How do labour regulations affect cross-border acquisitions?

Do a country’s labour regulations shape the inflow and outflow of capital? Do firms boost profits and stock returns by seeking out countries with weaker labour regulations in which to make investments?

The importance of understanding the answers to these questions for economic growth and employment has grown over the last couple of decades. Cross-border deals account for a large and growing proportion of all acquisitions, as illustrated in Figure 1. Furthermore, the dollar value of cross-border acquisitions rose from an average of $300 billion per annum during the 1990s to an average of almost $800 billion per annum since 2000, as depicted in Figure 2.

Figure 1. Cross-Border acquisitions as a percentage of total acquisitions

Figure 2. Total value of cross-border and domestic mergers (in Billions of US Dollars) by year

Prior research

Researchers have explored the financial and corporate governance determinants of cross-border acquisitions. Erel et al (2012) show that exchange rate changes, and changes in relative stock market valuations, influence the incidence and direction of international deals. Rossi and Volpin (2004), Bris and Cabolis (2008), and Chari et al (2009) demonstrate that firms in countries with stronger corporate governance systems have a higher likelihood of purchasing firms in other countries.

But researchers have not yet studied how the broad set of laws, regulations, and policies that shape labour markets – ‘labour regulations’ – influence the profitability and incidence of cross-border acquisitions. Although researchers have dissected the impact of offshoring and multinational firms on wages and employment – as in Revenga (1992), Grossman and Rossi-Hansberg (2008), Desai et al (2009), and Harrison and McMillan (2011) – they have not evaluated whether differences in the degree to which countries protect the employed and assist the unemployed influence cross-border acquisitions.

Flexibility and acquisitions

This is surprising. Besides influencing a large corporate expense – expenditures on wages and benefits – labour regulations shape the costs of hiring, firing, and adjusting the hours of workers, with potentially large effects on firm performance. Labour market flexibility could be especially important for the success of acquisitions since acquiring firms often restructure targets to minimise labour costs and maximise synergies.

We contribute by assessing three interrelated questions about the impact of differences in cross-country labour regulations:

• How does an acquiring firm’s stock price responds to a cross-border acquisition?
• How do an acquiring firm’s profits change after a cross-border deal?
• How are the number, total value, and deal size of cross-border acquisitions affected?

To address these questions, we assemble a sample of cross-border transactions –we examine individual deals, from the Securities Data Company database across 50 countries over the period from 1991 through 2012. This includes transactions between 2,450 (=50  49) country-pairs. We assess the cumulative abnormal stock returns (CARs) and the abnormal return on assets (ROAs) of acquiring firms following cross-border acquisitions. We use three measures of labour regulations. First, Botero et al (2004) provide cross-country measures of the degree to which laws impede employers from firing workers, increasing work hours, or using part-time workers. Such interventions increase the costs to employers of adjusting their workforces. Second, the OECD provides panel measures of the strictness of regulations on dismissals, including procedural inconveniences, notice and severance pay, and the difficulty of firing workers. Third, Aleksynska and Schindler (2011) provide panel data on the proportion of the unemployed covered by unemployment benefits. More generous unemployment benefits might increase labour costs by boosting the reservation wages of the unemployed. For brevity, we use the phrases ‘stronger’ and ‘weaker’ labour regulations to describe the degree to which laws and policies protect the employed and aid the unemployed.

Findings

We find an economically large and statistically significant connection between labour regulations and both abnormal stock returns and profits in exactly those industries in which theory suggests the relation should be most pronounced – labour dependent industries. We define a labour dependent industry as an industry in which firm performance depends heavily on labour markets. We use US data to create two benchmark measures of the degree to which a firm is in a labour dependent industry:

‘labour intensity’ equals labour and pension expenses relative to sales; and,
‘labour volatility’ equals the volatility of employment relative to assets.

We find that the CARs and abnormal ROAs of acquiring firms respond most positively to cross-border acquisitions of targets in countries with comparatively weak labour regulations when the target is in a labour dependent industry. In turn, when the target is in an industry in which labour regulations are unlikely to influence firm profitability, the stock market and profits do not respond much to cross-border differences in labour regulations. Figure 3 illustrates just how dramatic the difference is, with CARs of firms that acquire targets in countries with comparatively weak labour regulations rising, while the CARs tends to fall when firms acquire targets in countries with comparatively strong labour regulations.

The estimated impact of labour regulations on the profitability of cross-border acquisitions is large, indicating that stronger labour regulations in the target country make post-merger integration more costly and reduce the manifestation of synergies. For instance, if a firm from the US (which has weak labour regulations) acquires a firm in France (which has strong labour regulations), our estimates predict a decrease in abnormal ROA of about 25%.  The estimates differentiate by industry. For example, consider a Swedish firm (Sweden has strong labour protection laws) acquiring a target firm in the US (which has comparatively weak labour protection laws). Our estimates indicate that if the target is in the computer programming service industry, which is a comparatively high labour-volatility industry, the additional increase in the acquiring firm’s CAR (above the average increase) will be 0.61%. However, if the target is in the dairy products industry, which is a low labour-volatility industry, the corresponding additional boost in CAR (above the average increase associated with an acquisition) will be 0.29%. Given that the average CAR is 1.3%, the difference is economically significant.

We next turn to the question of whether cross-country differences in labour regulations shape the number, total value, and deal size of cross-border acquisitions. We control for many other factors that might shape cross-border acquisitions. Besides conditioning on acquirer country, target country, and acquirer industry fixed effects, we control for acquirer and target country characteristics, such as GDP per capita and population, as well as acquirer-target traits, such as geographic distance and whether they have the same major language and religion.

We find that a country’s firms acquire more firms and spend more on each acquisition in a country, if that target country has weaker labour regulations than the regulations in the acquirer country. That is, firms find targets in countries with weaker labour regulations more appealing than similar targets in countries with comparatively strong labour regulations. For example, when the target country has one-standard deviation lower labour protection laws than the median country, our estimates suggest that the volume of cross border acquisitions will be almost 60% higher. As another example, consider China, which has labour protections that are average in our sample. About 67% of its cross-border acquisitions flow to countries with weak labour protection laws (below the 25th percentile of the employment law distribution), while only 9% flow to countries with strong labour protection laws (above the 75th percentile of the distribution). These results are consistent with our core finding – acquiring firms enjoy larger CARs and abnormal ROAs after a cross-border acquisition, if the target is in a country with weaker labour regulations than the acquirer country’s labour regulations.

References

Aleksynska, M, M Schindler, (2011) “Labor market regulations in low-, middle- and high-income countries: A new panel database”, IMF working paper, No. 11/154.

Botero, J, S Djankov, R La Porta, F Lopez-De-Silanes, and A Shleifer (2004) “The regulation of labor,” Quarterly Journal of Economics 119: 1339–1382.

Bris, A, and C Cabolis (2008) “The value of investor protection: Firm evidence from cross-border mergers,” Review of Financial Studies, 21: 605-648.

Chari, A, P Ouimet, and L Tesar (2009) “The value of control in emerging markets,” Review of Financial Studies, 23: 1741–1770.

Desai, M A, C F Foley, and J R Hines (2009) “Domestic effects of the foreign activities of US multinationals,” American Economic Journal: Economic Policy 1, 181-203.

Erel, I, R Liao, and M Weisbach (2012) “Determinants of cross-border mergers and acquisitions,”Journal of Finance, 67: 1031–1043.

Grossman, G, and E Rossi-Hansberg (2008) “Trading tasks: A simple theory of offshoring,” The American Economic Review, 98: 1978-1997.

Harrison, A, and M McMillan (2011) “Offshoring jobs? Multinationals and US manufacturing employment,” Review of Economics and Statistics, 93: 857-875.

Revenga, A (1992) “Exporting jobs? The impact of import competition on employment and wages in US manufacturing,” Quarterly Journal of Economics, 107: 255–284.

Rossi, S and P F Volpin (2004) “Cross-country determinants of mergers and acquisitions,” Journal of Financial Economics, 74: 277–304.

This article is published in collaboration with VoxEU. Publication does not imply endorsement of views by the World Economic Forum.

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Authors: Ross Levine is the Willis H. Booth Chair in Banking and Finance, Haas School of Business, University of California at Berkeley. Chen Lin is a Professor in Finance at Department of Finance, Chinese University of Hong Kong.

Image: U.S. one dollar bills blow near the Andalusian capital of Seville in this photo illustration taken on November 16, 2014. REUTERS/Marcelo Del Pozo.