The United States has had a longstanding policy of openness to foreign direct investment, making it the world’s top destination for cross-border acquisitions. These investors have resulted in improved U.S. shareholder wealth as foreign acquirers pay large cash premiums, even compared to domestic buyers. In new research, Finance Professor Darius Miller of SMU Cox and his coauthors show that securities regulation intended to bolster U.S. national security reverses this trend. Increasingly, America is seen as being closed for business, particularly to some countries caught in the political crosshairs.
From 1998 to 2018, foreign investors spent an average of $289 billion per year acquiring U.S. firms, roughly 19% of all M&A activity, the paper notes. “When the government prevents industries from accessing foreign investment or being taken over, these buyers usually pay cash and higher premiums than domestic firms,” Miller says. “If you own stocks in your 401(k), one way for firms to make money is to be acquired. If you have the wealthiest purchasers taken out of the equation who could buy your business, that’s going to have a detrimental effect on the firm’s stock price.” These protectionist moves come at a cost to shareholders. They might have national security benefits — but it comes at a price.
The Committee on Foreign Investment in the United States (CFIUS) has broad powers to revise or reject foreign acquisitions of U.S. firms deemed critical to national security. This regulator is at the behest of the Executive Branch. The 2008 law, the Foreign Investment and National Security Act (FINSA), allows CFIUS to make or break deals with foreign buyers. Unlike most U.S. securities laws, congress created FINSA by amending the Defense Production Act of 1950. The act requires that even basic details about CFIUS interventions remain classified. More recently, we’ve heard of the use of the Defense Production Act during the COVID-19 pandemic as the U.S. sought to repurpose manufacturing of N95 masks, ventilators and other health items to battle the virus.
The research shows that this law deterred foreign acquisitions across a large portion of the U.S. economy and lowered U.S. firm values. The results document a tradeoff between national security and shareholder wealth: The regulation intended to improve national security reduces foreign demand for U.S. equities and lowers firm value. “There are national security interests that have to be factored in, but no one has looked at the costs of doing that,” says Miller. Their paper is the first to analyze the tradeoff between this national security law and its economic consequences.
“The FINSA law affects so many different industries in the U.S.,” says Miller. “It is so important at this time.” The study showed that one-third of the Compustat universe of U.S. firms are affected by the law as they are considered critical to national security. The authors found that foreign acquisitions of firms with CFIUS influence (or national security firms) declined by one-third to one-half compared to the period before the law was enacted.
According to the research tally, national security firms lose 3.12% of their market value, or $60 billion in aggregate, surrounding the FINSA law’s evolution. The authors say that FINSA has created new foreign investment barriers and has affected the U.S. takeover market in a serious way.
Less Attractive to Foreign Investment
In early 2018, CFIUS denied Moneygram’s acquisition by Ant Financial, a Chinese fintech firm, on national security grounds. Moneygram’s stock declined in the immediate aftermath. “In our research, we look at the law as an economic shock,” Miller says. “It affected many firms.” Given the secrecy, neither foreign nor domestic market participants know which M&A deals are investigated and why, or whether regulators impose national security risk mitigation agreements or prohibit transactions.
As a top destination for foreign direct investment in cross-border transactions, that U.S. title may be changing now given the protectionist barriers and the reputational hit. Miller notes that once CFIUS has had the ability to block or dissuade cross-border acquisitions, they are declining, according to their results. “The idea is that there is a deterrent effect,” he says. “The threat of CFIUS investigation or their requirements dampens the attractiveness of the U.S. takeover market to foreign companies.”
These barriers are clearly hurting U.S. capital markets, according to Miller. But since it’s under the auspices of national security, rather than an individual investor affliction, says Sarbanes-Oxley regulation, it flies under the radar with less controversy. “Foreign companies will go elsewhere, however,” Miller says. “This activity is also under the whims of the Executive Branch or whoever is in power that appoints these secretive committees.”
It’s important to talk about the costs of these national security denials of acquisitions. “We talk about national security benefits,” says Miller, “like not having technology fall into hands of adversaries, which is good. They are real. But we never talk about the cost to shareholders to prevent this technology from being deployed. Is it worth the billions of dollars we document, in order to prevent a financial services transaction going to the Japanese, for example?” The fintech of Ant Financial with its announced super-sized IPO is probably more valuable than ours in a lot of ways, Miller says. “Related to Moneygram, did thwarting that move really improve our national security? Knowing more about the cost, putting that back in the conversation, is important to see if the national security benefits you get are worth it.”
“National Security and Shareholder Wealth,” by Darius Miller, SMU Cox School of Business; David Godsell, University of Illinois; and Ugur Lel, University of Georgia, is under review.
Learn more about SMU Cox School of Business.