Payment Methods in Mergers and Acquisitions: A Theoretical Framework
Payment Methods in Mergers and Acquisitions: A Theoretical Framework
Payment Methods in Mergers and Acquisitions: A Theoretical Framework
ISSN 2162-3082
2018, Vol. 8, No. 1
N. M. Leepsa
Assistant Professor, School of Management, National Institute of Technology Rourkela
Pin-769008, Odisha, India
E-mail: leepsan@nitrkl.ac.in
Received: December 23, 2017 Accepted: January 5, 2018 Published: March 6, 2018
doi:10.5296/ijafr.v8i1.12354 URL: https://doi.org/10.5296/ijafr.v8i1.12354
Abstract
Purpose: This paper aims to review the prior literature on payment methods in Mergers and
Acquisitions (M&As) and summarizing its effects on the performance of companies involved
in M&As. This study also attempts to find out various determinants of the payment methods
of M&As that affects the decision of payment methods in M&As.
Methodology: To carry out the analysis, this study focuses the past literature relating to
payment methods in M&As and summarizes the positive and negative effects of different
payment methods. The review is carried out by dividing into four parts (i) Literature studies
on cash payment method (ii) Literature studies on stock payment method (iii) Literature
studies on mixed payment and (iv) Determinants of payment methods. The paper investigates
based on the findings of the major studies.
Research limitations: The scope of the study is confined to the contemporary review of
M&As literature than the empirical survey. The study is focused more on giving suggestions
for future work on M&As than providing conclusion.
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Research Implications: The knowledge gained from this study will help managers from both
acquirer and target companies for selection of appropriate payment methods and improve
their investment mechanism and strengthen their finances by value creation in M&As.
Originality: To the authors’ knowledge this paper is the first attempt to document for
summarizing the impact of different payment methods and its determinants of performance of
M&As deals.
Keywords: Merger and acquisition, Cash payment method, Mixed payment method, Stock
payment methods
JEL Classification: G34
1. Introduction
Merger and Acquisition (M&A) is an important corporate strategy action which is vital for
the corporate sector in order to survive in this competitive world. In recent times, M&A has
turned into a vital component in the economic and business environment and playing an
essential role to respond to the growing global competition and the rapid evolution of markets
(Vyas et al., 2012). Both in terms of values and volumes in M&A have been increasing over
the years throughout worldwide. As per Thomson Reuters, Merger and Acquisition review,
the value of worldwide M&A reached 777.7 billion US dollar during the 1st quarter of 2017
which is an increase of 12% as compared to the 1st quarter of 2016. However, overall 10,433
number of worldwide deals were announced during the 1st quarter of 2017, which is a 9 %
decrease compared to last year’s first quarter. That shows that in spite of decrease in the
number of deal the value of the deal is increased. A large number of research have been done
in the field of M&A. Most of the studies were conducted on the motive of M&A deals during
1970 to 1980 and proved hubris hypothesis, market power hypothesis, synergy hypothesis,
economy of scale and scope hypothesis, managerial hypothesis and method of payment
hypothesis (Chevalier & Redor, 2008). The studies similar to Vyas et al. (2012), Erdogan
(2012) and Ismail et al. (2011) focus on the determinants of M&A and identify that factors
like company size, age of company, leverage, culture, profitability, deal value, management
control, methods of payment, operating activities of company, tax implications and
macro-economic conditions affect the M&A performance. But there are some of studies like
Alshwer, Sibilkov and Zaiats (2011), Andre and Ben-Amar (2009), Dutta, Saadi, and Zhu
(2013) and Boateng and Bi (2013) that focus on determinants of methods of payment and
proclaim that the choice of methods of payment significantly influences M&A performance.
The choice of payment methods is an important risk management strategy. It is very critical
situation that the seller would always want the highest possible price for the business, but in
opposite side, the buyer would want to pay the lowest possible price. In such situation deal is
finalized by satisfying both buyer and seller with appropriate purchase consideration and
payment structure. Payment alternatives chosen in corporate acquisitions is a major decision
making factor for both acquirer and target companies.
According to Ray (2010) the M&A deal value is discharged through various payment mode
i.e. cash, share, debt, Leveraged Buyout (LBO) and earn-out plan. But as per Donald
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Depamphilis, (2010) the payment methods of M&A are divided into two types: one is cash
mode another one is non-cash mode. Cash payment mode is the simplest method of making
the payment of M&A deal. In this method, the total deal value discharges through cash
payment. The main advantage of cash payment mode is that the shareholders ownership and
earnings per share are not diluted in the company (Sherman, 2011). In Equity Share financing
method equity shares are given to shareholders of the target company by the acquiring
company. It results in shareholders of target company become the shareholders of an
acquiring company. In Debt and Preference Share payment methods, purchase consideration
is released by contributing a fixed percentage interest and a fixed rate of dividend. The main
aspect of this method is that there is no change in liquidity and ownership position of the
company. In case of Leveraged Buyout (LBO), deal price borrowed funds are utilized to
settle the whole or division of deal price for the acquisition of a company. The borrowed
funds are collected through bank loans, junk bond, loans from Target Company management
and private loans. When the management of the Target Company carries out a leveraged
buyout of the company is called as management buyout or MBO (DePamphilis, 2010)
The pre and post M&A performance of both acquiring company and target company highly
depends upon the method of payment used while making a M&A deal (Chevalier & Redor,
2008; Schlingemann, 2004). The payment method is one of the significant factors in
achieving the success of the deal. The payment methods of deal value are affected by various
factors like liquidity position, risk, leverage, ownership structure, cost of capital, capital
structure, tax implication, dividend policy, premium value, market price of share, government
rules and regulations, profit, free cash flow, equity flow, return on equity, market to book
value, debt flow, transaction cost and target company willingness (Boateng & Bi, 2013;
Kalinowska & Mielcarz, 2014; Barbopoulos & Sudarsanam, 2012).
In the light of past empirical and theoretical literature, this study summarizes both positive
and negative outcomes of various payment methods used in M&A deal. This study also
attempts to find out various determinants of the payment methods of M&A that affects
decision for choice of payment methods of M&A.
The rest of the paper is structured as follows: Section-2 discusses literature review on
methods of payments in M&A, Section-3 find out research gaps, Section-4 formulates the
research questions, Section-5 describes the conceptual framework, Section-6 summarizes the
results.
2. Literature Review
Over the last four decades, most of studies related to M&A were carried out by paying
attention on the financing part of M&A which is driven by various factors of both acquirer
and target companies (Amihud, Lev, & Travlos, 1990; Schlingemann, 2004). Choice of
Payment method of M&A is a critical aspect of the successful M&A deal. A number of
earlier studies have concentrated on M&A payment methods. Studies like Hansen (1987),
Yook et al. (1999), Wansley et al. (1987) and Fishman (1989) developed theories and analyze
the mode of payment in M&A based on asymmetric information. Some studies similar to
Martin (1996), Barbopoulos and Sudarsanam (2012), Boateng and Bi (2013) and Kalinowska
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& Mielcarz (2014) analyze the determinants of M&A payment methods. A few empirical and
theoretical studies, like Travlos (1987), Alexandridis and Travlos (2010) and Ladkani and
Banerjee (2012) concentrated on the shareholder wealth and stock returns due to
announcement of different payment methods M&A deal and disclosed that acquirer returns
are higher those choose cash payment method than those choose stock payment method.
Huang and Walkling (1987) and Franks et al. (1988) proved that the payment method has a
significant impact on the profitability of M&A deal. Faccio and Masulis (2005) focused on
the M&As deals in Europe and reported that mode of payment in M&A are significantly
affected by deal characteristics and target characteristics.
As per the past literature, the acquiring company financial variables affect the choice of
payment methods of M&A. According to Jensen (1986) large amount of cash availability and
sufficient debt raising capacity of acquiring companies prefer cash payment method in M&A
deal rather than stock payment method. The financial factors of the acquiring companies like
cash availability, leverage, collateral and profitability directly influence the decision of
choice of payment methods in M&A transactions (Chaney, Lovata, & Philipich, 1991;
Boateng & Bi, 2013).
According to Travlos (1987), when M&A deals are financed with stocks the abnormal returns
are negative, but in cash payment method it shows positive returns. Similarly, Antoniou and
Zhao (2004) supported that acquirer’s abnormal returns are significantly lower in case of
stock payment methods as compared to cash and mixed payment methods. In the same line of
research, various empirical studies yield evidence of higher returns for the target company
through cash offers M&As Deal. (Huang & Walkling, 1987; Eckbo & Langohr, 1989). Fuller
and Glatzer (2003) focused on the cross border acquisition by U.S. acquirer’s and their
payment methods for acquisitions of foreign targets. They found that acquirer’s returns are
higher in cash payment method.
Studies like Amihud et al. (1990), Martin (1996), Yook et al. (1999) and Faccio and Masulis
(2005) studied the link between managerial ownership of the acquiring company and the
payment mode of M&A and noticed that, managers of the acquiring company prefer
financing with cash payment method because of retaining ownership control with the
company management. Stock financing dilutes the ownership control of acquiring the
company. Amihud et al. (1990) verified that, stock payment method is negatively related to
inside ownership. Martin (1996) analyzed the relationships between management ownership
and investment opportunities with the payment method in corporate acquisitions and found
stock payment method is used at the time of the higher acquirer's growth opportunities. In the
banking sector, when the size of the target company is comparatively higher than acquiring
company the more possibility of use stock or combine of cash and stock as payment method
of M&A deal (Grullon et al. 1997). Boone et al. (2014) emphasized on mixed payment
method and empirically proved that mixed payment method is more used method in most of
the recent M&A deal.
The payment method of M&A affects the advertisement cost of the acquirer. Devos, Elliott
and Karim (2013) examined the relationship between payment method of M&A and
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advertising cost of acquirer and conclude that advertising cost of an acquirer in the pre M&A
period is relatively high in case of a stock based deal than cash based M&A deal. Similarly,
Yung, Sun and Rahman (2013) explored the relationship between earnings quality of the
acquirer and payment method of M&A and point out that the cash payment method of M&A
deal is negatively related with the acquirer long-term earnings quality.
The empirical studies regarding taxation hypothesis such as Niden (1986), Eckbo and
Langohr (1989) and Franks et al. (1988) suggested that cash payment method is more costly
than stock payment method in the reason of immediate taxability whereas stock payment is
taxable only when disposed-off. Ladkani and Banerjee (2012) studied on impact of payment
methods on the shareholder’s wealth of the acquiring companies in M&A in India and found
that, method of payment have positive effects on shareholder wealth. The studies, like Doytch
and Cakan (2011), Doytch & Uctum (2012) and (Ljungman, 2014) analysed the impact of
M&A on economic growth or contribution to the gross domestic product (GDP) of the
country.
Barbopoulos et al. (2017) focused on earnout payment method deals by US acquirers and
found that earnout deal’s performance are better as compare to non-earnout deals when
earnout deal is combined with stocks payment or mixed (cash & stocks) payment. Adra and
Barbopoulos (2018) detected that investor attention act as an important moderator in the
connection between the payment method in M&A and the abnormal returns of acquirer’s
announcement period.
The literature review is made as follows by segregating the past studies based on different
payment methods (cash, stock and mixed) and determinants affecting the choice of payment
method.
2.1 Cash Payment Method
Cash is the most common and simplest form of payment for acquiring shares and assets of
another company. Cash used in M&A transaction may be arranged by the acquiring Company
from internal sources or through additional debt. The main advantage of cash payment
method is a corporate identity and ownership structure remains unchanged. However the
drawback of this method is that there is need of immediate tax payment to target
shareholders.
Huang and Walkling (1987) proved that, the higher amount of cash used in M&A deal leads
to higher abnormal returns to both acquirer and target companies shareholders. Travlos
(1987), Hansen (1987) and Andrade et al. (2001) conformed the same result.
As per free cash flow hypothesis the acquiring company with excess free cash leads to cash
payment in M&A deal. Jensen (1986), Martin (1996) and Chaney et al. (1991) supported to
free cash flow hypothesis and found that there exists a direct relation between return on assets
and cash offers. Similarly, higher managerial ownership leads to higher cash payment in
M&A deal (Amihud et al., 1990).
Some empirical studied only concentrated on taxation hypothesis and observed that cash
payment method is more costly due to immediate taxability (Auerbach & Reishus, 1988;
Eckbo & Langohr, 1989).
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Fuller and Glatzer (2003) focused on the cross border acquisition by U.S. acquirer and their
payment method for acquisitions of foreign targets. They found that acquirer’s returns are
higher in cash payment method.
In the below Table 1 we summarized the both positive and negative results based on past
empirical studies relating to cash payment method in M&A.
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actual benefits to the shareholders of acquiring companies those choose stock as payment
method of M&As deals. Usually it is an ideal method of financing a M&A deal in case the
price-earnings ratio of the acquiring company is comparatively higher than the target
company.
Faccio and Masulis (2005) and Alshwer et al. (2011) developed a financial constraints
hypothesis which is just opposite of free cash flow hypothesis. This hypothesis explained that
financially constrained firms are more likely to use stock payment method. Similarly Industry
relatedness hypothesis implies that the deals in related industries would attract stock payment
(Swieringa & Schauten, 2007). Chang (1998) and Draper and Paudyal (2006) evidenced that
in stock payment method the abnormal return is positive in the case of privately held target
companies.
The main disadvantage of stock payment method is that it takes more time to complete the
deal. It also involves more transaction cost and lots of legal procedures for the deal (Myers &
Majluf, 1984).
Cho and Ahn (2017) studied on cross-border M&A by taking 4720 sample from 42 countries
and found that the cross-border M&A deals through stock payment method normally has a
negative impact on shareholder value. In takeovers deal acquirer’s short-run and long-run
performance is affected negatively when deal finance through stock (Fischer, 2017).
In the below Table 2 we summarized the both positive and negative results based on past
empirical studies relating to stock payment method in M&A.
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Regulation are significantly influence the decision for choice of payment method in M&A
deal.
Table 4. Literature on Determinants of Payment Method in M&A and Its Effect on Abnormal
Returns
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The payment method in M&A has significant implication for both the acquiring and target
companies, including post-takeover ownership structure, risk profile, capital structure and the
allocation of synergy from the transaction (Faccio & Masulis, 2005). There are less studies
given attention to the abnormal return of both acquirer and target due to announcement of
different payment methods M&As deals. Still, there is no clear cut evidence that the effect of
acquiring companies and target companies characteristics on choice of payment method in
M&A deal.
3. Research Gaps
The previous empirical and theoretical studies on payment methods of M&A have
focused on specific developed economies countries like The United States of America
(USA) and the United Kingdom (UK) which have scattered over ownership structures,
long term performance, tax implication, bid premium, free cash flow, financial
leverage, equity overvaluation, and the relative size, but there is limited number of
study focus on developing and under- developed countries.
The impact on the payment methods of M&A due to changes in rules and regulations
relating to M&A not focused in earlier studies.
There are insignificant studies deals with the relationship between different payment
methods of M&A and macro- economic conditions of the country.
4. Research Questions
There are several research issued that can be pursued based on research gaps. Several key
questions to be answered include:
Is the payment method in M&A affecting the performance of acquiring Company and
Target Company in M&A deal in emerging and developing countries?
What is the recent trend of payment methods used by acquiring companies in
emerging countries, whether they choose stock as a payment method or cash method
of payment or hybrid method of payment?
Which factors do influence the choice of payment method in M&A?
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5. Conceptual Framework
The conceptual framework of the choice of payment method in M&A can be built on a model
based on the determinants of acquiring company characteristics, target company
characteristics, deal characteristics and rule & regulation relating to M&A. Therefore, a
complete measurement and understanding of the foundation is needed to develop a model.
The conceptual model is developed on the basis of previous theoretical and empirical
literature that will help both acquiring company and target company management for decision
making on choice of payment method in M&A deal.
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