Do investment banks create value for their clients? Empirical evidence from European acquisitions

• Date: 01 January 2019
• DOI: http://doi.org/10.1111/eufm.12144
• Published date: 01 January 2019

DOI: 10.1111/eufm.12144

ORIGINAL ARTICLE

Do investment banks create value for their clients?

Empirical evidence from European acquisitions

Johannes Kolb

University of Hohenheim, Department of

Corporate Finance, Wollgrasweg 49,

70599 Stuttgart, Germany

Emails: johannes.kolb@uni-

hohenheim.de; kolb.js@gmail.com

Abstract

Europe providesan interesting setting to explore the rolethat

investmentbanks play in acquisitions becauseit is composed

of countries with different legal regimes –the shareholder-

oriented common law regime in the UK/Ireland and the

stakeholder-orientedcivil law regime in ContinentalEurope.

Since investment banks are hired to act in the interests of

shareholders, and due to differences in disclosure require-

ments, market transparency, accounting standards, and

ownership between theUK and Continental Europe, I argue

that investment banks are relatively more important in

UK-only acquisitions. My findings support this conjecture.

KEYWORDS

corporate governance, Europe, investment banks, law and finance,

mergers and acquisitions

JEL CLASSIFICATION

G34, G38, G14, G24

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INTRODUCTION

Most firms are not frequent bidders, and many managers may lack the skills necessary to initiate and

execute value-creating acquisitions. Moreover, executives who decide to acquire another firm are

I thank the editor (John Doukas) and an anonymous referee for valuable feedback that substantially improved the paper.

I am grateful to Tereza Tykvová, Monika Gehde-Trapp, Robert Jung, Michael Howard, and participants of the finance

research seminar at University of Hohenheim in June 2016 for their helpful conversations and feedback. I also received

helpful comments from participants of the research seminar series at Texas A&M University in November 2016.

I gratefully acknowledge the access to SDC Platinum, Compustat, Capital IQ, and Datastream provided by DALAHO,

University of Hohenheim. I thank Peter Kessler for valuable research assistance.

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under high pressure, as this choice is important for the future of their firms, the shareholders, and the

executive’s career. In a successful acquisition, synergies may be created, whereas in an unsuccessful

one, the firm is led into financial, operational, and strategic difficulties, which might eventually lead to

bankruptcy (Bao & Edmans, 2011).

Little acquisition know-how might be one reason that many managers rely on intermediaries

experienced and skilled in executing acquisitions, namely, investment banks that act as financial

advisors. In terms of value, advisors were involved in approximately 75% of all European acquisitions

between 2000 and 2015. With fees of approximately 1% of the acquisition value

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(see, e.g.,

McLaughlin, 1990, 1992), this equals a fee income of about US$85 billion over the period. In terms of

number, European bidders employ advisors in 32% of all acquisitions. Servaes and Zenner (1996)

argue that advisors provide valuable services to their clients, because they reduce transaction costs,

information asymmetries, and agency costs. Advisors might be able to screen the market, identify

promising targets, negotiate favorable terms at a lower cost and more efficiently than bidders that

execute an acquisition without an advisor (in-house acquisition). Furthermore, as repeated players in

the acquisition market, advisors may be able to build up and maintain their reputation by offering

consistently high-quality services (Golubov, Petmezas, & Travlos, 2012). In opposition to this

theoretical proposition, there is ongoing debate in the empirical literature on the US market on the

question of whether advisors help bidders to create shareholder value and whether they are worth the

cost. While the bulk of the literature documents an insignificant or even negative association between

bidder value creation and either advisor involvement (Servaes & Zenner, 1996; Wang & Whyte, 2010)

or advisor quality (Bowers & Miller, 1990; Hunter & Jagtiani, 2003; Ismail, 2010; Michel, Shaked, &

Lee, 1991; Rau, 2000), only two studies report a positive relation between bidder value creation and

advisor quality (Golubov et al., 2012; Kale, Kini, & Ryan, 2003).

In contrast to the United States, Europe is characterized by different corporate governance and

regulatory regimes –most notably common law in the UK

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and civil law in Continental Europe (CE).

The UK is characterized by a market-based system that relies on case law and focuses on the effective

protection of shareholder rights. In CE, the blockholder-based system, which is based on codified law,

focuses on the protection of stakeholders such as creditors and employees (Goergen, Martynova, &

Renneboog, 2005; Martynova & Renneboog, 2011b). Specifically, in the UK, there are higher

disclosure rules, higher market and regulatory transparency, less concentrated ownership, better

developed stock markets, and better protection of minority and majority shareholders than in CE

(Djankov, La Porta, Lopez-de-Silanes, & Shleifer, 2008; Faccio & Lang, 2002; Goergen &

Renneboog, 2004; La Porta, Lopez de Silanes, & Shleifer, 1999; La Porta, Lopez de Silanes, Shleifer,

& Vishny, 1997, 1998; McCahery, Moerland, Raaijmakers, & Renneboog, 2002). Europe appears to be

an interesting testing ground to provide further insights into the role of advisors in acquisitions and to

analyze whether the value advisors create differs given different regimes.

I argue that advisors are particularly valuable in acquisitions in which the bidder and target are both

located in the UK. The shareholder-oriented system in the UK is run in the interests of shareholders

rather than in the interests of stakeholders of a corporation (Magill, Quinzii, & Rochet, 2015;

Martynova & Renneboog, 2011b). Proponents of the shareholder-oriented system believe in the

‘invisible hand’and argue that perfect markets and profit-maximizing agents are also in the best

interests of stakeholders (Magill et al., 2015). Moreover, shareholders have a sunk investment that they

lose in case of bankruptcy, whereas stakeholders such as employees can walk away relatively easily

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Source: SDC Platinum.

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UK includes Great Britain and Ireland.

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from the company in such a circumstance (Shleifer & Vishny, 1997). Based on a survey, Yoshimori

(1995) shows that 70.5% of managers in the UK and only 17.3% of managers in Germany state that a

company should be managed mainly by giving shareholder interests first priority. Since advisors are

hired by managers, shareholders, or the board (and not by stakeholders), their priority should be to

maximize shareholder value. This is in line with the academic view, as the literature proposes that ‘[...]

managers should use the same decision in choosing an investment banker as in all other corporate

decisions: by evaluating the impact on shareholder wealth’(Bowers & Miller, 1990, p. 34) and ‘[...]an

investment banker or some similar intermediary acting as a monitor for the collective interest of

shareholders [...]’(Easterbrook, 1984,p. 654). The common law regime in the UK, with rules that give

priority to shareholder interests, should allow advisors to effectively increase bidder shareholder value

in UK-only acquisitions.

In my sample of 2,969 inter-European acquisitions from the first quarter of 2001 to the third quarter

of 2015, advisors seem to be valuable, as they help bidders to create shareholder value on average.

When I compare advisor involvement in the UK with CE, the results suggest that advisors create

shareholder value for their clients when the bidder and the target are both located in the UK but not

when either party is located in CE. These results are economically nontrivial, as bidders using advisors

appear to create 1.13 percentage points higher cumulative abnormal returns (CARs) in UK–UK

acquisitions than bidders with advisors in CE–CE acquisitions. The difference translates into a higher

bidder CAR of US$25.19 million for a mean-sized bidder. The results seem to be robust to different

variable definitions and sample specifications as well as to potential endogeneity and causation

concerns. To address issues related to the endogenous choice to use an advisor in an acquisition, I use a

propensity score matching (PSM) and an instrumental variable (IV) approach. I construct the

instrument –percent advisor –in the spirit of Wang and Whyte (2010). This instrument captures the

frequency with which advisors are used by any bidder during the time leading up to the acquisition of

interest. Specifically, it reflects the percentage of the 20 acquisitions preceding a subject acquisition

where any bidder employed an advisor (these 20 acquisitions, sorted by their announcement date,

might be executed by different bidders). The underlying idea of the instrument is that if many bidders

use an advisor prior to the subject acquisition, this might serve as a justification for the CEO to use an

advisor for the current acquisition as well. I argue that this instrument satisfies both necessary

conditions to serve as a valid exclusion criterion.

The present study contributes to the literature in several ways. Empirical evidence on European

acquisition activity is limited, despite a massive increase in recent years. I extend the limited amount of

research that examines the European market after the end of the fifth takeover wave in the year 2001.

To my knowledge, no other studies –besides Humphery-Jenner (2012), Dissanaike, Drobetz, and

Momtaz (2016), and Drobetz and Momtaz (2016) –examine the European acquisition market after the

fifth takeover wave. Over the past 15 years, the European market has become as important as the US

market in terms of volume. In Figure 1, I depict yearly volumes of US and European acquisitions.

Aggregated acquisition activity in the United States between 2001 and 2015, at US$15.01 trillion, is

higher than that in Europe, at US$12.52 trillion. However, compared to the 1980s and 1990s, European

acquisition volume has come close to US levels. In 2007, acquisition activity reached higher levels in

Europe than in the United States.

This is the first study to examine the question of whether advisors help bidders to create shareholder

value in European acquisitions.

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Whether advisors matter for bidder value creation in acquisitions has

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Schiereck, Sigl-Grüb, and Unverhau (2009) analyze advisor quality in European acquisitions but do not address the

question of whether advisor involvement per se matters.

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