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Cash holdings and the bargaining power of R&D-intensive targets

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Abstract

Prior literature suggests that R&D-intensive firms hold large amounts of cash due to financing constraints. This paper examines whether such firms could also use cash holdings as a strategic bargaining tool in M&A transactions. Using a large sample of takeover bids announced between 1980 and 2012, we demonstrate that cash holdings positively impact R&D-intensive targets’ takeover premiums and announcement-period abnormal returns. These effects disappear in non-R&D-intensive firms. Controlling for various endogeneity and financing concerns, we also find that R&D-intensive firms build up cash holdings in anticipation of becoming a takeover target. Further analysis indicates that in R&D-intensive firms, such cash holdings are valued highly by the market. Taken together, our findings shed new light on the strategic bargaining role of corporate cash holdings in the outcomes of acquisitions targeting R&D-intensive firms.

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Notes

  1. The share of R&D in total investment [R&D/(R&D + Capital expenditures + Acquisitions)] rose from 0.259 in 1980 to 0.493 in 2012. These numbers are based on a sample of all public R&D reporting firms in the Compustat database, excluding financial and utility firms.

  2. High technology firms such as Microsoft, Google, and Apple frequently acquire firms that are in the process of developing competing/supporting technologies.

  3. Harford (1999) documents evidence that cash-rich firms are less likely to be targeted.

  4. Bates and Lemmon (2003) and Officer (2003) document that target termination fee provisions are associated with higher takeover premiums. Burch (2001) finds that though target lockup options inhibit competition, deals with lockup options have higher target announcement returns.

  5. Based on the coefficient estimate in column (1) of Table 3, we calculate the change in the 41-day takeover premium for a target firm with a 5% R&D investment, given a one standard deviation increase in target cash holdings (0.202) as follows: Δ41-day takeover premium = 0.343*0.05*0.202 = 0.00, 346. Thus, Δ41-day takeover premium % = 0.00, 346/Median 41-day takeover premium = 0.00, 346/0.352 = 0.98%.

  6. Bates et al. (2009) show that increase in R&D intensity is one of the main factors driving cash build-up for US industrial firms from 1980 to 2006.

  7. We also use dependent variables measured at the end of years t + 1 and t + 2 to examine the degree of persistence in an R&D-intensive firm’s strategic response to takeover exposure and find consistent results.

  8. Based on the coefficient estimates in column (1) of Table 7, the percentage change in cash holdings for a firm with a 20% R&D spending is calculated as follows: (20.009*0.20 − 2.293)*0.1 = 17.088%.

  9. Although we control for time fixed effects in all of our estimations but we analyze cash holdings for these two periods separately as the period before 2000 was unusual in terms of M&A activities.

  10. In untabulated analysis, we divide our sample into four sub-periods, i.e. 1980–1995, 1996–2001, 2002–2006, and 2007–2012, we still obtain consistent results.

  11. Stráska and Waller (2010) reach a similar conclusion by studying the value impact of antitakeover provisions on certain firms with characteristics that indicate low bargaining power in takeover contests. They show that adopting more antitakeover provisions enhances bargaining power and is associated with a positive value impact on such firms.

  12. Pinkowitz et al. (2006) show that a dollar of liquid assets is worth much less to minority investors in countries with poor investor protection. Dittmar and Mahrt-Smith (2007) report similar results that a dollar of cash is valued significantly less in a poorly governed firm.

  13. Given that the Fama and French 25 portfolios are formed at the end of each June while the fiscal year-end of a firm could be any month during the year, a firm could belong to two portfolios in any year t. Therefore, following Faulkender and Wang (2006), we adjust the benchmark return by annualizing the monthly returns of the portfolio the firm belongs to each month.

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Acknowledgements

We would like to thank the Editor Cheng-Few Lee and two anonymous referees, Rahul Bhargava, Sheri Faircloth, Chunlin Liu, Greg Stone, an anonymous reviewer of the FMA 2015 program committee, the 2013 Southern Finance Association, the 2015 Eastern Finance Association, the 2015 Financial Management Association, and the University of Nevada Reno for helpful comments.

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Authors and Affiliations

  1. Department of Finance, College of Business, Florida International University, Modesto A. Maidique Campus, 11200 S.W. 8th Street, Miami, FL, 33199, USA

    Arun Upadhyay

  2. Managerial Science Department, College of Business, University of Nevada, Reno, 1664 N Virginia St, Reno, NV, 89557, USA

    Hongchao Zeng

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  1. Arun Upadhyay
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Correspondence to Hongchao Zeng.

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Table 10 Variable definition
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Upadhyay, A., Zeng, H. Cash holdings and the bargaining power of R&D-intensive targets. Rev Quant Finan Acc 49, 885–923 (2017). https://doi.org/10.1007/s11156-016-0611-z

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