Impact of excess cash reserves on M&A: Evidence from Europe

Abstract

PURPOSE OF THE STUDY: The amount of cash reserves in corporations has increased substantially over the years on a global scale. There are opinions that support hoarding cash in corporate stating that such action can save cost from raising expensive external capital. However, there are also opinions that high amount of cash reserves leads to agency problems and induces managers to take on value decreasing investments. I study the relationship between cash reserves and M&A activity in Europe to see if hoarding cash reserves is detrimental or beneficial for corporates.

DATA AND METHODS: My data collecting period is from 1995 to 2014. Mostly, I collect company financial information from Thomson One and deals information from SDC. First, I conduct normal cash model to determine the amount of excess cash reserves for each firm year taking into account the industry and firm's specific characteristics. Then, I use the probit models to see if excess cash reserves lead to higher probability of becoming a bidder or a target in M&A. Finally, I use panel regressions to see if M&A made by cash-rich firm is value increasing. In my models, first I study Europe as a whole and then I look into individual countries to examine the situation in each country.

RESULTS: For Europe as a whole, the results are not conclusive. High amount of excess cash reserves does lead to higher probability of becoming a bidder of a firm. However, the regression models cannot conclude if these investments are detrimental. The investments are only value-decreasing under the combined effect of high cash reserves and low investment opportunities. For individual countries, the picture is more clear. In France, Germany, Switzerland and Italy, managers tend to take advantage of cash reserves in a company as they are more likely to engage in M&A and the investments they make are value-decreasing. However, in United Kingdom, Denmark and Sweden, managers seem to hoard cash reserves for shareholders' benefits. They also more likely to engage in M&A but the investments they make add value for shareholders.