Exchange rates and cross-border mergers and acquisitions. Does the relationship still apply in today’s integrated markets?

Master's Thesis, 2014

69 Pages, Grade: Distinction


Table of contents

1 Introduction

2 Switzerland
2.1 R&D-intensive economy
2.2 Export leaders
2.3 Strong currency

3 Literature Review
3.1 The traditional view
3.2 The contemporary views
3.2.1 Asymmetries and imperfections in capital markets
3.2.2 Costs and imperfections in the factor markets
3.2.3 Costs and imperfections in the good markets
3.3 Research hypotheses

4 Data and methodology
4.1 Swiss acquisition FDI in the US and UK – An overview
4.2 Sample description
4.2.1 Dependent variable
4.2.2 Independent variables
4.2.3 Summary of samples
4.3 Methodology
4.3.1 Regression equations
4.3.2 Poisson model
4.3.3 Negative Binominal model
4.3.4 Random Effect Negative Binominal model

5 Results
5.1 Descriptive statistics
5.2 Empirical results
5.2.1 Swiss acquisition FDI in the US
5.2.2 Swiss acquisition FDI in the UK
5.2.3 Control variables
5.3 Summary of findings
5.4 Limitations and recommendations

6 Conclusion

7 References

8 Appendix

Table of Figures

FIGURE 1 – Bilateral M&A, Switzerland, US and UK

FIGURE 2 – Country expenditure on R&D

FIGURE 3 – Innovation Performance in Europe

FIGURE 4 – Bilateral Exchange Rates CHF

FIGURE 5 – Real exchange rate-M&A link, Switzerland, US and UK

FIGURE 6 – Swiss domestic & cross-border M&As in manufacturing industries

List of abbreviations

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The link between exchange rates and foreign direct investment is one that has caused for much discussion. Blonigen (1997) publishes one of the most influential papers and suggests transferable assets being the most important factor behind this relationship. He argues that when the real value of an acquirer’s currency increases, this acquirer will be able to purchase a foreign target cheap. Due to the nature of transferable assets, foreign acquirers will be able to generate returns from them in other currencies than the one used for the purchase. This bypasses the tradition economist’s view of purchasing power parity. One paramount condition exists in order for this link to hold: segmented markets between acquirers and targets.

We rerun Blonigen’s model to test his theory between integrated markets, as Georgopoulos (2008) suggests possible. Using industry-specific data at the three-digit NAICS 07 level, we empirically test our hypotheses with discrete dependent variable models. Testing for the link between real exchange rates and Swiss cross-border M&As in manufacturing industries in the United States and the United Kingdom for the years 1996-2013, we find no evidence for Blonigen’s firm-specific asset acquisition theory. We confirm that no relationship for low research and development manufacturing industries is evident, in line with Blonigen’s theory, whilst also no correlation is found for high research and development manufacturing industries for the studied country pairs, in the given observation period. Our findings lead us to conclude that the link between exchange rates and acquisition FDI no longer applies for integrated markets.

Moreover, we find evidence in our samples for Harris and Ravencraft’s (1991) theory that M&As in R&D-intensive industries happen more often on a cross-border basis, than on a domestic basis.

1 Introduction

“One plus one makes three;” this is the blunt philosophy behind mergers and acquisitions (M&A) (McClure, 2014). The process of an M&A entails one firm merging with or buying another firm. The main objective is always the same: creating shareholder value over and above that of the two separately trading firms. This can be achieved through economies of scale, scope and learning, increased market share and reduced volatility of earnings[1]. Cross-border M&A follows the same procedure but differs to national transactions in that a domestic company is looking to merge with (acquire) a foreign company (target). An acquisition usually involves a target much smaller than the acquirer, which is bought to satisfy inorganic growth, whilst a merger typically involves two similar sized companies. The IMF (2001) defines acquisitions as a purchase of more than 50 percent equity in foreign companies; this is the statistical reference we will use throughout this paper.

Foreign Direct Investment (FDI) is the action taken by foreign companies and individuals investing directly into the production and business of a country. FDI activity comprises brown field FDI, also known as cross-border M&A, and green field FDI, where the latter is defined by a multinational enterprise (MNE) starting a completely new venture in a foreign country from the ground up. Over the past two decades, these have caused for much discussion with regards to FDI trends[2].

Nominal exchange rates are the prices of currencies expressed in the values of other currencies (Fama, 1984). Herewith, exchange rates have two components: the domestic currency and the foreign currency. As may be evident, strength fluctuations between the two may have a substantial impact on a country’s inward and outward trade. Simply put, when country X’s currency becomes expensive in terms of country Y’s currency, country X’s goods and services will do so too, for currency Y holders. This usually leads to less export from country X to country Y. Simultaneously, this would imply that goods and services abroad should be cheaper than when acquired domestically. Indeed, this phenomenon is called the wealth effect (Malatesta, 1983) and causes people to feel richer, incentivising them to spend more as the value of their assets rise. Research has shown, companies take advantage of this when acquiring foreign targets.

Deeply engrained in the literature of FDI can be found its relationship to exchange rates[3]. Scholars such as Froot and Stein (1991), Klein and Rosengren (1994) and Blonigen (1997) have set milestones in this literature and come up with various theories about the origin of the relationship. Froot and Stein have by far written the most cited paper on this topic and argue that the existing link between FDI and exchange rates originates from imperfect capital markets. Klein and Rosengren build on Froot and Stein’s theory, but believe that their findings could also stem from the relative wage effect. No evidence was found for FDI seeking relatively cheap labour; Froot and Stein’s relative wealth theory prevailed. Blonigen, having published the more recent paper, argues differently again, and believes that the inherent link exists only with acquisition FDI, the driver being firm-specific assets (these are particularly often found in research and development (R&D) intensive industries). He states that foreign acquirers primarily target these when the target country’s currency is weak. He reasons that these assets can generate returns in other currencies than the one used for the purchase, which hence leads to an advantage over domestic acquirers and an increase in inward cross-border M&A activity.

While extensive research has been done in the field, the link between cross-border M&A and exchange rates specifically is one that has rather been neglected. The majority of theoretical and empirical research has focused on inward FDI only and the corresponding weakness of the associated country’s currency, the United States of America (US) typically being the grounds of research. It seems that less attention was paid to the actual country being researched, but rather if data would be available for the empirical analysis. Furthermore, Blonigen states that the relationship between acquisition FDI and exchange rates can only hold if the countries in question have segmented markets. In other words, an “imperfect goods market” must be present. Many studies have not made a difference of this in their empirical work, possibly being one of the reasons which have led to mixed results. According to Georgopoulos (2008), this shouldn’t matter, as he presents evidence for the firm-specific asset acquisiton theory to hold also for integrated markets. This leaves an open question in the field. Additionally, a large portion of the research only looks at five to ten year observation periods at a time. Often these observation periods were placed before the millennium, where growth in FDI was substantial due to the general consolidation of industries[4]. Studies as such lead one to believe that the associated results have potentially fallen victim to bias.

Considering the above, we choose to focus on Switzerland as our research platform. Switzerland offers several interesting characteristics advantageous for our study, including a strong economy, a unique manufacturing industry and, most importantly, an associated presence of R&D activity comparable to few other countries. Further, acting upon the controversy between the papers from Blonigen and Georgopoulos, we shall test whether the link between real exchange rates and cross-border M&A still holds within integrated markets. We test this relationship between the country pairs Switzerland-US and Switzerland-UK, making Switzerland the acquirer in both scenarios (evidence is found that both manufacturing market sets are highly integrated - FIGURE 1). A contemporary dataset covering 18 years will be used for our research, ranging from 1996 to 2013. Our aim is to create the best conditions in order to test if Blonigen’s firm-specific asset acquisition theory still holds in today’s markets and, henceforth, answer the question if companies in R&D-intensive industries are more likely to be targets when real exchange rates are favourable for foreign acquirers. We will herewith be bridging a gap in the exchange rate and FDI literature.

This study is built up in the following way: section two explains our choice for Switzerland as ground of research for our study; section three covers the most relevant literature on the link between exchange rates and FDI, focusing on acquisition FDI, and introduces our research hypotheses as relevant; section four defines our data samples and methodologies; section five unfolds the results of the methods applied, describes our robustness checks, and evaluates the validity of our hypotheses; section six concludes on our findings.

FIGURE 1 – Bilateral M&A, Switzerland, US and UK

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Source: Data on M&A deals is retrieved from Thomason One SDC (2014) - Evidence for integrated markets in the manufacturing sector between Switzerland, the US and UK: bilateral acquisition FDI activity.

2 Switzerland

Switzerland is a very unique country in terms of its economy, and currency, the Swiss Franc. There is reason to believe that several factors within these have contributed to the recent increase in cross-border M&A activity (Kuhn, 2012). In particular, we believe their R&D-intensive economy, being a world leader in exporting and an ever-strengthening currency against most world currencies, are potentially strong drivers. We elaborate on these below.

2.1 R&D-intensive economy

Due to its political stability and long-term monetary security, Switzerland counts itself among one of the few safe refuges for investors. In terms of gross national income (GNI) per capita, Switzerland has achieved one of the highest (No. six) in the world (World Bank, 2013), whilst holding one of the lowest unemployment rates with 3.1 percent (SECO, 2011). Industry and trade are the sources of its success, which are spread in the following manner: services (71%), industry (27.7%), and agriculture (1.3%) (BFS, 2014). In contrast to most western countries, Switzerland has not built its economy on mass production, but strives in the niche of quality. Highly skilled workforce and high quality products prevail in a country where even small companies have established themselves worldwide in their niche disciplines (Couchepin, 2012). In order for Swiss products to command their premium price, a strong emphasis on R&D is necessary. In 2008, over 2.2 percent of gross national product (GDP) was spent on research by Swiss companies, twice as much as the EU27 average (1.1 percent) (World Bank, 2014). This makes Switzerland one of the leading countries in this regard after Israel, Sweden, Finland, Japan and Korea (FIGURE 2). Switzerland is also Europe’s innovation leader (FIGURE 3) (Innovation Union Scoreboard, 2014). This is primarily related to it having registered the highest amount of patents per capita among industrialised countries (World Bank, 2014).

FIGURE 2 – Country expenditure on R&D

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Source: Wordbank (2014) - Government and Business expenditure on R&D in 2008 as a percentage of GDP.

FIGURE 3 – Innovation Performance in Europe

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Source: Innovation Union Scoreboard (2014)

Harris and Ravenscraft (1991) found that acquisitions of targets in R&D-intensive industries happen more often in cross-border, than in domestic M&As. This leads one to believe that cross-border M&A initiated from Switzerland should show this relationship even clearer, if one does exists. Harris and Ravencraft found that in 75 percent of the time the acquirer and the target, in cross-border M&As, are in the same industry. Even though Switzerland is not the largest of countries, with a population of around 8 million (BFS, 2014a) and a GDP of $693.5 billion (IMF, 2014), the above should ensure for clear results in our research. We will be running a robustness test, applying these scholars’ theory, to check if R&D-intensive firms really are targeted more than firms with low R&D.

2.2 Export leaders

Swiss exports amount to $308.4 billion (2012) and primarily comprise goods from the machinery, chemicals, pharmaceuticals, metals and watch industry (Swissworld, 2014). This amounts to almost half the country’s GDP output. Chemicals, pharmaceuticals, and mechanical and electrical engineering alone, are responsible for over half of this revenue. In some industries, up to 90 percent of produced goods are exported. Switzerland’s main export partners are Germany (18.5%), United States (11.6%), Italy (7.6%), France (7%) and United Kingdom (5.7%) (2013 est.) (CIA, 2014).

Switzerland has strived in periods of internationalisation by marketing its goods cross-borders. Responsible are primarily the 1990s and the years after the change of the millennium (Wagner, 2007). Transaction cost literature suggests that an increase in exports will, in the long run, give rise to an increase in tariffs charged by importers. Importing countries do this in order to safeguard their own industries. This again leads to an increase in FDI, which allows to bypass these tariffs[5]. In line with Wagner’s this literature, we argue that the extensive amount of exports produced by Swiss industries is a potential contributor of domestic cross-border M&A. To test this, we will add a control variable for tariffs to our regression.

2.3 Strong currency

The Swiss Franc has experienced an increase in its value over the past 18 years against all major currencies (FIGURE 4).

FIGURE 4 – Bilateral Exchange Rates CHF

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Source: World Bank (2014a) – These graphs show the bilateral exchange rate movement, on average per year, between the Swiss Franc and the US Dollar, Euro, British Pound and Japanese Yen, respectively.

Switzerland is rich in quality products and services industries, as discussed above. A high degree of R&D intensity needs highly qualified workforce. This need for human workforce can be outsourced to countries with weaker currencies than the Swiss Franc, as Blonigen suggests, in order to lower costs and increase profitability. As he argues that returns do not have to be in the same currency as used to purchase a foreign target, one could derive that an increase in the real value of the Swiss Franc, in relation to a target country’s currency, should lead to an increase in acquisition FDI into that country. Our aim is to find out if this unique currency has been a major determinant of the increasingly developing outward cross-border M&A activity in Switzerland.

3 Literature Review

Over the years, various scholars have tried proving the link between exchange rate movements and FDI flow; often with mixed results. Different motives have been attached to this relationship, amongst which imperfect capital markets, imperfect factor markets and imperfect good markets are the most robust. The first and last are explained through economic theory by their authors. On the other hand, the traditional economics view rejects such link. Investments are valued according to their return. This suggests that if the value of that return decreases too, because of currency fluctuations, no advantage can be gained from the purchase of “discounted” foreign assets. This section of our study will go over some of the existing theoretical and empirical literature on the link between exchange rates and acquisition FDI. We cover the traditional view, as well as the more contemporary views of the field and explain why a new study is needed to answer some left-open questions. Particularly, a gap in the literature is present between Blonigen’s (1997) and Georgopoulos’s (2008) papers as shall be explained below. Once the relevant theories have been introduced, our research hypotheses emerge. These are tested empirically.

3.1 The traditional view

The traditional economics view, taken by most economists, states that a correlation between exchange rate movement and acquisition FDI between two countries is non-existing. As introduced above, it is not the actual price of the asset that should matter in a valuation, but the nominal return on the asset. Creating a hypothetical scenario using the Swiss Franc and a US asset to explain this, we assume the Swiss France increases in nominal value against the US Dollar. We should now be able to buy more of a US asset for the same price it cost us earlier to buy less of it. Even though more of the US asset was bought, the return on this augmented amount does not change in terms of Swiss Francs. The depreciation of the US asset in terms of Swiss Francs, also led to a depreciation of its returns. No advantage can be gained over a domestic acquirer. As McCulloch (1989, p. 188, as cited in Froot and Stein (1991)) states:

“If a U.S. asset is seen as a claim to a future stream of dollar-denominated profits, and if profits will be converted back into the domestic currency of the investor at the same exchange rate, the level of the exchange rate does not affect the present discounted value of the investment.”

The theory behind this phenomenon is the purchasing power parity (Dornbusch, 1985). This one states that in the long run, a basket of goods in one country will cost the same than in any other country, once taking the exchange rate into account. Whilst this remains the economist’s view, numerous scholars have shown otherwise and proven this empirically.

3.2 The contemporary views

Several papers have discussed the exchange rate-FDI link. Within these, two theoretical explanations arise: asymmetries and imperfections in capital markets, and costs and imperfections in product markets.

3.2.1 Asymmetries and imperfections in capital markets

Before the change of the millennium, Froot and Stein’s (1991) model was considered the highpoint of the exchange rate and FDI link literature, having proposed the first theoretical explanation for the relationship. Their theory states that a currency advantage allows foreign acquirers to have more internal capital available to them. This relative wealth increase, henceforth permits them to leverage a higher acquisition price for a target company than domestic acquirers. This again increases the foreign acquirer’s chances for the deal and reduces it for the domestic acquirer, leading to an increase in acquisition FDI when a country’s currency is experiencing a low.

Their theory is based on the assumptions that in an acquisition, the acquirer will always be in need of external capital, having to finance some of the funds internally, nevertheless. (Firms find it hard to finance 100 percent of an acquisition externally due to information asymmetries present in the acquisition of a firm and the associated risk. This would be too costly.) Interest rates are assumed to be equal around the world. Assuming the percentage of external finance available in relation to internal funds remains the same, a relative decrease in the target currency allows for a higher purchasing price threshold and increases the chance of the foreign acquirer winning the bidding war for the US target. The US acquirer’s purchasing price threshold doesn’t change, due his wealth being in the form of the domestic currency, the US dollar.

Other scholars have found ambiguous results, running the same regressions as Froot and Stein. Particularly, Stevens (1998), who used Froot and Stein’s identical observation sample, split the data into sub-samples in order to check if the same correlation was still found between exchange rates and numbers of M&As. Their results failed to find any significant relationship.

3.2.2 Costs and imperfections in the factor markets

Through the 1980s and 1990s, another explanation arose: imperfect factor markets. This theology revolves around the cost of labour and assumes that all foreign companies will primarily want to locate in countries where labour is cheap. The relative wage effect, as it has been named in various literature, states that, ceterus paribus, capital follows cheap labour as long as productivity is not affected and transaction costs don’t overweigh profits. Exchange rates are considered of paramount importance in this event. As Klein and Rosengren (1994) explain, a depreciation of a domestic currency should make production for foreign acquirers attractive and cause an increase in FDI into the country. Cushman (1985) and Culmen (1988) have both proven this empirically. Nevertheless, Klein and Rosengren come to the conclusion that the relative wage effect is often assumed, finding actual results for the relative wealth effect. Through an empirical study, they prove the non-existence of the relative wage effect in acquisition FDI, and find evidence for the relative wealth effect instead. Foreign acquiring firms may include low labour costs into their evaluation, but it is certainly not at the pinnacle of their priorities in choosing where to allocate their capital in general.

3.2.3 Costs and imperfections in the good markets

In the late 1990s, discussion arose on firm-specific assets and their relevance to acquisition FDI. The idea that certain domestic assets could be worth more to foreign companies than to domestic companies proved to leave extensive previous research about the determinants of FDI in its shadow. Market imperfections, spill-over effects and economies of scales are considered the most contemporary drivers of FDI (Harris and Ravenscraft, 1991). According to the underlying theory, particularly research and development (R&D) intensive industries, with a high degree of transferable goods, are considered good candidates for takeovers by foreign companies (Blonigen, 1997). Several good reasons underline this: R&D creates barriers to entry and competitive advantage; technology transfers are complicated and are most efficient through corporate takeovers; the acquisition of R&D-intensive companies may yield rewarding profits as fixed costs can be spread over several markets in which a multinational enterprise (MNE) will inevitably be operating in (Harris and Ravenscraft, 1991).

In 1997, Blonigen published his “firm-specific assets and the link between exchange rates and foreign direct investment”, through which he revolutionised the way one should look at the relationship between exchange rates and FDI, but more specifically acquisition FDI. Blonigen criticises Froot and Stein’s paper, having not distinguished between the different types of FDI. This is surprising, he states, as even their empirical results present evidence that different forms of FDI responded differently to fluctuations in exchange rates. He argues that the reason why Froot and Stein’s results found evidence for the link with general FDI is because the majority of FDI, at the time, was acquisition-specific due to the consolidation of industries.

Blonigen’s firm-specific asset acquisition theory brings forward that exchange rate movements are not linked to FDI in general, but specifically to cross-border M&A activity instead. He clarifies this by explaining that foreign firms, established in segmented markets from the target market, enjoy opportunities in which they can generate returns on transferable assets over that of domestic firms, and in different currencies. This leads to a higher valuation of the asset as it bypasses the traditional valuation method (discounted value). Blonigen portrays this using a Japanese and an American acquirer looking to buy an American target. He describes how the Japanese firm is able to make more use of the transferable asset, being able to harvest returns in his own currency by transferring the asset to his own market. The scholar’s empirical study confirms: Japanese acquisition FDI increases solely in R&D-intensive industries in the US when the US dollar is experiencing a relative low to the Yen.

In 2008, Georgopoulos questions Blonigen’s requirement of “segmented markets” in order for his firm-specific asset acquisition theory to hold. Georopoulos believes that such is not necessary, arguing that multinational enterprises will be looking to exploit valuable transferable assets nevertheless, also in integrated markets. In line with Blonigen’s paper, he finds evidence for the link between exchange rate movements and the probability of cross-border M&A activity, but only in R&D-intensive industries. Additionally, he finds evidence that the relationship holds for “non-segmented” markets by finding his significant results between Canada and the US, for the observation period 1985-2001.

3.3 Research hypotheses

Now, one needs to take a step back. Even though Georopoulos claims to have found evidence for Blonigen’s link between integrated markets, his observation period suggests this conclusion may be biased. Riwe (2013) criticises Georgopoulos’s paper on this particular point as he claims that the scholar’s observation period is likely to start with a degree of market integration far lower than that of at the end of the period. The period of analysis (1985-2001) was still considered a period of substantial FDI growth (Andrade, Mitchell and Stafford (2001). Riwe himself used a data sample ranging over seven years, which, is our opinion, is too short to be forming a decisive conclusion over. Due to this unsolved gap in the literature, we make it our work to test if Blonigen’s 1997 theory of firm-specific transferable assets still holds in today’s international and integrated markets. Due to our study focusing on cross-border M&As from Switzerland to the US and the UK, between 1996 and 2013, the following hypotheses emerge:

Switzerland acquiring in the US

A. Industry-specific exchange rate movements (real) between the Swiss Franc and the US Dollar are not correlated in any particular way to the number of Swiss cross-border M&As in low R&D manufacturing industries in the US.

B. Industry-specific exchange rate movements (real) between the Swiss Franc and the US Dollar are highly positively correlated to the number of Swiss cross-border M&As in R&D-intensive industries in the US.

Switzerland acquiring in the UK

C. Industry-specific exchange rate movements (real) between the Swiss Franc and the British Pound are not correlated in any particular way to the number of Swiss cross-border M&As in low R&D manufacturing industries in the UK.
D. Industry-specific exchange rate movements (real) between the Swiss Franc and the British Pound are highly positively correlated to the number of Swiss cross-border M&As in R&D-intensive industries in the UK.


[1] See Eun, Kolodny and Scheraga (1996); Seth, Song and Pettit (2002); Lowinski, Schierack and Thomas (2004)

[2] Calderón, Loayza and Servén (2004) explain how the 1990s brought with it a rise in FDI due to the extensive privatisation of public enterprises. This meant that investment was primarily taking place in the form of cross-border M&A, which grew a lot more rapidly than investment in the form of green field FDI. See Nocke and Yeaple (2007) and Stepanok (2010) for further discussion.

[3] See Froot and Stein (1991); Harris and Ravenscraft (1991); Klein and Rosengren (1994); Dewenter (1995); Blonigen (1997); Kiymaz (2004); Blonigen (2005); Erel, Liao and Weisbach (2012); Lin, Officer and Shen (2013)

[4] See Andrade, Mitchell and Stafford (2001) and Holmstrom and Kaplan (2001)

[5] See Williamson (1979); Hennart (1988); Brouthers and Brouthers (2000)

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Exchange rates and cross-border mergers and acquisitions. Does the relationship still apply in today’s integrated markets?
University of St Andrews  (School of Economics and Finance)
MSc Finance
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ISBN (Book)
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mergers and acquisitions, Mergers, Acquisitions, M&A, FDI, Foreign Direct Investment, Foreign Direct Investments, FDIs, Brown Field Investments, Green Field Investments, Real Exchange Rates, Exchange Rates, Transferable Assets, Intangible Assets, Research and Development, R&D, R&D Intensive Takeovers, Manufacturing Industry, M&A in Manufacturing Industry, FDI in Manufacturing Industry, Industry specific M&A, Manufacturing Takeovers, Swiss market, US market, UK market, Swiss M&A, US M&A, UK M&A, Swiss cross-border M&A
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Marc Waldhof (Author), 2014, Exchange rates and cross-border mergers and acquisitions. Does the relationship still apply in today’s integrated markets?, Munich, GRIN Verlag,


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