The impact of cross-border M&As in services Policy issues

1. The impact of cross-border M&As in servicesPolicy issues Pehr-Johan Norbäck, Institutet för Näringslivsforskning Lars Persson, Institutet för Näringslivsforskning

2. Background • Strong increase in FDI during the last decades • Welcoming attitude towards inward FDI in general • Development of new technologies (IT)

3. Increasing FDI in the world economy Percentage of GDP Stock of inward FDI (world) Sweden Developed countries Source: WIR (1997, 2005)

4. Background, cont • The composition of FDI has shifted towards services • Mergers and Acquisitions is a major driving force in the increase of FDI in services

5. M&As in services increasingly important Source: UNCTAD. Current values. By purchaser.

6. Policy issues Concern 1: Cross-border M&As, in contrast to greenfield FDI, are driven by market power motives hurting consumers Concern 2: Strong foreign entrants will be able to acquire domestic firms at “too low” a price Concern 3: Obstacles for FDI in the service sector (EU)

7. Purpose • Develop a theoretical framework to analyze: • Driving forces of cross-border M&As and greenfield investments (new ventures) in service markets • The welfare impact of cross-border M&As and greenfield investments in service markets • Examine: • Cross-border merger policy • Privatization policy

8. Theoretical framework • Stylized Fact 1: Service markets have high trade and entry barriers • → Oligopoly interaction • Stylized Fact 2: M&As are the dominating entry mode of FDI in services • → M&As can increase the risk of abuse of market power • Stylized Fact 3: MNEs are typically the most efficient firms in their industries • → Potential synergies from M&As

9. Theoretical framework, cont Theoretical framework capturing these stylized facts: • MNEs bid for the domestic firm • MNEs can invest in new assets • Firms interact in an oligopolistic service market

10. Cross-border M&A policy • We compare: • A discriminatory policy which allows for greenfield investments (new ventures) but not cross-border M&As • A non-discriminatory policy which allows both greenfield investments and cross-border M&As

11. Cross-border M&A policy Result 1:Restrictions on foreign acquisitions can increase welfare when synergies are low • A market power driven foreign acquisition can be an alternative to a more pro-competitive greenfield entry • Domestic owners break-even from selling • Higher consumer prices due to a more concentrated market and lower efficiency • However, for a foreign acquisition to take place, the MNE must be sufficiently efficient

12. Cross-border M&A policy, cont • Result 2:Foreign acquisitions can increase the welfare if synergies are sufficiently large • Increased productivity in the merged firm tends to lead to lower consumer prices • Bidding competition among MNEs leads to the selling domestic firm getting a large share of the surplus

13. Example preemptive acquisition • In November 2000, Banco Santander Central Hispanio (BSCH) won a controlling minority stake in Banespa, in competition with its Spanish rival Banco Bilbao Vizcaya Argentaria (BBVA) • According to Business Week (April 23, 2001): "It cost an astronomical $3.55 billion, but it put BSCH back on top"

15. Domestic Competition Policy • EU has documented severe obstacles for greenfield investments in the service sector. • Can cross-border acquisitions mitigate this problem? • Result 3:For sufficiently concentrated service markets: Preemptive domestic acquisitions will take place and may preempt efficient foreign acquisitions.

16. Privatization policy • Problem with lack of efficiency improvements in privatized firms • Focus on competition effects • Set-up: • Government liberalize by: • (i) selling of state firm • (ii) allowing for new investments • One efficient MNE and one inefficient domestic firm competing to enter the market

17. Privatization policy, cont • Result 4: Risk that the inefficient owner obtains the state assets without updating the technology • Selling procedure is used to limit competition: • The domestic (inefficient) firm buys at a low price • The MNE (efficient) obtains a strong market position • → Both firms gain from inefficient ownership

18. Privatization policy, cont… • How to avoid inefficient ownership? • Introduce several MNEs • Result 5: Increased competition for the market decrease the risk that owners strategically using the selling process to limit competition • Foreign (efficient) firms then risk to not be able to enter the market if not acquiring state assets

19. Conclusions • Allowing cross-border M&As can increase host countries welfare due to: • increased productivity • bidding competition among MNEs over target firms. • Market power driven cross-border M&As occur, but for cross-border M&As to take place, MNEs must be sufficiently efficient • For sufficiently concentrated markets preemptive acquisitions can take place and thus competition authorities should monitor such behaviors

20. Conclusions, cont • In privatizations one owner can induce another to take on the role of the weak owner • Authorities should not only ensure competition over the privatized firm, but also competition for de-novo entry • Merger and privatization policies, but not discriminatory policies towards foreigners, can play an important role in the development of service markets