M&A is being made more difficult by the speed at which the economic and regulatory environment is changing. But cross-border deals can be a source of significant value creation, and present attractive opportunities for companies to seek growth in new markets or accelerate expansion where they already have operations. What is more, evidence suggests that M&A activity undertaken during periods of high volatility offers greater long-term value to shareholders than M&A in steadier market conditions. Despite market volatility, now may be a good time to embark on cross-border activity.

This report, published by Clifford Chance and including analysis from the Economist Intelligence Unit, looks at how companies identify, assess and manage the risks and opportunities involved in cross-border M&A. Based on a global survey of senior executives from companies that have conducted deals in the past two years, and a programme of interviews with industry experts and commentators, the report explores ways in which companies can achieve successful cross-border deals through preparation, agility and effective risk management in a fast-changing economic environment.

"Insurance is pretty stodgy business," began an article in The Economist in March 2010. But the article went on to describe a deal that was anything but stodgy. AIA, the Asian business of US insurer AIG, had accepted a US$35.5bn takeover offer from Prudential, the UK insurer, which would provide, The Economist continued, "a closely-watched test of what can and cannot be done by financial firms as they try to build Asian franchises."

And so it proved. The announcement of the deal caused a 20% drop in value of each company's shares. A core of shareholders, believing the US$35.5bn offer was far too big, forced Prudential to put the deal to a vote, which it lost. AIG refused to lower the purchase price and the deal collapsed, leaving Pru shareholders with a £450m bill.

The demise of this deal highlights the risks and barriers regularly encountered by would-be deal-makers as they brave a volatile M&A market to seek opportunities outside their home markets. In addition to increasing shareholder scrutiny of deals, the antitrust environment in many developed markets appears to be tightening. New entrants into high-growth, emerging markets must also get to grips with new, increasingly sophisticated and yet untested regulatory environments.

M&A is being made more difficult by the speed at which the economic and regulatory environment is changing – the twists and turns of the market mean that buyers and sellers need to be well-prepared, have flexible strategies, and react quickly to the latest challenges. Buyers and sellers who develop creative solutions – to bridge valuation gaps, for example, or circumvent regulatory difficulties – will have an edge on success in the new era of cross-border M&A. Existing practices for risk assessment also need to evolve to the developing environment. Equally important is the need to overcome language, cultural and management challenges that are inherent with expansion into new markets and geographies.

Overcoming these challenges is a necessity. Cross-border deals can be a source of significant value creation, and can present attractive opportunities for companies to seek growth in new markets or accelerate expansion where they already have operations. The opportunities for these investors are plentiful and significant, and in many cases represent an essential part of the long-term strategy of the business. Now may be a good time to embark on cross-border activity – evidence is mounting to suggest that deals executed during periods of high volatility offer greater long-term value to shareholders than those undertaken in steadier market conditions.

This report, which is produced by the Economist Intelligence Unit and commissioned by Clifford Chance, looks at how companies identify, assess and manage the risks and opportunities involved in cross-border M&A. Based on a global survey of senior executives from companies that have conducted deals in the past two years, and a programme of interviews with industry experts and commentators, the report explores ways in which companies can achieve successful cross-border deals through preparation, agility and effective risk management in a fast-changing economic environment.

Key findings

Companies are maintaining a cautious approach to M&A activity. Continuing volatility in the global economy means that most companies are taking a cautious approach to deal-making. Survey respondents are fairly evenly split between those who plan to expand through organic growth (55%) and those who intend to prioritise inorganic growth (45%). Companies also appear inclined to stick to what they know, rather than diversify into new areas: 79% of respondents say their company 's current growth strategy is to develop its core business.

M&A opportunities are seen in emerging, high-growth markets. Respondents may be cautious about the prospects for deal activity, but in general they are more excited about the possibility of M&A in emerging markets than anywhere else. When asked to choose the key focus of their growth strategy, 56% select emerging, high-growth markets, as opposed to domestic or developed markets (both 22%).

Alongside new opportunities, new risks are also emerging. Companies embarking on cross-border M&A appear acutely aware that they face different risks to those they might have to deal with in their established markets. This group sees protectionist measures and political pressure as key political risk factors, maybe reflecting recent high-profile interference by politicians and regulators in M&A deals. Meanwhile, shareholder scrutiny is also seen by survey respondents as a risk for their M&A strategies, particularly for those focused on cross-border deals. As they seek new markets, companies will need to bear in mind the interests of their key stakeholders at home.

Cash is king for acquirers. For those that are planning acquisitions, accumulated cash reserves remain the preferred method for funding M&A deals, except for the US where bank borrowing is the preferred financing route.

Shareholders are influencing M&A strategy. Companies embarking on cross-border M&A increasingly see shareholder pressure as an influence on strategy. Overall, 18% of respondents say shareholder pressure is a main driver for pursuing M&A activity, and this increases to 26% for North American respondents. Many companies, particularly in the US, have come through the crisis with strong balance sheets and deep reserves of cash. Shareholder sentiment over whether such cash should be deployed for new investments, or returned to shareholders, is an increasingly important factor in their strategic planning.

The competitive landscape will be a key barrier to M&A activity, suggesting that, for now, prime M&A targets are scarce and therefore likely to be pursued by multiple buyers. When asked about the key risks that could derail their M&A strategies, respondents point to increased competition for assets as the leading factor. One reason for this could be a shortage of attractive assets and investment opportunities, combined with a pervasive mood of caution in the market. Continuing economic uncertainty means many vendors conclude that now may not be the best time to sell. A focus on emerging markets is also a likely cause, with many companies courting a limited supply of prime targets in these economies in the absence of growth opportunities closer to home.

Joint ventures are becoming increasingly important as companies seek ways of sharing and mitigating risk in cross-border deals. The financial, cultural and political risks inherent in cross-border deals mean that many companies are taking a more gradual approach to gaining a foothold in the market. A desire for risk-sharing, and recognition that local partners can play a vital role in smoothing the investment process, means that companies increasingly prefer joint venture arrangements when investing across borders. Investee companies, in turn, often see minority investment by more sophisticated partners as being for mutual benefit. Protectionism and foreign ownership policies are also factors at play in this trend.

Concerns about cultural differences can be an important deterrent to cross-border deals. Despite the growing need for companies to invest in new markets in order to realise their growth ambitions, more than one-half say that they are discouraged from acquiring overseas because of concerns about bridging cultural differences. This rises to 63% for respondents in the US. Many companies admit that they find the softer side of deal-making challenging, with just 44% of companies saying that they are effective at handling cultural integration as part of the transaction process.