Is Cheaper Always More Attractive? Target Attributes and the Gains from Acquisitions in Different Legal Environments

Previous U.S. M&A studies have shown that the acquisitions of under-performing firms by well-performing firms generate greater synergies; however this is inconsistent with the well-documented “Cherry Picking” behavior of foreign investors in emerging markets. This paper develops a theory within the “law and finance” framework to explain this puzzle. First, highly profitable firms will self select better corporate governance, and this evidence is stronger in weak investor protection countries. So, in weak investor protection countries, acquiring a well-performing target firm requires the acquirer to pay smaller control premium relative to the underlying value of the traded equity shares. Second, acquiring well-performing target firms generates greater post-acquisition performance by avoiding a large amount of restructuring, which is more costly in weaker legal environments. Consequently, acquiring well-performing target firms can generate greater synergies in countries with weak legal environments; however the opposite is true in countries with strong legal environments. The model is confirmed by data on U.S. firms’ acquisitions in 37 countries after accounting for endogenous matching, country heteroscedasticity, endogeneity and sample selection bias.