A new research paper entitled, “Institutional Cross-ownership and Corporate Strategy: The Case of Mergers and Acquisitions” by ICMA Centre academics, Professor Chris Brooks, Dr Yeqin Zeng, and former ICMA Centre PhD student Dr Zhong Chen, has recently been accepted by the Journal of Corporate Finance.
Previous studies have suggested that institutional ownership keeps growing in U.S. stock markets and has an important role in both corporate activities and stock prices. In this paper, we study institutional investors who hold stocks of both acquirers and targets before the announcements of mergers and acquisitions (M&As). In the context of M&As, these institutional investors are defined as “institutional cross-owners.”
Using the Tesla and SolarCity merger deal case from Thomson Reuters and the Wall Street Journal as an example, we observe that 45% of Tesla’s shareholders also hold the stock of SolarCity and three of the top five institutional investors of Tesla are also among the top five investors of SolarCity. Thomas Burnett, Head of Research at Wall Street Access commented that “This common ownership is something Tesla is going to take advantage of”. The article in the Wall Street Journal also expressed the view that large institutional cross-owners had “out-size influence on whether the deal goes through” especially when insider executives like Elon Musk, Lyndon Rive, Antonio Gracias all recused themselves from voting on the deal. Further, top investors like Fidelity even expressed their support for a “potential future partnership” between the two firms a long time before the deal announcement. Tesla’s CEO Elon Musk also admitted that “institutional shareholders had some idea of the plan (acquisition)”, and “this idea has been bandied about with some of our largest institutional shareholders. Yeah, there have been discussions”. The deal was finally approved by over 85% of unaffiliated shareholders. This example clearly shows that large cross-owners enjoy superior information through their active interactions with corporate management and their opinions are greatly valued by corporate management, thus proving a better monitoring role and they can wield their influence on the firm’s corporate strategies such as acquisitions.
Unlike non cross-owners, who only hold the stock on one side of a merger deal, cross-owners tend to make decisions from a broader perspective that nets off any potential losses from one side (usually the acquirer) with gains made on the other (usually the target) and will consider how the newly formed joint entity would sit within their portfolios compared with the two existing separate stocks. Therefore, cross-owners may have different information sets, different incentive structures and may make different choices than those that would have arisen for single stock holders of either acquirers or targets. Furthermore, institutional cross-owners may have an important governance role in the M&A process, reducing information asymmetry and mitigating the bargaining and transaction costs that would normally arise between entirely independent parties. Understanding whether and how institutional cross-ownership affects M&A decision making and deal outcomes are, by themselves, of particular importance.
In this paper, we provide new evidence on the important role of institutional investors in affecting corporate strategy. Institutional cross-ownership between two firms not only increases the probability of them merging, but also affects the outcomes of mergers and acquisitions (M&As). Institutional cross-ownership reduces deal premiums, increases stock payment in M&A transactions, and lowers the completion probabilities of deals with negative acquirer announcement returns. Furthermore, deals with high institutional cross-ownership have lower transaction costs and disclose more transparent financial statement information. The effect of cross-ownership on the total deal synergies and post-deal long-term performance is positive, which can be attributed to independent and non-transient cross-owners. Overall, our results suggest that the growth of institutional cross-holdings in U.S. stock markets may greatly change corporate strategies and decision-making processes.