Cherry Picking in Cross-Border Acquisitions

Abstract

This paper attempts to explain the tendency of foreign acquirers to choose better performing firms in emerging markets, which limits underperforming firms’ access to foreign capital. Using a simple law and finance model, we offer an explanation based on emerging countries’ weaker investor protection (IP) compared to acquirers’ home countries, predicting a positive relation between the gap in the strength of IP (between acquiring and target countries) and the intensity to cherry pick. To test this prediction, we identify among our sample countries 20 economies that enacted major corporate governance reforms (CGRs). These CGRs change the gap in IP between an acquirer and a target country in a staggered fashion, enabling us to estimate differences-in-differences. Estimation results reveal that cherry picking moderates after a target country undertakes a CGR, which narrows the IP gap. Conversely, cherry picking intensifies after an acquirer’s home country enacts a CGR, which enlarges the IP gap. These results imply emerging economies must strengthen investor protection if they want to increase underperforming firms’ access to foreign capital.

Keywords: Investor Protection, Corporate Governance Reforms, Target Selection, Private Benefits of Control, Control Premiums

JEL Classification: F21, G34, K22