51²è¹Ý

At a time when capital has never been more mobile and available, financial protectionism is on the rise. The costs of these economic nationalistic policies are little known however. In new research, 51²è¹Ý Cox Finance Professor Miller and co-authors reveal the important consequences of government-related incursions in deals between foreign and domestic companies and the resulting decline in shareholder value for a wide range of industries.

"Economic nationalism is sweeping the globe," says Miller. "Sometimes the rationale of national security is valid, and sometimes it's an excuse to thwart mergers. You might think it's good for national security but what are the costs? We don't really what harm it does." Both Germany and Britain are also seeking more scrutiny over foreign direct investment and deals, as well as the European Union. A recent acquisition of Dallas-based Moneygram by Ant Financial, a Chinese payments company, collapsed when the Committee on Foreign Investment in the U.S. (CFIUS) refused to approve it. More cases of this type of government influence are on the rise.

Foreign investors generate 15% of all U.S. M&A activity by deal value, notes the research. In 2016 alone, foreign acquisitions of U.S. companies exceeded $500 billion, according to a Thomson Reuters database. Given increased public concern about record amounts of cross-border M&A activity, U.S. regulators passed the Foreign Investment and National Security Act of 2007, or FINSA. The purpose of FINSA is to spur the CFIUS to inhibit foreign investments in U.S. companies across a broad array of industries that produce technologies critical to national security.

"There is a long history of US financial protectionism, but with little impact on thwarting acquisitions," notes Miller. However, FINSA has had a dramatic and chilling impact, he suggests. "There was a significant drop in the number of acquisitions before and after FINSA," says Miller. "There may be good reasons for China, for example, not owning part of an U.S. aerospace firm. But if you're a shareholder with retirement dollars, it clearly hurts you financially."

Shareholders lose

The study is a first about the economic impact of specific legislation that formalizes U.S. government jurisdiction over foreign M&A activity. The authors quantify the impact of financial protectionism, specifically the impact of FINSA on shareholders. The study finds that foreign takeovers of firms affected by FINSA legislation declined 68%. For firms with high R&D expenditures, like technology firms, the decrease in M&A activity after FINSA was more acute.

While the atmosphere of protectionism is popular in some political camps, the costs are not well known. Some of the industries affected by FINSA include advanced materials and processing, chemicals, information technology, telecommunications, biotechnology, energy, space systems and marine systems. "At least eleven major countries accounting for 40 percent of global FDI have adopted or are considering the adoption of FINSA-type laws," the authors write.

A key finding of the paper is the loss of shareholder wealth, owing to FINSA enactment. "If you are a shareholder who has built a business and wants to exit it," explains Miller, "the government now says that the potential buyer who could have paid the most is no longer a player; you then have to sell your business for less. Wiping that group of investors off the slate, with the loss in shareholder value, means the business cannot be sold for what it's worth."

The study shows that firms lost 1.12-2.15% of their value on average. The decrease amounted to roughly $24.9 billion to $47.9 billion in lost value for FINSA-affected firms over a three-day event window. "We looked at every single company and each industry, and on average the shares went down," says Miller. The amount lost represents a lower figure than the total costs of FINSA because private firms are not part of the study. Additionally, the impact of financial protectionism harms shareholder wealth via a less liquid market for corporate control or ownership.

There are implications for economic activity in the longer term related to financial protectionism. Miller states, "A 2% drop in one company in three days is a big drop.”

Less investment, more costs

Financial protectionism deters foreign investment and reduces equity prices, surmise the authors. Distressed firms that may benefit from a foreign acquirer are being limited by the government actions. The study shows that domestic acquirers did not come to the rescue either.

An element of political risk is added by giving Congress a larger role in the investment approval process. Earlier research shows that this uncertainty decreases investment activity. The costs imposed by FINSA include delays in an acquisition's timeline and the risk of competitors bidding against the would-be acquirer. Additionally, costly national security risk mitigation agreements are more likely to burden a would-be acquirer and these costs tend to be large. News articles post-FINSA enactment indicate a steady rise in withdrawn offers for U.S. firms.

The problem is that we don't know who the Committee investigates exactly, says Miller. The information is not publicly available. "We looked at this somewhat by looking at news articles and SEC filings," notes Miller. "It's very opaque. You don't know whether it's political or justified."

How justified is this legislative and extra-regulatory activity? Miller answers, "Some of it is just sentiment around the globe. Some of it is just that people don't like foreign companies buying their domestic institutions." Previously, foreign deals under scrutiny of were one-offs, but now the government has ratcheted up its activity. The protectionism is formalized into law. "Our study looks at this first instance of legal, mandated protectionism which has considerable teeth," summarizes Miller. "What does that do? We show it causes takeovers to be muted and affect the value of the firm."

Policy makers should pay attention to the costs of financial protectionism. The efficient allocation of capital and resources across borders is at risk too, adds Miller.

"Financial Protectionism, M&A Activity, and Shareholder Wealth" by Darius Miller, Caruth Chair in Finance of the Cox School of Business, 51²è¹Ý; David Godsell, University of Illinois at Urbana-Champaign; and Ugur Lel of University of Georgia is under review.

Written by Jennifer Warren.