New Research from Yanbo Wang on Motivations for Cross-Border Reverse Mergers: Bonding Vs. Defrauding

in Emerging Research, Faculty, News, Strategy & Innovation
June 26th, 2013

From Siegel, J.I., & Wang, Y. (2012). “Cross-border reverse mergers: Causes and consequences.” Harvard Business School Strategy Unit Working Paper No. 12-089.

A new study by strategy scholars Jordan I. Siegel of Harvard Business School and Yanbo Wang of Boston University School of Management looks at the intersection of cross-border reverse mergers, corporate governance outcomes, and the motivational role of bonding vs. defrauding.

Firms typically pursue reverse mergers (where a non-U.S. company seeks to adopt U.S. state- or Federal-level corporate law by targeting a U.S. shell company bound by U.S. state- or Federal-level corporate law and merging with it) to gain a higher or lower level of legal oversight.

In their paper “Cross-Border Reverse Mergers: Causes and Consequences,” Siegel and Wang note that the literature on bonding has paid scant attention to reverse mergers involving state-level corporate law. They aim to correct this, in part because studying these mergers enables a comparison between firms who adopt only state-level corporate law and those renting both state-level corporate law and U.S. federal securities law.

Debunking assumptions about Chinese & Canadian firms in Nevada & Delaware

The researchers compile a study-set using statistics on cross-border reverse mergers into the U.S.; financial data from Capital IQ, Thomson ONE, Worldscope, and Osiris; SEC filing restatements and auditor changes from Audit Analytics; and data on formal enforcement outcomes. They then apply this data to widely held assumptions about cross-border reverse mergers. They explore such questions as:

  • Is Delaware vs. Nevada a good proxy for a firm’s decision to bond itself vs. to defraud investors?
  • Does the choice of a Big Four auditor prove far more important in determining the quality of corporate governance than the choice of U.S. state?
  • Do Chinese reverse merger firms show more frequent negative corporate governance outcomes that Canadian reverse merger firms (the two main sources of cross-border reverse mergers into the U.S.)?

They find that:

  • Later cohorts—companies who adopted the strategy of reverse mergers later, after the first wave of reverse-merger pioneers—tend to display more problematic accounting than the early adopters.
  • Firms with Big Four auditors tend to display less problematic accounting.
  • Chinese firms have no greater tendency to display problematic accounting than any other firms in the data set.
  • The location of Nevada for the reverse-merger  incorporation makes no difference in the likelihood of a firm displaying problematic accounting.

Are cross-border reverse mergers more corrupt than domestic ones?

The study also addresses whether the incidence of bad governance among the cross-border reverse merger sample proves different from among domestic reverse merger firms or American OTC firms in general. Among its findings:

  • The cross-border reverse mergers had lower incidences of trading suspensions than U.S. OTCs for nearly all of the sample time period.
  • The cross-border reverse mergers had lower incidences of SEC enforcement than either the domestic reverse mergers or the American OTC firms for nearly the entire sample time period.
  • The cross-border reverse mergers had an incidence rate of private litigation that was mostly the same or lower than the two comparison groups for most of the sample time period.

Download a copy of the paper “Cross-Border Reverse Mergers: Causes and Consequences.”