The Transparency Premium in China’s M&A Market

China’s Burgeoning M&A Sector

The researchers chose China to study the topic because of the rapid growth in its M&A sector on the back of continuous opening up market reforms, the loosening of regulations, advancement in technology, as well as general industrial upgrades. According to accounting firm PWC, the country recorded just shy of 13,000 M&A transactions in 2021, up 30 percent compared to 2017. Specifically, they looked at the stock market returns of companies which were on the purchasing end of M&A transactions, rather than the returns of the combined post-M&A entity, since most transactions in China involved the acquisition of private companies which were not traded on the major stock exchanges and for which pricing data was unavailable.

In conducting their research, Prof. Young and her co-authors focused on Chinese M&A data between the years 2006 and 2016. They analysed firms’ abnormal returns, which measures the difference between a stock’s actual and expected returns, surrounding over 2,000 M&A deals to see how this correlated against a basket of indicators related to firm transparency. They found that the level of transparency of a company’s disclosures was significantly and positively tied to the performance of its stock price around the time that it announces an M&A transaction. In economic terms, it found that a one-unit increase in transparency increased abnormal returns by 1.2 percent over a five-day period.

Investor Concerns Over Corporate Agency

Next, Prof. Young and her collaborators turned to looked at the reasons behind this link. The theory is that, in the absence of proper incentives and monitoring, a company’s senior managers may not always act in the best interests of shareholders, and this may manifest in the pursuit of M&A projects that enrich their personal wealth and destroy firm value.

On the other hand, when companies provide adequately transparent disclosures, it helps to inform shareholders when a firm’s managers undertake M&A that fail to add value and it reduces investor risk. When a company is more transparent around its disclosures, it also helps investors to choose corporate managers that are more competent and more likely to increase firm value.

They also reasoned that this “agency” problem would likely to be more severe in provinces with weaker institutional environments, characterised by factors such as less stringent investor protections or corporate governance standards. “Using the level of a province’s marketisation as a proxy for its institutional development, we found that this link between disclosure transparency and M&A returns was indeed more pronounced in provinces with a weaker institutional environment,” says Prof. Young.

Because the absence of a strong institutional environment may create incentives for firms to engage in value-destroying M&A, it becomes reasonable to expect investors to reward companies which were more transparent in disclosing information related to their M&A transactions, she adds.

“What the study results tells us is that investors in China are significantly concerned about agency problems in the M&A process, and that they look at the level of transparency in disclosures as a potential solution,” Prof. Young says.

The Effects of Institutional and State Ownership

They also found that this link between M&A disclosure transparency and stock market performance was stronger for firms with lower institutional investor ownership. Institutional investors, who are typically better informed and have more resources at their disposal than retail investors, are considered a positive influence on a firm’s corporate governance practices and help to reduce agency problems.

Finally, the researchers looked at the strength of this link for state-owned enterprises, which were generally considered more prone to agency problems. State-owned firms are considered more informationally “opaque” than the rest of the market because they lack strong market-based incentives to release a steady stream of credible information, but all the while they enjoy privileged access to capital as well as business opportunities.

Consistent with the study’s other findings, it found that, compared to companies that were not stat-owned, this informational transparency effect was more pronounced for state-owned enterprises on the buying side of M&A transactions.

Commenting on the study, Prof. Young notes that the findings are likely to be relevant to other emerging markets with institutional characteristics similar to those of China. “Our results also provide insights to international investors and regulators, as China continues to open up its market and as Chinese firms expand rapidly and grow around the world,” she says.