Institutional Quality and MNC Investment:

Evidence from Russia NES 20th Anniversary

Randolph Bruno, Saul Estrin and

Catherine Thomas

December 2012

1

Introduction • This paper examines the role of institutional quality (IQ) in

determining the local efficiency gains from FDI through

M&A using data from Russia;

• There is a large literature about the relationship between IQ

and economic outcomes (Shleifer et al. 1997; Berkowitz et

al., 2004; Acemoglu and Johnson, 2005; Cull and Xu, 2005,

etc.);

• A subset of this literature examines FDI and IQ. For

example, Javorcik and Spatereanu (2011) show that the

source country of the parent matter for the benefits of

inward-FDI because it affects the extent of local sourcing

and, hence, the potential for vertical spillovers.

2

Introduction (cont.ed) • When M&A is efficient, we expect to see efficiency gains

reflected in higher productivity levels in a merged firm.

• National and local policy initiatives seeking to encourage

FDI are fairly common, in certain sectors, across many

countries.

• More generally, the local institutional environment is likely

affect investment decisions, including firms’ decisions to

upgrade productivity.

• Our starting point: The returns from undertaking M&A

activity are related to the quality of the local institutional

environment of the acquired firm.

• This paper studies this relationship in the context of

acquisitions of Russian firms by domestic and foreign

parent firms, between 2001 and 2010. 3

Novel Data 1. Institutional quality measure (Bruno, Bytchkova, Estrin, 2013):

Political Turnover in Russian Regions (Subyekt Federatsii) between 2001-2010.

a) Occurrences of elections (NB: no election after 2005)

b) Occurrences of governor’s change (regardless of elections)

c) Occurrences of change of the political circle (regardless left or right)

d) Overall summary indicator of Political Fluidity (0 status quo, 1 election, 2 governor change, 3 new ‘opposition’ governor).

2. M&A: Zephyr (BvD), we currently have data on nearly 10,000 M&A in Russian target firms from domestic and foreign investors – both leading to control and minority stake acquisitions, of these around 1200 involve a non-Russian acquirer firm.

3. Firm-level performance data: ORBIS (BvD) we currently have financial data on around 5500 of these target firms (in a panel).

4

Map of Russia

5

Political Fluidity

6

M&A Acquisitions: Firm-Year Pattern

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Total

Never

Acquired 107558 126511 130765 177128 190117 197319 203631 205161 191421 309634 1837200

5.8% 6.9% 7.1% 9.6% 10.3% 10.7% 11.1% 11.2% 10.4% 16.8%

Domestic 48 70 133 304 303 459 927 908 910 791 4852

1.0% 1.4% 2.7% 6.3% 6.2% 9.5% 19.1% 18.7% 18.8% 16.3%

Foreign 11 14 30 42 76 92 137 132 82 64 680

1.6% 2.1% 4.4% 6.2% 11.2% 13.5% 20.1% 19.4% 12.1% 9.4%

Total 107617 126595 130928 177474 190496 197870 204695 206201 192413 310489 1844778

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M&A Main Regions

outcome Moscow St. Petersburg Other Regions

Never Acquired 771,073 137,921 928,206 1,837,200

42% 8% 51%

Domestic 783 263 3,806 4,852

16% 5% 78%

Foreign 143 73 464 680

21% 11% 68%

Total 771,999 138,257 932,476 1,842,732

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M&A main Patterns: 1. The bulk of acquisitions after 2007-2009.

2. There is particular concentration in Moscow (16% of all

domestic and 21% of all foreign M&A) and St.

Petersburg (5% of all domestic and 11% of all foreign

M&A), but still the overwhelming majority is outside

these two federal cities.

3. There is also evidence of sector dispersion (but financial

sector and manufacturing cover around 50% of all

deals), i.e. not concentrated in extractive industries (oil

and gas).

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Outline of Empirical Approach • We focus on how the "quality" of the host country

institutions affects the "quality" of M&A activity, in terms

of the productivity-upgrading undertaken by acquired

Russian firms, as well as the quantity of acquisitions.

• This suggests that the type of firms being acquired, by

foreign, but also by domestic parents, may also vary with

the local institutional context.

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Institutional Quality and Post

Acquisition Performance:

Φi,t=α+β(Fluidityt)+γ(Acquiredi,t)+δ(Fluidityt*Acquiredi,t)

+ζ(Foreigni,t)+η(Foreigni,t*Fluidityt)+i.T+i.I+εi,t

a) Φi,t : ln Sales per Employee (labour productivity)

b) Fluidity: Summary Indicator of Political Turnover

c) Acquired (minority & majority ): step dummy

d) Foreign: step dummy conditional to be

Acquired(=1), Foreign M&A

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Productivity (LHS) and Political Fluidity (RHS): The role of M&APooled

Pol. Fluidity -0.0088***

(0.0014)

Acquired

Acq*Fluidity

Foreign Acquired

Foreign*Fluidity

Year FE Y***

Firm FE N

Obs: 1661274

Nr. Firms 517839

Clustered SE in parentheses12

Productivity (LHS) and Political Fluidity (RHS): The role of M&A

Pooled Firm FE

Pol. Fluidity -0.0088*** -0.0076***

(0.0014) (0.0018)

Acquired

Acq*Fluidity

Foreign Acquired

Foreign*Fluidity

Year FE Y*** Y***

Firm FE N Y***

Obs: 1661274 1661274

Nr. Firms 517839 517839

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Productivity (LHS) and Political Fluidity (RHS): The role of M&A

Pooled Firm FE Firm FE

Pol. Fluidity -0.0088*** -0.0076*** -0.0076***

(0.0014) (0.0018) (0.0018)

Acquired 0.5243***

(0.0224)

Acq*Fluidity

Foreign Acquired

Foreign*Fluidity

Year FE Y*** Y*** Y***

Firm FE N Y*** Y***

Obs: 1661274 1661274 1661274

Nr. Firms 517839 517839 517839

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Productivity (LHS), Political Fluidity (RHS) and M&A (RHS)

Pooled Firm FE Firm FE Firm FE

Pol. Fluidity -0.0088*** -0.0076*** -0.0076*** -0.0082***

(0.0014) (0.0018) (0.0018) (0.0018)

Acquired 0.5242*** 0.3391***

(0.0224) (0.0487)

Acq*Fluidity 0.0415***

(0.0100)

Foreign Acquired

Foreign*Fluidity

Year FE Y*** Y*** Y*** Y***

Firm FE N Y*** Y*** Y***

Obs: 1661274 1661274 1661274 1661274

Nr. Firms 517839 517839 517839 517839

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Productivity (LHS), Political Fluidity (RHS), and M&A (RHS)

Pooled Firm FE Firm FE Firm FE Firm FE

Pol. Fluidity -0.0088*** -0.0076*** -0.0076*** -0.0082*** -0.0083***

(0.0014) (0.0018) (0.0018) (0.0018) (0.0018)

Acquired 0.5242*** 0.3391*** 0.3423***

(0.0224) (0.0487) (0.0514)

Acq*Fluidity 0.0415*** 0.0339***

(0.0100) (0.0108)

Foreign Acquired 0.0054

(0.1425)

Foreign*Fluidity 0.0542***

(0.0266)

Year FE Y*** Y*** Y*** Y*** Y***

Firm FE N Y*** Y*** Y*** Y***

Obs: 1661274 1661274 1661274 1661274 1661274

Nr. Firms 517839 517839 517839 517839 517839

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Summary of productivity levels analysis

1. Political Fluidity (uncertainty) has a negative impact on productivity in the cross-section, and within-firms over time.

2. Firms that are acquired have higher levels of productivity post-acquisition.

3. …but acquired firms see higher increases in productivity post-acquisition in politically fluid environments.

4. Furthermore, foreign-acquired firms have even higher relative level of productivity in politically fluid environments.

5. That is, the institutional context is associated with the extent of post-acquisition productivity growth, for firms acquired both by domestic and foreign parents.

6. Conversely, the extent to which instability is associated with lower productivity is mitigated when the firm has come under new control.

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Which firms are acquired? • The market for corporate control appears to function well,

particularly in politically unstable environments.

• We now turn to ask whether higher productivity-

upgrading on acquisition within politically fluid

environments is a consequence of the fact that different

types of firms are acquired in these contexts.

• That is: Can the results be attributed to a treatment

effect, or is there a selection component?

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Political Fluidity and Selection into Acquisition

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Logit Regression: The probability a firm is ever acquired

Acquired Acquired

Foreign

Acquired

Pol. Fluidity (average) -0.0884*** -0.0884*** -0.1131***

(0.0096) (0.0096) (0.0278)

Sales Per Employment (t0) 0.000 0.000

(0.00) (0.00)

Fluidity*Sales per Empl (t0) 0.000 0.000

(0.00) (0.00)

Sector FE Y*** Y*** Y***

Nr. Firms, Obs 575899 575899 575899

Discussion • So far, we have found no evidence that acquirers

(including foreign acquirers), select to buy more or less

productive firm when there is political instability.

• We will continue to investigate this in the panel.

• We are also turning now to understand variation in

productivity growth among acquired firms – e.g. is there

industry and regional variation?

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Conclusions

• Institutions matter for the productivity growth associated

with M&A market outcomes.

• Early findings are consistent with the hypothesis that

changes in corporate control create value and can act to

offset the negative effect of political instability on firm-

level productivity.

• These patterns are particularly pronounced for foreign

acquisitions of Russian firms.

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Extensions

• TFP, IV, propensity sore matching, extension of the data

Alternative Explanation

• Asymmetric information cost: foreign firm are much able to cope with uncertainty once entered in the market (ex post), but this not true ex-ante.

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Appendix: Acquisition patterns (1 digit sector breakdown)

outcome Agr. &

Mining Manuf. 1 Manuf.

2 Elect. Water

Supply Construction, Wholesale and

Transport Accomodation and

Food Financi. And Real

Estate Administrative &

Support PA and Educ. Arts and Other Total

Never Acquired 145,968 59,330 96,361 35,061 908,721 83,710 273,689 195,298 32,499 6,563 1,837,200

7.95 3.23 5.24 1.91 49.46 4.56 14.9 10.63 1.77 0.36 100

Domestic 452 509 959 481 776 328 835 421 67 24 4,852

9.32 10.49 19.77 9.91 15.99 6.76 17.21 8.68 1.38 0.49 100

Foreign 63 90 156 55 85 50 117 55 4 5 680

9.26 13.24 22.94 8.09 12.5 7.35 17.21 8.09 0.59 0.74 100

Total 146,483 59,929 97,476 35,597 909,582 84,088 274,641 195,774 32,570 6,592 1,842,732

7.95 3.25 5.29 1.93 49.36 4.56 14.9 10.62 1.77 0.36 100

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Appendix: Mean Sales/Empl by sector and year

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2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Total

Agriculture & Mining 807 831 643 1391 1960 2318 1909 2060 2067 2268 1660

Manifacturing 1 1243 1303 1674 2366 2684 5064 4293 4182 3593 4704 3491

Manifacturing 2 990 966 1545 3225 4764 4231 3726 3510 2493 2916 3011

Electricity and Water 2020 1714 2332 2550 4480 6738 5815 4771 3593 5315 4175

Construction, Wholesale &

Transport 2220 2244 3282 2290 3008 3863 3941 36029 2510 3817 6920

Accomodation and Food 1294 1697 1973 1735 1284 1367 1676 1569 1318 2414 1672

Financial and Real Estate 2370 3153 5599 1572 6928 12849 13624 8001 6733 5587 7151

Admistrative and support 3120 1879 2407 3061 2166 2801 3587 1922 1633 2322 4485

PA, Educationa and Health 1026 1885 2014 1245 1282 997 1255 1099 1116 2112 1384

Other 373 483 570 1468 1509 2640 5614 2885 3326 1093 2094

Total 5642 2024 2937 2210 3411 4935 5124 20130 3001 3855 5552

Foreign Direct Investment and

Performance • IQ may also affect the composition of target firms: recent

studies document positive selection into being acquired

(Arnold and Javorcik, 2009; Ramondo, 2009;

Guadalupe, Kuzmina and Thomas 2012).

• This suggests the "value-added“ through FDI (its

"quality") is increasing in the acquired firm's initial

productivity.

• On the other hand Estrin, Hanousek, Kocenda and

Svejnar (2009) analyse the effects of privatisation and

ownership (more relevant for our paper) in Transition

Economies more broadly.

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Hypotheses and Research Question: • Local institutional environment affects returns to M&A,

both on the extensive and intensive margin:

a) Increase in FDI;

b) When M&A is efficient, we expect to see efficiency

gains reflected in higher productivity levels through

upgrading in a merged firm.

• M&A decision to upgrade productivity is likely to affect the

costs, but also potentially the benefits: which prevail?

• We examine which institutions are related to the extent of

positive selection into foreign acquisition among Russian

firms, and also whether institutional quality is correlated

with subsequent productivity gains between 2001 and 2010.

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