and Minority Equity Investments
Continuing a trend of several decades, the formation of joint ventures and alliances grew dramatically during the 1990s, as shown in Exhibit 6.12. Robinson (2001) argued that the growth of JVs and alliances was due to their success as commitment devices between organizations—alliances bind the partners not to divert resources in inefficient ways. Also, he found that alliances are more likely than acquisitions where the risk of the venture is greater than the risk of the partner’s core business.
EXHIBIT 6.12 Formation of Joint Ventures and Alliances by Year and as a Percentage of Total M&A Activity
Source of data: Thomson Financial SDC, Platinum Joint Ventures Database.
Desai, Foley, and Hines (2002) studied the formation of international joint ventures and found a trend away from minority ownership and toward whole ownership. They speculated that this change might reflect relaxation of restrictions on whole ownership or changes in the geographic mix of investments. They found that “whole ownership is most common when firms coordinate integrated production activities across different locations, transfer technology, and benefit from world-wide tax planning” (page 1) and that this propensity toward global organization explained a declining tendency to organize foreign operations as joint ventures.
Lerner, Shane, and Tsai (2003) studied R&D ventures formed by small biotechnology firms. They found that when external equity financing is unavailable or limited in supply, these firms are more likely to fund their R&D by organizing research JVs with large corporations. And the agreements structured under these circumstances tend to assign the bulk of control to the large corporate partner. Such agreements are likely to be renegotiated and to be significantly less successful than others. Robinson and Stuart (2002) found that the staging of investment is ubiquitous between small biotechnology R&D firms and their partners. Staging releases investment funds as the R&D firm passes preset milestones—this is discussed in more detail in Chapter 14.
The overarching conclusion about the profitability of joint ventures, alliances, and minority equity investments is that, like M&A, it is profitable for targets, a break-even proposition for purchasers, and for both target and purchaser combined, an economically positive activity. Exhibit 6.13 summarizes findings across 12 studies and shows significantly positive abnormal returns of 0.5 to 1.0 percent to firms announcing investments in JVs. JVs seem to pay. The findings suggest that JV partners do better when:
Buyers have good investment opportunities. Chen et al. (2000) find that where the buyer has a good record of investment returns, the announcement of a JV is associated with gains to shareholders. But where the buyer’s record is weak, the JV announcement could be taken as a signal of pessimism about the buyer’s internal opportunities.
JV increases focus for the buyer. Ferris et al. (2002) find materially better returns for buyers where the JV increases the business focus of the firm.
JV reduces agency costs. Allen and Phillips (2000) concluded that intercorporate equity investments in the form of JVs, alliances, and minority stakes reduced “the costs of creating, expanding, or monitoring the alliances or ventures between firms and their corporate block holders.” (Page 2813) Robinson (2001) argued that JVs help to shelter “underdog” projects from the adverse behavior sometimes found in internal capital markets (e.g., winner-picking). Allen and Phillips (2000) found that the returns from JVs and alliances were greatest in the instance of R&D intensive industries. These gains may stem from alleviating the problems of information asymmetries arising from the development of new technology.
JV is in a favorable foreign environment, in terms of laws and regulations. Returns from JVs vary by country and region, consistent with the discussion in Chapter 5 that variations in deregulation and rule of law will affect investment returns.
EXHIBIT 6.13 Summary of Studies of Market Returns to Parent Shareholders at Announcements about Joint Ventures, Alliances, and Minority Equity Investments
| Study | Cumulative Abnormal Returns at the Event | Cumulative Abnormal Returns after the Event | Sample Size | Sample Period | Notes |
|---|---|---|---|---|---|
| Gleason, Mathur, Wiggins (2003) | +0.51%* full sample +0.45%* domestic +0.60%* international +0.61%* horizontal +0.47%* diversifying | +7.94%† full sample +9.40%† domestic +4.05% international +14. 79%† horizontal +5.10% diversifying (months +1,+18) | 638 311 197 134 376 | 1985–1998 | Sample of deals involving financial services institutions. |
| Ferris et al. (2002) | +0.52%* whole sample +0.71%* focus-increasing JVs 0.11% focus-decreasing JVs (all estimates are around days –1,0) | +5.31% whole sample +9.43%† focus-increasing –1.42% focus-decreasing (estimates around months 1,36) | 325 200 125 | 1987–1996 | Sample of international JVs by Singaporean firms. |
| Johnson, Houston (2000) | + 1.67% horizontal JVs +5.0% suppliers in vertical JVs 0.0% buyers in vertical JVs | N/A | 85 horizontal JVs 106 Vertical JVs | 1991–1995 | Compared returns to JV investors with returns to firms using simple contracts. |
| Schut, van Frederikslust (undated) | +0.40% (days–1,0)* | 233 | 1987–1998 | Sample of Dutch JVs. | |
| Chen, Ho, Lee, Yeo (2000) | +0.96% (days–1,0)* |
