB implies a

Table 6

Mean (median) buy-and-hold returns (%) by PROBa distribution: 19912001

Trading days relativeto initial takeover

announcement date

(day zero)

PROB distributionLow (the bottom

three deciles of

the firms)

Medium (between the

fourth and seventh

deciles of the firms)

High (the top

three deciles of

the firms)

Panel A: All acquired firms (n = 750)

250 to1 59.6* 41.6* 30.1*

(30.2)* (27.3)* (22.6)*

250 to +1 63.6* 50.5* 36.9*

(41.2)* (37.1)* (32.1)*

250 to Last date 74.5* 62.0* 36.7*

(50.9)*

(46.9)*

(35.0)*

Panel B: Correctly classified acquired firms (n = 580)b

250 to1 62.1* 45.9* 31.9*

(33.6)* (29.3)* (25.6)*

250 to +1 66.7* 50.5* 34.7*

(44.7)* (39.5)* (29.3)*

250 to Last date 70.3* 60.8* 34.1*

(48.1)* (43.2)* (38.1)*

Panel C:Portfolio of correctly classified acquired firms and random non-target control firms

(n = 893)c

250 to1 45.8* 35.3* 26.2*(27.3)* (24.5)* (22.0)*

250 to +1 48.8* 38.3* 22.5*

(34.5)* (31.1)* (24.5)*

250 to Last date 51.1* 44.9* 27.6*

(48.1)* (36.7)* (30.2)*

* Significant at p < 0.01.a The probability of acquisition, PROB, by type of acquiring firm, is estimated based on the


foreign firms (LBOs).b

Firms correctly classified as acquired in the test period 19902001. We use a cutoff point ofPROB from the estimation period based on the five-group logistic regression and the method

explained in footnote 17.c Portfolio consisting of the 580 correctly classified acquired firms and a random sample of 313

non-target firms. The composition of firms in the portfolio is based on applying the percentage of

both correctly classified acquired firms and misclassified non-target firms for the estimation period,

19781990, to the testing sample in 19912001.



21/29

higher likelihood of a takeover through LBO. We conclude that the probability

summary-value measure, PROB, composed of eight components of financial

data, is beneficial for investment strategies in takeovers.To check the validity of these conclusions for investment strategies, we also

calculate the ex-post mean buy-and-hold returns for four portfolios of takeover

targets classified by the type of actual acquiring firms: foreign, US publicly

traded, US private acquirers and LBOs. Table 7shows the results for two re-

turn intervals: (1) from day250 to day +1 relative to the announcement date;and (2) from day250 to the last trading day. The results are presented sepa-rately for the entire sample period 19782001 and for the two sub-periods

19781990 and 19912001. The results show significantly higher buy-and-hold

returns for the portfolio of takeover targets acquired by either foreign firms orpublicly traded US firms compared with those acquired either by private US

acquirers or through LBO. 21 For example, the results in Panel A for the entire

sample period, 19782001, show that investors in firms acquired by either for-

eign firms or publicly traded US firms gained, on the average, 66% returns,

while investors in firms acquired by private US acquirers or through LBO

gained, on the average, returns of only 46.2% and 41.8%, respectively, in an

Table 7

Mean buy-and-hold returns (%) for acquired firms classified by type of acquirer

Trading days relativeto initial takeover

announcement date

(day zero)

Type of acquiring firmsForeign US Publicly traded US Private LBO

Panel A: 19782001

250 to +1 58.62* 56.78* 38.87* 31.69*

250 to Last date 66.30* 66.11* 46.22* 41.80*

Panel B: 19781990

250 to +1 59.79* 55.24* 38.26* 32.23*

250 to Last date 66.88* 65.65* 46.29* 41.59*

Panel C: 19912001

250 to +1 56.23* 58.16* 41.09** 18.94**

250 to Last date 65.72* 66.49* 45.94* 45.79**

* Significant at p < 0.01.** Significant at p < 0.05.

21

We also examine shorter intervals of both cumulative abnormal returns (CARs) and buy-and-hold returns and find comparable results. For example, for the 19782001 period, the 11-day CARs

surrounding the announcement are 21.9%, 21.7%, 15.4%, and 8.1% for investments in firms taken

over by foreign acquirers, US publicly traded acquirers, private US acquirers, and LBOs,

respectively. Buy-and-hold short-interval investments provide comparable but lower returns to

those returns that start at day 250 across the three portfolios.



22/29

interval from 250 trading days prior to the initial takeover announcement date

through the last day of trading. These results are consistent with those obtained

using the probability summary-value measure, PROB, for investment strategyamong takeover targets.

7. Summary and conclusions

This study examines whether financial accounting information on US pub-

licly traded target firms provides useful input for the corporate governance

mechanisms of these firms, facilitated by four different types of acquirers, dur-

ing the period surrounding the acquisition. For this purpose, we examine thevalue relevance of information available from the financial statements of US

publicly traded acquired firms prior to the acquisition. Our focus is on value

relevance of the accounting information to different types of acquirers and

other investors in acquired firms. The acquired firms are grouped into four

types of acquirers: foreign firms, publicly traded US firms, private US acquir-

ers, and leverage buyouts (LBOs). We expect that accounting information of

the acquired firms differ across types of acquirers and provides different inputs

and signals to investors. In addition, we expect that the accounting information

is useful for investment strategy in choosing among acquired firms.Rather than focusing only on earnings and book values, which may not pro-

vide sufficient information at the end of the firms life cycle, we construct a

probability summary-value measure, composed of other components of

accounting data. This measure consists of specific characteristics of accounting

information used by each type of potential major financier in the corporate

governance of takeovers. This probability measure differs across acquired firms

classified by the four types of acquiring firms.

We use logistic regression to construct the probability summary-value meas-

ure and find that certain firm-specific financial accounting characteristics of theacquired firms are useful in identifying the type of acquirer. Then, we employ

OLS price and return regressions and provide strong evidence that the proba-

bility summary-value measure is value relevant in price and return valuation

models. Finally, we use univariate statistics to examine whether the probability

summary-value measure is useful to potential investors for investment strategy

in choosing among acquired firms. We find that the probability measure is a

very powerful investment instrument. In sum, the empirical results strongly

support our expectations.

Our test sample consists of most of the population of US publicly tradedmanufacturing firms acquired in the period 1978 through 2001. In addition,



23/29

we use a control sample drawn from the population of US publicly traded

manufacturing firms that were active during the 1980s and remained active

throughout the year 2002.In sum, our results strongly indicate that the probability summary-value

measure provides investors with incremental value-relevant information be-

yond that provided by earnings and book values of equities, which alone

do not provide sufficient information to explain returns during the period

surrounding the acquisition announcements. Overall, the results imply that

the financial accounting characteristics of acquired firms differ across the

four types of acquirers, providing dissimilar signals as input for effec-

tive operation of the corporate governance mechanisms of US takeovers.

Thus, our study suggests the increasing importance of financial account-ing information during takeovers. Finally the probability summary-value

measure is shown to be beneficial to the investment strategies in

takeovers.

Acknowledgments

We appreciate the research assistance of Yan Bao and Dave Cannon. Thisresearch was partially funded by the Henry Crown Institute of Business

Research in Israel at Tel Aviv University. Data were obtained from sources

identified in the paper. All potential remaining errors are of course ours.

Appendix A. Reasons for expected signs of estimated coefficients of Eq. (A.1)

TDUMi;j a01a02a03a1RDIja2RSja3 ADIj

a4LEVja5TQja6 LIQja7LSIZEja8GDUMjej: A:1

In the multi-group logit regression, TDUM is a grouping of the acquired

firms that equals 0, 1, 2, 3 for the four types of acquirers: foreign, US pub-

licly traded, US private, and LBO, respectively. Accordingly, significant pos-

itive estimated coefficients indicate that the probability of acquisition by

private US acquirers (group 2) and through LBO (group 3) increases. Signif-

icant negative estimated coefficients indicate that the probability of acquisi-

tion by foreign firms (group 0) and by publicly traded US firms (group 1)increases.



24/29

Variable Expected

sign

Reasons for expected signs of estimated coefficients of Eq.(A.

RDI Negative Research and development intensities are expected to be larger

firms, in support of the technology transfer hypothesis (Chen

firms targeted by private acquirers, in support of the financial

Titman, 1993).Eun et al. (1996) show that shareholders gains

acquirers are significantly greater than for acquisitions by US

foreign acquirers benefit from the targets R & D capabilities.

show that in R&D-intensive industries takeovers by foreign fir

takeovers by US acquirers. Conclusion: a negative sign is expec

coefficient of RDI.

RS Negative Other things being equal, firms with lower profit margins have

lacking the ability to control costs properly. Such firms are mo

targets and have their inefficient managers replaced. The ineffic

suggests that firms with lower profitability will be less likely to

acquirers than by US publicly traded acquirers (Chen and Su,

as the former are less able to analyze and identify the true ope

Incumbent management may be aware of the situation and try

purchasing their firms through LBO, in support of the incentiv

distress theories (Opler and Titman, 1993). Further, they may

other shareholders by implementing various techniques, inclu

altering firm economic decisions, earnings decrease manipulat

to minimize prices. Conclusion: a negative sign is expected for


25/29

ADI ? Prior studies do not provide a theory or empirical evidence reg

advertising intensity across types of acquirers or its impact on

by a certain type of acquirer. Conclusion: the sign of the estima

unpredictable.

LEV Positive Firms acquired through LBO are typically highly leveraged bo

acquisition. Since debt is the primary source of financing LBO

higher financial leverage. Based on the debt-management and t

hypotheses,Chen and Su (1997)suggest that highly leveraged

acquired by foreign and US public acquirers. Foreign acquirer

acquire highly leveraged firms. Conclusion: a positive sign is exp

coefficient of LEV.

TQ Negative The undervaluation-target hypothesis suggests that the probab

traded firm by a foreign acquirer increases with increasing Tob

Gonzalez et al., 1998). The incentive realignment theory, the fi

unfavorable investment opportunities hypothesis suggest that t

decreases with increasing Tobins Q(Opler and Titman, 1993).

some corporations and the financial incentive hypotheses pred

Tobins Q(Weir and Laing, 2002).Kim and Lyn (1991)find th

significantly smaller market to book ratio . Conclusion: a nega

estimated coefficient of TQ.


26/29

Appendix A (continued)Variable Expected

sign

Reasons for expected signs of estimated coefficients of Eq. (A

LIQ Positive The enhanced liquidity hypothesis suggests that, other things

liquidity may become more attractive takeover targets. Incum

have better inside information regarding current and prospect

other things being equal, to acquire their firm through LBO f

other types of acquirers. Opler and Titman (1993) find that L

cash flow (the incentive realignment theory). Lehn and Poulse

likelihood of going private tends to increase with greater cash

cash flow theory associated with the agency problem. Chen an

firms acquired by foreign acquirers have significantly lower liq

other publicly traded US firms. Conclusion: a positive sign is e

coefficient of LIQ.

LSIZE Negative Chen and Su (1997)provide evidence in support of the size hy

of acquisition by a foreign acquirer increases with size. Other

more likely to be a foreign takeover target because of the high

desirable small-firm target. Kim and Lyn (1991)find that firm

smaller than firms not going private. Conclusion: a negative si

coefficient of LSIZE.


27/29

GDUM Positive This variable represents mismatch between growth and financ

higher growth rate of sales or total assets has more profitable

positive earnings prospects than does a firm with lower growt

argue that the growth potential or redeployment of corporate

that firms with higher growth rate tend to be more attractive t

for mature acquirers. They find insignificant empirical differen

publicly traded firms acquired by foreign firms and by US puno support for this hypothesis in comparing the two modes of

Poulsen (1989)show that the likelihood of going private tend

sales growth, in support of the free cash flow theory associate

Kim and Lyn (1991), however, find that firms going private h

than firms not going private, but the growth coefficient is insig

Conclusion: overall, a positive sign may be expected for the esti


28/29

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