An Empirical Analysis Of M & A Performance Based On The Free Cash Flow Hypothesis

With the rapid increase of transaction scale and quantity, M&A has been regarded as an important way to accelerate the adjustment of industrial structure and optimization of resource allocation. However, M&A doesn't means value creation all the time. It is generally accepted that M&A performance is not very good in China. So it's very meaningful to identify the influence factors of M&A performance. Researches abroad in this field are always based on related classical theories, including the free cash flow hypothesis put forward by Jensen. He defined the residual cash flow after meeting the need of profitable investments as free cash flow which should be paid as dividends for the sake of shareholders. But managers prefer not to do this because of the agency problems. In companies with large amount of free cash flow, managers are likely to take unfavorable M&A on their own account. The hypothesis hasn't been widely applied in China and there is divergence of views in exsiting researches. In order to verify the FCF hypothesis, this paper conducts an empirical study on relationship between free cash flow and M&A performance of the bidders.According to the FCF theory, agency problem becomes more severe as free cash flow increases, while liability plays an very important role in controlling managers'behavior. Two research hypotheses are generated in this paper:H1:the more free cash flow is, the worse M&A performance is; H2:there exists an positive correlation between M&A performance and debt level.178 samples are divided into different groups according to their cash flow and investment opportunity to measure the free cash flow and their M&A performance are calculated by factor analysis.Firstly, this paper gets descriptive statistics of the variables and conducts a T-test for M&A performance. It is concluded that the proportion of samples whose performance are positive is slightly higher than 50%, and the other transaction causes serious value destruction. The M&A brings more to companies with abundant cash flow than other ones. Given the investment opportunity, M&A performance in low opportunity companies vary with their cash flow levels, which can't be found in other samples. In this regard, low investment opportunity can be taken as an improtant condition for the existence of agency problem of free cash flow. Secondly, this thesis draws a comparision of business performance around the M&A transaction. Performance in companies with plenty of cash flow declines on the whole after M&A, whereas the other companies has taken on an entirely different trend. Continuous drop in performance can be found in samples with rich cash flow but poor investment opportunity, which conforms to the FCF hypothesis. Thirdly, this paper gives regression analysis for both low investment opportunity sample and full sample. It comes to the conclusion that agency problem of free cash flow is common in China. M&A performance gets worse as cash flow increases, and liability hasn't act as a control mechanism. Lastly, we carry out the robust test by changing the way of measuring M&A performance.In a word, findings in this paper supports core points of free cash flow hypothesis, but challenges the control mechanism of liability.