How Do Firms Choose Financial Advisors in Mergers and Acquisitions and Why Do They Switch?

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1 How Do Firms Choose Financial Advisors in Mergers and Acquisitions and Why Do They Switch? Bill Francis * Iftekhar Hasan Xian Sun May, 2006 * Corresponding author: Bill Francis, Francb@rpi.edu, Professor of Finance of Lally School of Management, Rensselaer Polytechnic Institute. Lally School of Management, Rensselaer Polytechnic Institute, 110A 9 th Street, Troy, NY, 12180, Iftekhar Hasan, Professor of Finance of Lally School of Management, Rensselaer Polytechnic Institute, hasan@rpi.edu, (518) ; sunx4@rpi.edu, (518) , (518) (O). Please do not quote without notifications to the authors.

2 Abstract This paper investigates the choice of financial advisors of corporations and the importantly factors associated with regard to the decision of retaining them or switching to different intermediaries during the life cycle of corporations. Specifically, I examine whether an acquiring firm s previous relationship with an investment bank correlates with its announcement abnormal returns and whether this relationship impacts the likelihood that the investment bank will be used as a financial advisor in a subsequent M&A transaction. I divide a sample of M&As conducted by US firms over the period of into three groups based on their activities prior to the focal M&As: (1) a group of acquiring firms that had only issued equity (ies) within five years prior to the announcement date; (2) a group that had only conducted M&As within five years prior to the announcement date; and (3) a group that had conducted both activities within five years prior to the announcement date. For firms in the first group that had only issued equity (ies), I find that on average they experience positive and significant abnormal effects due to the M&A announcement but those who retain their previous equity underwriters experience significantly lower abnormal returns in stock paid transactions; and that the previously related underwriters can solicit subsequent M&As successfully by providing more optimistic recommendations if it is the first time for their client firms to conduct a M&A in five years. In contrast, for firms from both the second and third group that had conducted M&As repeatedly within five years prior to the announcement, acquiring firms experience positive and significantly higher announcement effects if they stay with the same financial advisors in all the M&As that they had conducted; and it is the previous M&A announcement effect that increases the likelihood that acquiring firms choose prior related financial advisors again in current transactions.

3 1.1 Introduction U.S. firms have experienced a period of merger and acquisition (M&A thereafter) mania over the last two decades. The total transaction value of M&As in the U.S. increased from $243 billion in 1984 to its peak of $1,788 billion in 1999 (Securities Data Corporation, Mergers and Acquisitions Database -SDC thereafter). A common characteristic of most of these transactions is that they are usually conducted with a financial advisor. For instance, financial advisors were used in over 82% (See Figure 3-1) of M&As over the 1984 to 2003 time period. 1 An interesting aspect of M&As is that there seems to be little loyalty on the part of acquiring firms in retaining financial advisors that they had previously used in M&As transactions. For example, in the sample of 619 U.S. public firms that conducted M&As repeatedly from 1985 to 2003, only about 15% of them retained the same financial advisor(s) for their M&A transactions. This high switching rate is puzzling given the arguments of Rajan (1992) and James (1992) among others, that by developing a lasting bank-client relationship more effective and efficient services can be provided to the client. Thus, the question remains why there is such a high preponderance of the switching of underwriters in M&As? Is it the case that the benefits of changing financial advisors outweigh the benefits from a lasting bank-client relationship? In this paper I focus on the choice of financial advisors in M&As. Although the theoretical and empirical literature on M&As is vast, little of this literature focuses on the role of investment banks in these transactions and the evidence coming from this literature is mixed as to their importance. Bowers and Miller (1990) find that the choice of first-tier investment banks has a positive impact on the total wealth gained at the announcement. Servaes and Zenner (1996) find that financial advisors are more likely to be used when the transaction is more complex, the acquirer is less experienced, and the target is more diversified and publicly traded. Given that acquiring firms decide to Figure 0-1 The M&A Transactions from 1984 to 2003 and the Use of Financial Advisors 1 Securities Data Corporation: league table.

4 Transaction Value($bil.) US M&As from 1984 to , , , , , , With Financial Advisor Without Financial Advisor Data source: Own elaboration from SDC database use a financial advisor in M&A, whom to choose and whether and how the choice matters is still a puzzle. Interestingly, they present evidence indicating that the reputation of investment banks does not impact the announcement effects in M&As. Kale, Kini and Ryan (2003) find support for the notion that it is the relative reputation of financial advisors between acquiring firms and targets that matters. In this paper I try to fill this void by examining the nature of the advisor-client relationship to answer the following questions. Does the choice of financial advisors matter in terms of acquirers announcement effects? Do deals in which the financial advisor had a previous relationship with the acquirer create more value? Does the type of activity in which the financial advisor was involved (equity issuing or M&A) impact the announcement period returns? Does previous relationship increase the likelihood of being retained? Are financial advisors who are involved in value-destroying M&As more likely to be replaced in following deals? Does being proactive in terms of providing other investment banking services such as optimistic analysts forecasts increase the likelihood of being hired or retained? I believe that whether the choice of financial advisors matters is worthy of further investigation. The extant literature focuses on the reputation of hired financial advisors and examines whether it affects the announcement effects of M&As. However, the reputation of financial advisors may be just one of many other factors that determine

5 acquiring firms choice. For example, studies that examine the firm s choice of underwriters in equity issuings find that firms retain investment banks if they have had a satisfying experience with them (Ljungqvist and Wilhelm, 2004); and firms may choose investment banks for a particular service, such as better analyst coverage (Krigman et al, 2001; Burch et al, 2005). The existing literature in M&As also share the common assumption that the choice of which financial advisor to use is completely at the discretion of acquiring firms managers. However, it is possible that if investment banks are proactive, then this choice could be influenced significantly by the investment bank(s), a possibility that has not been previously explored in the M&A literature. The proactive side of investment banks has been cited and commented on by Business Week magazine as far back as in as one of the underlying factors in the M&A wave that started during this time period. There is reason to suspect the solicitous side of investment banks given the significant amount of fees that they received during the last two decades. Figure 0-2 The Rise of Investment Banking Industry with the M&A Waves $million The Rise of Investment Banking Industry with M&A Waves $billion 300, , , , ,000 50, ,000 1,800 1,600 1,400 1,200 1, Revenue($million) TransactionValue($billion) Data source: own elaboration based on data from SDC and SIA 2 There s been steady movement away from the traditional role as counselor toward activity initiated by the investment banker himself (Business Week, Nov 24, 1986, p.77).

6 Figure 3-2 presents the total revenue of investment banking industry from 1984 to 2003, which is denoted by the left side vertical axis and the total value of M&A transactions from 1984 to 2003, which is denoted by the right side vertical axis. There appears a close and positive correlation between the rise of the investment banking industry measured by size and the M&A waves. Figure 3-3 presents the estimated amount of revenue that investment banks received from the M&A advisories and the amount of revenue received from the underwriting activities from 1984 to There is a clear trend that M&A advisory fees have become an important revenue sources for investment banks due to the M&A waves, especially in 90s. Figure 0-3 Revenue Sources for Investment Banks Revenue Sources for Securities Industries ($mil.) estimated M&A Revenues($MIL) Equity Underwriting Revenue Data source: own elaboration based on data from SDC and SIA Ellis et al. (2004) analyze the supply side of investment banking activities in equity underwriting. They find that investment banks are very proactive in their drive to acquire business and therefore revenues. Given that M&As activities contribute significantly more revenues than equity offering activities during the M&A mania period, 3 it stands to reason that investment banks are at least as proactive in these 3 The estimated amount of revenues coming from M&A advisory fees has increased from $1.5 billion in 1984 to its peak of $ 15 billion in Even the Securities Industry Association (SIA) has the number of how much revenue is from advisory fees in M&A for investment banks, since it is reported in the category of revenues from other investment banking related business. I estimated the revenue from M&A

7 activities as they are in equity offerings. If investment banks do act proactively in M&As, then it may be the case that they may be more concerned with completing the deal than with providing advice that would be within shareholders best interest (Kisgen et al., 2005). Furthermore, as shown by Rau (2000) investment banks are not concerned about completing bad deals thereby damaging their reputational capital because their market share is not impacted by the results of the services provided. To examine whether the choice of financial advisor(s) affects announcement period abnormal returns and whether investment banks that are more proactive, measured as providing recommendations that are more optimistic than the consensus, are more likely to be chosen, I obtain information on every M&A deal completed with financial advisors information available between 1990 and 2003 from SDC. These data are then divided into three groups. The first group contains acquiring firms that have only issued equity in the previous five years. The second group contains acquiring firms that have only conducted M&A(s) in the previous five years; and the final group contains other firms that have conducted both activities. Given relatively less knowledge is accumulated in this area, to separate the sample this way makes it easier to observe and interpret results. I find that the choice of financial advisors matters to acquirers announcement effects significantly. The choice of advisors, in terms of their prior relationship with acquiring firms, however shows different relation with the announcement effects. To be specific, acquiring firms that have only conducted equity issuings in five years and keep with their previous equity underwriters in current M&As experience significantly lower announcement effects and it is driven by deals in which stock is the exchange medium. In contrast, acquiring firms that have only conducted M&As in the previous five years and stay with the same financial advisor(s) through all their M&As experience significantly higher announcement period abnormal returns. For the group of acquiring firms that conducted both activities, the impact of staying with the same financial advisor(s) is similar to that of the group of firms that only conducted M&As. advisory by multiplying the total amount of transaction values assisted by financial advisors with the average percent of fees charged from SDC, which is estimated to be 0.9% over the years.

8 In studying factors that affect acquiring firms choice of financial advisors, I find that, for the group of firms that have only conducted equity offerings in the previous five years, the optimism of analyst recommendations significantly affects the likelihood whether the underwriter used in the previous equity offering is kept in the subsequent M&A or not. This result suggests that investment banks that act proactively prior to the transaction are rewarded by being hired. In contrast, for the other two groups of firms (those that have at least conducted a M&A in the previous five years), analysts recommendations do not increase the likelihood of investment banks being retained in subsequent M&A deals. In these two groups, it is the acquiring firms announcement effects in the previous M&As that decide if an investment bank will be retained.. In sum, the results indicate that investment banks, whose previous relationship was that of an equity underwriter, are successful in using analyst recommendations as a means of getting hired to be the financial advisor in subsequent M&As. That is, for this group, being proactive pays. However, to be positively biased does not always increase the likelihood of being retained in subsequent M&As. Nevertheless, when firms do decide to switch to new banks they tend to choose the one that provides the most optimistic forecast. Finally, I find that for acquiring firms that conduct M&As repeatedly, the likelihood of retaining the previous financial advisor(s) is positively related to announcement period abnormal returns of prior M&As. The remainder of the paper is structured as follows. Section 3.2 reviews the relevant literature and motivates of the empirical analyses. Section 3.3 describes the data and Section 3.4 discusses the event study results. In Section 3.5 I present crosssectional analysis of the announcement effects. Section 3.6 discusses results in analyst recommendations along with results from the choice models. I conclude in Section Related Literature As pointed out above the number of papers that have examined the choice of investment banks in corporate takeovers and how the choice impacts acquiring firms performance is sparse and the evidence provided by these papers is inconclusive. The choice of investment banks has been specifically focused on choosing prestigious financial advisors. For instance, Servaes and Zenner (1996) suggest which factors might

9 impact acquiring firms choice of professional firms or in-house expertise and find no relation between advisor reputation and bidder wealth. Rau (2000) concludes that advisor reputation has a positive relationship with the likelihood of completing the deal but not on clients stock prices. Kale, Kini, and Ryan (2003), on the other hand, look at this question from the relative reputation point of view, in which both acquirers and targets advisors reputation are examined, and they find that the absolute wealth gains and the total share of wealth gains to bidder increases as the reputation of the bidders advisor increases relative to that of the target. In examining the role of investment bank-client relationship I rely on two perspectives from the existing literature. One which is less used and explored in the finance literature but is more prevalent in the management literature relies on organizational theories. This strand of research argues that professional firms (such as investment banks) derive power from their specialized expertise and lead clients towards complex problems that favor their own interests. When studying the nature and implications of professional actions, two perspectives are taken. One is that professional firms are impartial conduits of organizational practices (DiMaggio and Powell, 1983) and the other is that professions and their member firms and individuals are sometimes cast as guileful, manipulative and self-serving (Hayward, 2003). Hayward suggests that one explanation why firms make stock-financed acquisitions given the strong evidence that those acquisitions result in inferior performance is because stock financing allows finance professionals to apply their abstract knowledge and this enables them to gain greater influence over the acquisition process (Abbott, 1988; Pfeffer, 1981). Such decisions reflect the preferences and biases of acquiring firms executives and their advisors who decide what and how to acquire (Cyert et al, 1963). I believe that by identifying financing methods in current M&As and the involvement of current M&A advisors in acquiring firms previous equity issuing activities will offer stronger evidence for explaining the performance variation among corporate takeovers especially stock-financed deals from the professional influence perspective. Since professional firms and individuals can set the agenda for the adoption and implementation of their favored practices by deriving power from their specialized expertise and lead clients towards complex solutions with problematic outcomes

10 (Abrahamson and Fairchild, 1999; Hayward, 2003), investment banks that have helped their clients go public and/or SEOs are likely to approach their clients again with possible takeover opportunities and convince them stock-financing is a better option for the potential deal. The solicitous side of investment banks has received little or no attention in the finance literature. I believe that, although technically it is difficult to tell who initiated the deal, those deals helped by previous equity managers and financed by stock would be more likely to be categorized as investment banks-solicited deals. This is because first, it is arguable that by making relationship specific investments in clients such as researching client problems and investing in client executives and communication channels (Abbott, 1988), those previous equity managers are better placed to approach their clients again with a possible takeover opportunity. Second, as argued by Hayward (2003), stock-financed deals enable investment banks to gain greater influence on the acquisition process. Such deals are obviously favorable to those have-been equity managers. I also believe that firms allow their investment banks to manage the relationship, manipulate strategic directions or exercise other influence would-be firms with managers face less monitoring and higher information asymmetry. As result, the market punishes this kind of deal by adjusting down the price. Therefore, I should expect a negative relationship between acquiring firms announcement abnormal returns and the use of previous equity managers. This negative relationship should be driven by stock-financed deals. The other perspective I use in examining the relationship between firms and their investment banks is the reputation building concerns suggested by McLaughlin (1990, 1992). He argues that reputation-building concerns will mitigate investment banks incentives to complete deals at any cost to their clients and protect the interests of the client firm. Although Hayward (2003) suggests that banks work on clients acquisitions increases the likelihood that clients will hire banks in their subsequent acquisitions, I believe that an investment bank would lose their clients to their rivals in subsequent activities if bad performance results. Investment banks are notoriously not responsible for the services they have offered. However, I believe that there are many reasons that most clients will dump their investment banks if bad performance results. Therefore, I

11 should expect that those firms that stayed with their investment banks should have had better experience in previous M&As and should receive positive reaction from the market by announcing the current deal. Recent studies have shown that analyst coverage is an important factor in firms decision of switching underwriters. For example, Krigman et al (2001) suggest that one major reason that firms switch underwriters is because they request additional and influential analyst coverage from new lead underwriters. They conclude that issuers place value on incremental and perceived high-quality research coverage by sell-side analysts and they allocate their resources, in the form of underwriting fees, to increase and improve this coverage. At the end of their article, they comment that it is still a puzzle why firms place such high value on sell-side research coverage. From a difference perspective, Ellis, Michaely and O Hara (2004) look at how investment banks compete for follow-on equity offerings with a focus on the services offered by banks. Their results indicate that investment banks compete proactively by using analysts capability to cajole issuers for follow-on offerings. To be specific, the new underwriting firm is more optimistic than either the old underwriter or the average analysts consensus several months in advance of the offering. Their paper offers a unique perspective in the study of client-investment banking relationship by pointing out that investment banks act proactively to win business in a market with intensive competition. In sum, as quoted by Hayward, the prominence of professional firms in Western societies underscores the continued need the theory and evidence on the nature and implications of professional action. I believe that it is worthwhile to look into the relationship between acquiring firms and their investment banks over time and how this relationship influences firms performance in current activities. As argued above, I predict that stock-financed M&As helped by acquiring firm s previous equity managers would be punished more by the market, while current M&As assisted by firms previous M&A advisors who had helped them previously outperform others would be awarded by the market.

12 1.3 Data and Summary Statistics Sample The data used in this study come from several sources. The initial sample includes all the U.S. firms that conducted a merger or acquisition between January 1990 and December Since I measure their relationship with investment banks in their previous activities, I identify those acquiring firms that had issued initial public offering and/or seasoned equity offerings, and/or conducted a merger or acquisition within five years prior to the announcement date of the original M&A sample. Using the Securities Data Company (SDC) New Issues Database and Global Mergers and Acquisitions Database, I screened the sample for the following criteria: a) Completed M&As by public U.S. firms from 1990 to 2003 are included in the focal sample; b) Acquirers financial advisors information must be available 4 ; c) The underwriters information must be available for equity issuings; d) Mergers or acquisitions in utility or financial industry are excluded; e) Shares owned after the merger or acquisition must be larger than 50%; f) Self-tender offers are excluded; g) Mergers or acquisitions remained in the focal sample did not have any merger or acquisition within 255 days prior the announcement date (too close M&As for the same company have been deleted in order to avoid clustering problem); Thus, the sample consists of M&As from 1990 to 2003 with acquiring firms financial advisors information available, that had also conducted equity issuings and/or mergers or acquisitions within five years prior to the announcement date. To check the 4 Since it is important for us to conduct this study with investment bank information available and the SDC seems not to have acquiring firms financial advisor information all the time, I double checked the representability of the sample. According to SDC M&A database, among the total number of 91,230 M&As conducted by U.S. acquirors from 1990 to 1999, 11,043 have acquirors financial advisors information available. I then checked SDC league table. From 1990 to 1999, SDC league table report a total number of 95,368 M&As in U.S. market and 19,430 of them are helped by financial advisors. So the SDC M&A database capture about 60% of the deals helped by financial advisors and 85% from a value perspective.

13 stock information available for event study, the CRSP database is applied. M&As included in the focal sample must have 265 days stock price information available prior to and 10 days after the announcement date so as to create a 255-day estimation window and 21-day event window for the event study; Therefore, subjected to the standards above, SDC and CRSP report a total of 1,793 merger or acquisitions between January 1990 and December 2003 that meet the standards. Table 1 presents the distribution of the previous activities of the acquiring firms in the focal sample by payment method and target type. Of these, 1,793 focal M&As, 879 (49%) only issued equities in five years; 380 (21%) had only conducted M&As in five years; and 534(30%) conducted both activities. The reason that I separate the sample this way is because it is easier to observe and interpret the prior relationship between acquiring firms and investment banks in relatively simple scenarios, given the lack of knowledge of what impacts acquiring firms choice of financial advisor in M&As. Besides, it is always easier to combine these three groups at the end if similar patterns are observed. 32% of the deals were paid in all cash and 73% acquired private targets. Stock is a dominant financing method in acquiring public targets because 399 out of 484 deals (82%) acquiring public targets are financed by stocks. Acquiring firms that had only issued equity in the previous five years are more likely to conduct stock financed M&As (72%), while those that had only conducted M&As in five years are more likely to pay by cash (42%).

14 Table 0-1 Acquiring Firms Previous Activities This table presents acquiring firms previous activities sorted by the type of targets and the payment methods. All percentages are calculated as the ratio to the total number of observations in total sample and each group, respectively. Group 1: Issued Equity refers to those acquiring firms that had only issued IPO or SEO or both within five years prior to the announcement of current M&A; Group 2: Conducted M&A(s) refers to those firms who had only conducted M&A within fives years prior to the announcement date of current M&A; Group 3: Both Activities refers to acquiring firms that had conducted both equity issuings and M&A(s) within five years prior to the announcement of current M&A; Public Tgts. Refers to public targets; Private Tgts. refers to private targets; AllCash refers to transactions that are paid in all cash; Stock refers to transactions that are paid in stock or a combination of cash and stock. All All Cash Stock Total Public Tgts. Private Tgts. Sub. total Public Tgts. Private Tgts. Sub. total Public Tgts. Private Tgts. All % 73.34% 26.99% 32.29% 27.55% 4.74% 67.71% 45.79% 22.25% Group 1: Issued Equity % 74.63% 25.37% 28.33% 25.03% 3.30% 71.67% 49.60% 22.07% Group 2: Conducted M&A(s) % 73.42% 26.58% 42.11% 33.68% 8.42% 57.89% 39.74% 18.16% Group 3: Both Activities % 70.04% 29.96% 31.84% 27.34% 4.49% 68.16% 42.70% 25.47%

15 1.3.2 Prior Relationship Since the intention is to investigate the relationship of the acquiring firms current M&A advisors in the firms previous activities, I present a summary of the relationship between acquiring firms and their current financial advisors in Table 2. Keep in the group of the firms that only issued equity refers to those who stay with one of their previous equity underwriters in current M&As. For example, Lehman Brothers helped Premier Parks in taking over Six Flags in October 1997 and Lehman Brothers also helped Premier Parks on its IPO issuing and seasoned equity issuings within five years prior the announcement date of the takeover. Premier Parks is categorized into the group of firms that keep with their equity underwriters in current M&As. Those who switched from their previous underwriters are grouped as Switch. I relax the definition of Keep in this group by not limiting it to the firms that stay with the underwriters who helped all their issues. I believe this is a more natural way of describing the relationship between acquiring firms and their underwriters in M&As because first, underwriting and M&As are two different types of activities. Second, underwriting and M&A advisory are two different departments in investment banks, which means the acquiring firms are dealing with two groups of professionals. Of course, they might assist each other in getting business. But it would be too risky to make an assumption at the beginning that there are similar seasons for acquiring firms to stay with their financial advisors as they do in equity underwritings, especially when it is still a puzzle whether the choice of financial advisors matters and what determines this choice. Therefore, I am more comfortable describing the definition of Keep in this group as a familiarity approach.

16 Table 0-2 Summary of Relationship This table displays the number of acquiring firms that retain their previously related investment banks (equity underwriter for group 1, financial advisor for group 2 and both for group 3) in current transactions as a percentage of the total number of observations in each group and sub groups.. Group 1: Issued Equity refers to those acquiring firms that had only issued IPO or SEO or both within five years prior to the announcement of current M&A; Group 2: Conducted M&A(s) refers to those firms who had only conducted M&A within fives years prior to the announcement date of current M&A; Group 3: Both Activities refers to acquiring firms that had conducted both equity issuings and M&A(s) within five years prior to the announcement of current M&A; Public Tgts. Refers to public targets; Private Tgts. refers to private targets; Allcash refers to transactions that are paid in all cash; Stock refers to transactions that are paid in stock or a combination of cash and stock. I define keep in Group 1 as to keep with any prior related underwriters from previous 5 years equity issuings in current M&As; in Group 2 as to keep with the same financial advisors from previous 5 years all M&As in current M&As; in Group 3 where both activities had been conducted in previous 5 years, I define Keep as to stay with the same investment banks from all M&As. Difference denotes the difference in the Keep ratios between sub sample (3) and (2). diff. denotes the difference in Keep ratios between cash paid deals and stock paid ones. Keep Ratio All Private Tgts. Public Tgts. Difference (1) (2) (3) (3)-(2) Group 1 Issued Equity 46% 41% 61% 20%*** All Cash 38% 36% 48% 12%* Stock 49% 43% 62% 19%*** diff. 11%*** 7%* 14%* Group 2 Conducted M&As 15% 12% 24% 12%*** All Cash 13% 11% 19% 8% Stock 17% 13% 26% 14%*** diff. 4% 2% 7% Group 3 Both Activities 20% 18% 24% 6%* All Cash 16% 16% 17% 1% Stock 22% 20% 25% 5% diff. 6%* 4% 8% The symbols *, **, *** denote statistical significance at the 10%, 5%, and 1% respectively

17 Stricter criteria are applied in identifying Keep or Switch in the other two groups of acquiring firms that conducted M&As in five years. To be specific, I define Keep if acquiring firms stay with the same financial advisors in all their M&As. The reason that I use a stricter definition in these groups is because if there are any factors that influence acquiring firms decision to retain or switch advisors, it should be even more obvious in extreme cases where firms consistently stay with same financial advisors. Table 2 displays the summary of acquiring firms relationship with prior related investment banks, sorted by different types of previous activities. Group 1 refers to the group of acquiring firms that only issued equity in five years; Group 2 refers to the group of firms that only conducted M&As in five years; Group 3 refers to the group of acquiring firms that conducted both activities in five years. The percentages reported for each group denotes the proportion of firms that stay with their investment banks from previous activities. Specifically, Keep in group 1 refers to those acquiring firms that stay with either of their equity underwriters in current M&As; Keep in Groups 2 and 3 refer to those acquiring firms that stay with the same financial advisors in all their M&As (including the current one) in five years; Private Targets. refers to those firms that acquire private targets in current M&As; Public Targets refers to those firms that acquire public targets in current M&As; Cash refers to current M&As that are paid in all cash; Stock refers to current M&As that are paid in stocks or a combination of stocks and cash. There are number of M&As among investment banks from 1985 to To ensure I did not lose any prior relationships, I collected M&As news within investment banks from Lexis-Nexis Academic. According to the results in Table 2, 46% of the acquiring firms that only issued equity in five years use previous equity underwriters in current M&As. The ratio of Keep is much lower in Groups 2 and 3, where acquiring firms have M&As experience in five years. Specifically, only 15% of the acquiring firms that only conducted M&As in five years stay with the same financial advisors and only 20% of the firms with both activities do not switch. The high switch ratio of over 80% in the groups with M&As conducted recently is especially interesting and it suggests at least two things. First, it is a more competitive business than underwriting because according to Ljungqvist and

18 Wilhelm (2005), the switch ratio is about 36% when issuing firms conduct sub-sequent equities. Second, given that acquiring firms are not particularly loyal to their investment banks and switch frequently, it is surprising that investment banks market share in M&As is not related with the results of the services they provided (Rau (2000)), which means, if they lose business with this client, they can always get business somewhere else. So what determines acquiring firms choice of financial advisors? Summary Statistics Table 3 presents the summary statistics for the focal sample of M&As from 1990 to Acquiring firms that only conducted M&As in the previous five years are generally larger than the other two groups of firms. The average market capitalization of acquiring firms four weeks prior to the transaction in this group is $13.6 billion, while it is $1.1 billion for the group of acquiring firms with only equity issued and $4.4 billion for the group of firms conducting both activities. For the groups of firms that issued equity in five years, stock is the more dominant payment method if acquiring firms keep with their prior related investment banks. Acquiring firms with only equity issued pay significantly less fees 5 if they keep with their prior related equity underwriters. In either group, public targets are more frequently observed in M&As if acquiring firms keep with their prior related investment banks. This is consistent with Hayward s (2003) conjecture on the professional influence on clients in M&As, where more abstract knowledge (such as evaluation of both acquirors and targets stock values, negotiation with the management teams under public scrutiny) is in more demand in stock paid transactions and in acquisitions of public targets. The summary table of characteristics sorted by prior relationship gives us an initial understanding of the sample. There are some distinct attributes of the participating firms and deals between firms remaining with and switching from their 5 I should point out that fees information is very limited from SDC, which only reports about 5% of the total M&As. According to the SDC league table, however, about 20.4% of the total number of M&As from 1990 to 1999 are assisted by financial advisors and I assume they do not do it for free, I miss about 75% of the fees information in conducting analysis of M&As. The fees reported here should be interpreted with cautioun.

19 Table 0-3 Summary Statistics for Focus Sample of M&As This Table presents the summary of deal characteristics and firm characteristics sorted by acquiring firms previous 5 years activities and the relationship between previously related investment banks and acquiring firms. Group 1: Issued Equity refers to those acquiring firms that had only issued IPO or SEO or both within five years prior to the announcement of current M&A; Group 2: Conducted M&A(s) refers to those firms who had only conducted M&A within fives years prior to the announcement date of current M&A; Group 3: Both Activities refers to acquiring firms that had conducted both equity issuings and M&A(s) within five years prior to the announcement of current M&A; Transac. Value ($mil.) refers to the size of current M&As in million US dollars; Acquirors Mkt ($mil.) refers to acquiring firms market capitalization 4 weeks prior to the announcement date in million of US dollars; All Cash refers to transactions are paid in all cash; Related M&As refers to relatedness of current M&As and it is one when acquiring firms and targets firms have the same first 3 digits SIC codes; IB Rank is the ranking of investment banks in M&A markets retrieved from the SDC league table, with higher number referring to higher ranking; Fee_Perc. is the fees that acquiring firms pay to financial advisors as a percentage of the total transaction value; Tender refers to M&As that are tender offers; Foreign Tgts. refers to outbound cross-border M&As; Public Tgts. is one if acquired targets are public ones; Keep in Group 1 refers to those acquiring firms who retained their previous equity managers for the current M&A; Switch in Group 1 refers to those acquiring firms who did not retain their previous equity managers at all in current M&As; Keep in Group 2 refers to those acquiring firms that retained their previous M&A financial advisors in all M&A transactions; Switch in Group 2 refers to acquiring firms switched from their previous M&A advisors; Keep in Group 3 refers to those acquiring firms that retained their previous M&A financial advisors in all M&A transactions; Switch includes the other. Diff. is the test of the difference of means. t-statistics are reported. Equity Issued M&As Conducted Both Activities Group 1 Group 2 Group 3 Total Keep Switch Diff. Total Keep Switch Diff. Total Keep Switch Diff. Observations (N) Transac. Value ($mil.) Acquirors' Mkt ($mil.) 1,122 1,088 1, ,599 7,208 14, * 4,401 1,980 5, * All Cash *** *

20 Related M&As * IB Rank Fee_Perc. (When avail.) ** Tender ** Foreign Tgts *** *** *** Public Tgts *** *** * The symbols *, **, *** denote statistical significance at the 10%, 5%, and 1% respectively

21 prior related investment banks. In the next section, I will examine if the choice of financial advisors matters in terms of acquiring firms shareholders wealth at the announcement. 1.4 Announcement Period Returns to Acquiring-firm Shareholders I use the most traditional way to evaluate bidder returns following Brown and Warner, (1985). I estimate these abnormal returns over the three-day event window (- 1,+1) using market model benchmark returns with the CRSP equally-weighted index returns. The parameters for the market model are estimated over the (-266, -11) 6 interval and significance levels are measured by Patell s Z value. The abnormal returns for the focal sample of 1,793 M&As from 1990 to 2003 is given in Table 4 by payment method and target type. It is 1.20% for period t= (-1, 1) at 1% significant level. These results are consistent with those reported by Moeller et al. (2004). In their paper, they report 1.10% highly significant abnormal returns for a sample of 12,023 from 1980 to The estimation of dollar wealth loss to the overall sample around period t = (-1, 1) is 44.01million US dollars. The median, however, is positive 0.75 million US dollars. The estimation is close to that of Moeller et al (2004) who report that average dollar denominated wealth gains is negative due to the size factor. Consistent with the theory, acquisitions conducted with cash bid experienced higher positive abnormal returns than those with stock payment. While stock payment usually does not benefit acquiring firms shareholders, it is only driven by those acquisitions of public targets, which report significant negative abnormal returns of % at 1% significance level. On average, shareholders of acquiring firms with public targets and stock payment experience an average million dollars loss around the announcement date, a result that is consistent with Andrade et al. (2001). In contrast, shareholders of the firms that acquired private targets with stock payment experience positive abnormal returns and much less economic loss around the announcement date. This is consistent with the findings of Chang (1998). 6 I also estimate the announcement effects by stopping 46 days prior to the announcement date. The results remain the same.

22 Table 5 presents the announcement effects for acquiring firms aggregated by acquiring firms prior relationship with investment banks in three groups: firms with only equity issued, with only M&As conducted and with both activities. The results indicate that there are significant differences between firms that Keep with their investment banks and those who Switch, statistically and economically, though the directions are opposite between groups of firms with only equity issued and firms with M&As conducted. Acquiring firms staying with their previous equity underwriters experience average abnormal returns of 1.31% at 1% significance level, which is significantly lower than that of the firms who switch, which is 3.51%. The difference is significant at 1% level. I notice that such significant difference is driven by stock paid M&As. To stay with prior equity underwriters in stock paid transactions taking over public targets, acquiring firms experience negative and significant abnormal returns of %, which is significantly lower than that of the firms who switch. Table 0-4 Announcement Abnormal Returns and Dollar Abnormal Returns: Sorted by Payment Method and Target Type This table presents acquiring firms cumulative abnormal returns and dollar denominated wealth gains around period t = (-1, 1). All Cash refers to those transactions that are paid in 100 percent cash, Stock refers to those transactions that are paid in stock or a combination of stock and cash; Public Tgts. refers to those acquiring firms that took over public targets; Private Tgts. refers to those acquiring firms that took over private targets; CARs denotes the cumulative abnormal returns of acquiring firms due to the announcement. To be included in the event study, acquiring firms must have at least 255 days stock information prior the announcement date; P-values are based on Patell s Z values. CARs Dollar Denominated Abnormal Returns ($mil.) Obs. Mean Median All 1.20*** All Cash 1.70*** Public Tgts. 1.53** Private Tgts. 1.73*** Stock 0.97*** Public Tgts *** Private Tgts. 2.37*** The symbols *, **, *** denote statistical significance at the 10%, 5%, and 1% respectively

23 To stay with prior financial advisors, however, shows an opposite relation with firms announcement effects. The results indicate that acquiring firms remaining with their previous M&A advisors experience positive and significant CARs of 2.10% at 1% significance level in the group that only conducted M&As and 1.18% at 5% significance level in the group with both activities. Those firms who switched from their previous M&A advisors experienced negative and significant CARs of -0.70% at respectively 1% significance level and -0.28%. The difference in announcement effects between the Keep group and Switch group is significant at 1% and 10% respectively. The results in Table 5 suggest that when previous equity managers are used in current M&As and when stock is the financing method, the market has more negative reactions. Hayward (2003) suggests that professional firms generate revenue by getting clients to engage in deals that utilize professional expertise. For example, consulting firms use engagements to persuade clients that they have ongoing strategy problems (Maister, 1993) and investment banks use acquisitions to alert clients to future financing problems (Abbott, 1988; Eccles and Crane, 1988). Hayward (2003) argues that stockfinanced acquisitions more intensively apply investment banks expertise. Therefore, for investment banks that had successfully issued the clients equity previously, it should be relatively easier for them to approach the specific client again by offering a stockfinanced acquisition opportunity. In the sociology of professions literature, where professions and professional firms could be cast as aggressive, manipulative, amoral and self-serving, it is understandable that the shareholders of acquiring firms punish such stock-financed acquisitions because they have concerns about whom exactly the transactions benefit. The evidence from the event study shows that regardless of the types of targets, stock-financed acquisition helped by previous equity managers underperformed.

24 Table 0-5 Announcement Abnormal Returns for Acquiring Firms by the Relations of Investment Banks This table presents the announcement effect on acquiring firms around period t =(-1,1), sorted by acquiring firms relationships with investment banks in previous equity issuings and M&As. Group 1: Issued Equity refers to those acquiring firms that had only issued IPO or SEO or both within five years prior to the announcement of current M&A; Group 2: Conducted M&A(s) refers to those firms who had only conducted M&A within fives years prior to the announcement date of current M&A; Group 3: Both Activities refers to acquiring firms that had conducted both equity issuings and M&A(s) within five years prior to the announcement of current M&A; Keep in Group 1 refers to those acquiring firms who retained their previous equity managers for the current M&A; Switch in Group 1 refers to those acquiring firms who did not retain their previous equity managers at all in current M&As; Keep in Group 2 refers to those acquiring firms that retained their previous M&A financial advisors in all M&A transactions; Switch in Group 2 refers to acquiring firms switched from their previous M&A advisors; Keep in Group 3 refers to those acquiring firms that retained their previous M&A financial advisors in all M&A transactions; Switch includes the other. All Cash refers to those transactions that are paid in 100 percent cash, Stock refers to those transactions that are paid in stock or a combination of stock and cash; Public Tgts. refers to those acquiring firms that took over public targets; Private Tgts. refers to those acquiring firms that took over private targets. CARs denotes the cumulative abnormal returns of acquiring firms due to the announcement. The estimation window is from (-265, -11) and the event window is (-10, 10). To be included in the event study, acquiring firms must have at least 255 days stock information prior the announcement date; P-values are based on Patell s Z values. Diff. is the test of the difference of means. The actual differences between means are reported. Group 1: Issued Equity Group 2: Conducted M&As Group 3: Both Activities Total Keep Switch Diff. Total Keep Switch Diff. Total Keep Switch Diff. All All Cash Public Tgts Private Tgts Stock Public Tgts

25 Private Tgts CARs (-1, 1) All 2.50*** 1.31*** 3.51*** -2.20*** -0.28* 2.10** -0.70*** 2.80*** ** * All Cash 2.87*** 3.47*** 2.51*** *** *** 0.69*** 1.13* 0.92** 0.21 Public Tgts. 2.21** 3.30*** *** 9.59*** ** Private Tgts. 2.96*** 3.50*** 2.65*** *** *** 0.94*** 1.29** 1.21** 0.08 Stock 2.36*** 0.65*** 3.99*** -3.34*** -0.96*** *** ** 2.08** Public Tgts *** -2.18*** * -2.91*** -3.77*** -2.61*** *** ** 2.84** Private Tgts. 4.00*** 2.48*** 5.14*** -2.66** ** ** 0.86*** 2.34*** 0.34* 2.00* The symbols *, **, *** denote statistical significance at the 10%, 5%, and 1% respectively