JOURNAL OF FINANCIAL AND QUANTITATIVE ANALYSIS Vol. 52, No. 2, Apr. 2017, pp. 613–644
COPYRIGHT 2017, MICHAEL G. FOSTER SCHOOL OF BUSINESS, UNIVERSITY OF WASHINGTON, SEATTLE, WA 98195
doi:10.1017/S0022109017000175
Policy Uncertainty and Mergers and
Acquisitions
Nam H. Nguyen and Hieu V. Phan*
Abstract
This research examines the relationship between policy uncertainty and mergers and acqui-
sitions (M&As). We find that policy uncertainty is negatively related to firm acquisitiveness
and positively related to the time it takes to complete M&A deals. In addition, policy un-
certainty motivates acquirers to use stock for payment and to pay lower bid premiums.
Acquirers, on average, create larger shareholder value from M&A deals undertaken during
periods of high policy uncertainty, which is attributable to their prudence as well as the
wealth transfer from the financially constrained targets to acquirers.
I. Introduction
Policy uncertainty can harm the economy. Stock and Watson (2012), Julio
and Yook (2012), and Gulen and Ion (2016) argue that uncertainty related to tax,
government spending, and regulatory and monetary policies hampers the post–
Great Recession economic recovery. Organizations such as the Federal Open
Market Committee (FOMC) and International Monetary Fund (2012) came to a
similar conclusion about the effects of policy uncertainty on the economy.
1
Baker,
Bloom, and Davis (2016) show that the level of U.S. policy uncertainty increased
by 50% over the period 1985–2012, particularly due to the federal debt-ceiling
battles and the political fights over extending the Bush tax cuts in the later years.
*Nguyen, nam nguyen@uml.edu, School of Management, Universit
´
e du Qu
´
ebec
`
a Montr
´
eal;
Phan (corresponding author), hieu phan@uml.edu, Manning School of Business, University of Mas-
sachusetts Lowell. This paper was written while Nguyen was a Ph.D. student at the University of
Massachusetts Lowell. We are especially grateful to Art Durnev (the referee), whose comments on the
paper substantially improved the exposition and analyses. We also appreciate the helpful comments
from Julian Atanassov, Brian Baugh, Sudip Datta, Kathleen Farrell, Geoffrey Friesen, Steven Freund,
Jarrad Harford (the editor), Mai Iskandar-Datta, Anand Jha, Sedzro Komlan, Tunde Kovacs, Manoj
Kulchania, Saira Latif, Kooli Maher, Ranjan D’Mello, Stas Nikolova, Shakil Quayes, Guay Richard,
Emre Unlu, John Wagster, Jing Wang, Liying Wang, Julie Wu, and Mouchette Xavier as well as ses-
sion participants at the 2016 Financial Management Association Doctoral Consortium and seminar
participants at the University of Massachusetts Lowell, University of Nebraska Lincoln, Universit
´
e du
Qu
´
ebec
`
a Montr
´
eal, and Wayne State University. We thank Di Huang for sharing the fuzzy matching
codes. All errors remain the sole responsibility of the authors.
1
http://www.federalreserve.gov/monetarypolicy/fomcminutes20091216.htm
613
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614 Journal of Financial and Quantitative Analysis
Business media reported that the increase in policy uncertainty led to a decrease
of more than 1 percentage point in the real gross domestic product (GDP) and
the loss of over 1 million jobs in the United States during the period 2011–2012.
2
Given the far-reaching consequences of policy uncertainty, researchers and poli-
cymakers have been increasingly interested in investigating its effects on corpo-
rate behavior and firm value.
The relationship between uncertainty and corporate investments is unclear
ex ante. Hartman (1972), Abel (1983), and Caballero (1991) argue theoretically
that output price uncertainty may increase the investments of risk-neutral firms
operating in perfect competition with a constant returns-to-scale production func-
tion and no irreversibility. However, other research argues that firms are likely to
delay irreversible investments amid uncertainty (Bernanke (1983), McDonald and
Siegel (1986), Dixit and Pindyck (1994), Abel and Eberly (1994), and Gulen and
Ion (2016)). Policy uncertainty can exacerbate firms’ financial constraints and in-
crease the cost of external financing (Greenwald and Stiglitz (1990), P
´
astor and
Veronesi (2013), Gilchrist, Sim, and Zakraj
ˇ
sek (2014), and Brogaard and Detzel
(2015)) and increase managerial risk aversion (Panousi and Papanikolaou (2012)).
However, no prior study has investigated the link between policy uncertainty and
mergers and acquisitions (M&As), one of the most important forms of corporate
investments. This research attempts to fill this gap by empirically investigating
the relationship between policy uncertainty and M&As and its implications for
shareholder value.
3
We examine the effects of policy uncertainty on firm acquisitiveness, the
time it takes to complete the M&A deals, the payment consideration, and acquirer
and target shareholder value. M&As are typically large and difficult-to-reverse
investments. They also represent managers’ discretionary risk taking and tend
to increase the acquirers’ default risk (Furfine and Rosen (2011), Phan (2014)).
Therefore, consistent with recent evidence documented in the literature, we pre-
dict a negative relationship between policy uncertainty and firm acquisitiveness.
Moreover, from the real option perspective, firms are more likely to delay irre-
versible investments until some of the uncertainty is resolved (Bernanke (1983),
Dixit and Pindyck (1994)). This observation suggests that even if the acquiring
firms engaged in M&A bids, it would take them more time to complete the deals
during periods of high policy uncertainty.
We use the policy uncertainty index developed by Baker, Bloom, and Davis
(BBD) (2016) as a proxy for policy-related economic uncertainty to examine its
effect on M&As. The BBD index is constructed based on the weighted average of
three components: the frequency of newspaper articles containing key terms re-
lated to policy uncertainty, uncertainty about future changes in the federal tax code
measured by the dollar impact of tax provisions set to expire in the near future, and
the dispersion in economic forecasts of government spending and Consumer Price
Index (CPI) as a proxy for uncertainty about future fiscal and monetary policy.
2
Wall Street Journal, Apr. 28, 2013. Available at http://www.wsj.com/articles/SB1000142412788
7323789704578443431277889520
3
It came to our attention that Alice Bonaime, Huseyin Gulen, and Mihai Ion were working inde-
pendently on a similar research topic.
https://doi.org/10.1017/S0022109017000175 Published online by Cambridge University Press
Nguyen and Phan 615
Using a sample of 88,768 firm-year observations of 9,673 unique firms over
the period 1986–2014, we find a negative relationship between policy uncertainty
and firm acquisitiveness. Our estimation indicates that a 1-standard-deviation in-
crease in the BBD (2016) index value is associated with a 5.8-percentage-point
decrease in the acquisition probability of an average firm, which is economically
important given the sample’s unconditional M&A probability of 23.71%, and a
decrease of $30.1 million in average M&A deal value. Moreover, our analysis of
the completed M&A deals indicates that policy uncertainty is positively related to
the time it takes to complete the deals.
Policy uncertainty tends to be countercyclical, and both policy uncertainty
and M&As can be jointly correlated with unobservable factors, such as investment
opportunities, which raises an endogeneity concern and renders our probit model’s
coefficient estimates biased and inconsistent. To address this endogeneity concern,
we employ an instrumental variable (IV) probit model and use a measure of the
U.S. Senate’s political polarization as an instrument for policy uncertainty. The
IV probit estimation results indicate that our findings are robust to endogeneity
correction.
The BBD (2016) index may capture other, nonpolicy-related economic un-
certainty (e.g., currency uncertainty, stock price volatility, oil price shocks, or la-
bor market variations), which suggests a potential error-in-measurement problem
that biases the M&A probit estimation results. Gulen and Ion (2016) argue that
the U.S. and Canadian economies are closely related, and therefore a shock that
affects the economic uncertainty in the United States is likely to affect the eco-
nomic uncertainty in Canada as well. Following their argument, we estimate the
BBD index for the United States as a function of the Canadian BBD index and
other macroeconomic variables, then use the regression residuals as a proxy for
policy uncertainty in the M&A probit regressions; however, our finding is quali-
tatively unchanged.
Policy uncertainty can exacerbate firms’ financial constraints, expose them
to higher default risk, and make it harder and more costly for acquiring firms to
raise external funds to support M&A deals. In addition, policy uncertainty can
increase future cash flow volatility, which increases firm risk. Faced with policy
uncertainty and its adverse effects, acquiring firms are expected to be prudent with
their liquidity and are more (less) likely to use stock (cash) for M&A payment.
Our analysis of the acquirers’ payment consideration indicates that policy uncer-
tainty is positively related to all-stock payment as well as the percentage of stock
used for M&A payment. We further investigate and find a negative relationship
between policy uncertainty and bid premiums, which suggests that policy uncer-
tainty induces acquirers to be more conservative in setting the bid prices.
Policy uncertainty can increase firms’ operating risk, amplify the risk of large
investments such as M&As, and increase the costs of capital, potentially leading
to a decrease in acquirer shareholder value. However, as firms become more pru-
dent and tend to delay large and risky investments during the high-uncertainty
periods (Bernanke (1983), Rodrik (1991), Bloom, Bond, and Reenen (2007), and
Gulen and Ion (2016)), acquirers are likely to engage in those M&A deals that
are expected to produce better outcomes. This proposition implies a positive re-
lationship between policy uncertainty and acquirer shareholder value. Given the
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616 Journal of Financial and Quantitative Analysis
possible opposing effects of policy uncertainty on acquirer shareholder value, we
will need to sort them out empirically.
We examine the effect of policy uncertainty on both short-term and long-term
acquirer shareholder value. We run cross-sectional regressions of the acquirers’
3-day cumulative abnormal returns (CARs) centered on the deal announcement
day to capture the short-term effect of policy uncertainty on acquirer shareholder
value. The regression results reveal a positive relationship between policy uncer-
tainty and acquirer CARs. Because pursuing M&As is a firm decision rather than
a random assignment, our cross-sectional regression results could be prone to the
self-selection bias. Therefore, we employ the Heckman (1976), (1979) 2-step self-
selection correction model to address the self-selection bias concern, but we find
robust results. The economic effect of policy uncertainty on acquirer shareholder
value is also important. Our point estimates indicate that, holding other variables
fixed at their sample means, a 1-standard-deviation increase in the BBD (2016) in-
dex value above its sample mean is associated with an increase of 70 basis points
(bps) (i.e., 0.7%) or $31.4 million in an average acquirer’s shareholder value. Our
further analysis indicates that the positive effect of policy uncertainty on acquirer
CARs is attributable to the acquirers’ prudence with M&As and the value transfer
from the financially constrained targets’ to acquirers’ shareholders.
We complement our short-term value analysis with an investigation of the ef-
fect of policy uncertainty on acquirer long-term stock and operating performance.
We employ the buy-and-hold abnormal returns (BHARs) using the matched firm-
adjusted method suggested by Barber and Lyon (1997) and Lyon, Barber, and
Tsai (1999) as a proxy for long-term stock performance. We use the long-term
abnormal operating performance calculated based on the matched firm-adjusted
method suggested by Barber and Lyon (1996) as a proxy for long-term operating
performance. Our analysis indicates that acquirer long-term stock and operating
performance is positively related to policy uncertainty, implying a positive rela-
tionship between policy uncertainty and acquisition synergies. Overall, our find-
ings demonstrate that policy uncertainty not only reduces firm acquisitiveness or
delays M&A deal consummation but also motivates acquirers to exercise a careful
screening of acquisition targets and prudence with the acquisition terms, thereby
creating value for acquirer shareholders.
There is a stream of literature that examines the effects of political uncer-
tainty on corporate behavior (e.g., Julio and Yook (2012), Jens (2017)); however,
it is worth noting that political uncertainty is different from policy uncertainty
in a number of ways. Political uncertainty is typically associated with specific
political events, such as presidential elections (Julio and Yook) or gubernato-
rial elections (Jens). Gulen and Ion (2016) argue that although elections may be
good exogenous indicators of uncertainty, they do not tell how policy uncertainty
changes during these elections. Moreover, the election indicator variable used in
empirical studies does not capture the variation in policy uncertainty between
elections. On the other hand, policy uncertainty is broader and includes different
types of uncertainty that are directly tied to policies. It is noteworthy that the BBD
(2016) index spikes during events that are associated with high policy uncertainty,
such as the Gulf Wars, the 9/11 attack, the 2011 debt-ceiling dispute, and battles
over fiscal policy. We are interested in policy uncertainty because it can have a
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Nguyen and Phan 617
profound impact on important corporate decisions, such as those related to M&As,
in a continuous fashion. To ensure that our findings are not confounded by the ef-
fects of political uncertainty, we perform additional analyses that explicitly con-
trol for political uncertainty, but our results are qualitatively unchanged.
Our research contributes to the literature in three important ways. First, our
study adds to a growing stream of literature that examines the effects of policy un-
certainty on corporate decisions (e.g., Bloom et al. (2007), Gulen and Ion (2016),
and Baker et al. (2016)). Our research focuses on the relationship between pol-
icy uncertainty and M&As, one of the most important forms of corporate invest-
ments, and further considers its effect on acquirer shareholder value. Second, our
research highlights the negative effect of policy uncertainty on financially con-
strained firms’ operations. Our evidence suggests that policy uncertainty weakens
the bargaining power of financially constrained targets, resulting in a lower value
for their shareholders. Finally, our research findings can have timely implications
for policy and corporate decision makers, which can be particularly useful given
the recent wide swings in policy uncertainty and its adverse effects on the real
economy.
Our research is close to that of Gulen and Ion (2016), who investigate the
effect of policy uncertainty on capital expenditures. However, we focus on a dif-
ferent type of investment, M&As, which are typically large and readily observ-
able. We further examine the implications of policy uncertainty for shareholder
value, which suggests a channel through which policy uncertainty affects cor-
porate investments. Our research is also related to that of Bhagwat, Dam, and
Harford (2016), who investigate the relationship between stock market volatility
and M&A activities. However, we note that the variable of interest in our research
is policy uncertainty proxied by the BBD (2016) index, whereas Bhagwat et al.’s
variable of interest is stock market uncertainty proxied by the Chicago Board Op-
tions Exchange (CBOE) Volatility Index (VIX). Baker et al. (2016) point out that
the BBD and VIX indices are different in measurement, time frame, and impli-
cations. In particular, the VIX index is constructed based on the implied volatil-
ity of 30-day maturity put and call options, whereas the BBD index is based on
newspaper coverage, the future expiration of the federal tax code, and forecaster
disagreements about future fiscal and monetary policies. Moreover, the VIX index
is more related to financial and stock market events, such as the 1997 Asian crisis,
the 1998 Russian crisis, and the 2002 stock market scandals, whereas the policy
uncertainty index reflects more policy-relevant events. Finally, the VIX index is
related to short-run financial uncertainty, whereas the BBD index tends to capture
the long-run policy uncertainty.
The remainder of the paper is organized as follows: We present a description
of the data and variables construction in Section II. Section III develops empirical
predictions and discusses the research methods and results. Section IV presents
robustness checks, and Section V concludes the paper.
https://doi.org/10.1017/S0022109017000175 Published online by Cambridge University Press