Acquisitions and Mergers - Dissertation Example

Acquisitions and Mergers “There are various theories that attempt to explain a firm’s motive to engage in merger or acquisition activity. With reference to the evidence provided in the academic literature, critically evaluate the extent to which various merger/acquisition theories help explain companies strategies on mergers and acquisitions “. Introduction Mergers and Acquisitions (M&A) is a common phenomenon and term used in business echelon. It is a part of organisational strategy to expand the business of a company or to acquire benefits from another company such as technological and other advancements of another company to their own benefit. It generally relates to management and corporate finances dealing with buying, selling as well as combining of various organizations for mutual growth and benefit without requiring any creation of separate or another business related unit. Merger and acquisition are two different business strategies. Acquisition mainly relates to buying process of a company termed as target by an acquiring company. Merger, on the other hand, relates to combining of two different companies into creation of completely different and a new company. Acquisitions are of different types like hostile, and friendly. From the business prospective, mergers are of different types like vertical, horizontal, and conglomerate mergers. The industry in which a firm belongs, and whether they are in similar industrial set up are considered by the merging companies before going for a merger. M&A activities became quite popular among the companies all across the world in the 1980s. In the late 1990s, merger activities ruled the corporate deals for the companies that wanted to be the global players by venturing outside of their own country shores. Deregulation and liberalisation emerged as two main reasons for companies’ willingness to venture in foreign countries. Change in business environment and also in technology has contributed to the increase of mergers. Rationale for Mergers and Acquisitions The main reason for companies going for mergers and acquisitions is their desire for increasing their market power and market reach. A company generally acquires market power in the situation when it is able to sell its services as well as goods at a price lower than its competitors or when their cost of production is much lesser, compared to their competitors. Therefore, most of the M&A takes place with this endeavour of increasing market power. The various types of mergers that are related to this scenario are horizontal mergers, vertical mergers and conglomerate mergers. Some other factors that encourages a company to venture out and think of M&A are overcoming entry barriers, cost of new product development, increased speed to market, lower risk compared to developing new products, increased diversification as well as that of reshaping a firm’s competitive scope. Mergers and Industry Life Cycle There is very close connection in between the industry life cycle and the level of M&A activities. The four stages of industry life cycle i.e. introduction, exploitation, maturity, and decline have a distinct role to play in merger and acquisition activities. In the initial stage, when a firm is on the growth path, the new as well as small firms are generally considered as a target for conglomerate or related mergers. The larger companies or firms initiate and provide financial as well as managerial efficiency which is required for M&A activity. Horizontal merger also takes place between relatively smaller companies or firms for acquiring financial and managerial resources. In the maturity stage, the horizontal and related mergers also occur for companies endeavour to match low cost and also price performance of other companies of their industry. Achieving economies of scale in research and also marketing and production are also part of main strategic decision making for undertaking M&A. In the exploitation stage, mergers are quite similar to introductory stage. The main impetus for mergers in this stage is reinforced by more observable indications of perspective growth and also profit and also by the large amount of capital requirements for achieving higher growth rate. In the decline stage, horizontal mergers are mainly undertaken for survival purposes, while vertical mergers are necessitated by the need for increase in profit margin and efficiency. A concentric merger relating to firms in related industry provides opportunity for carry over and synergy. Conglomerate acquisitions of firms and companies in growth industries are generally undertaken for utilising the funds accrued by mature companies primarily in the declining industries. In these industries, the internal flow of funds exceeds the amount of investment requirement of their own traditional lines of activities in business (ICMR, 2005). Management Capacity Perspective for M&A Activities Mergers and acquisitions are part of extremely crucial managerial decision making. A company can earn profit and place themselves in the global market echelon by undertaking successful M&A. In the recent time, there is a growth in literatures mainly on long range strategic planning. Modern literature on long range strategic planning provides indication related to it such as integration of the strategic planning process into a penalty or incentive and reward system, a consideration of capabilities, mission as well environmental related interaction from the standpoint of a company, emphasis on feedback process for dealing with ill structured problems. According to P. F. Drucker, financial factors work as a stimuli for mergers and acquisition activities. In order for a merger to be economically viable, it should follow five rules like a common core related to unity, the acquiring company or the acquirer has to contribute some benefit to the acquired company, the acquirer also has to pay respect to the business of the acquired company, within a span of an year or there on the acquiring company has to provide top management to an acquired company, and within a period of the first year of a merger managements ought to receive promotions across all the entities (ICMR, 2005). Economic Role in Mergers From the economic point of view, in case of mergers and acquisitions, the perspective of the acquiring company observes as a net addition to the companies stock of available assets as a prime activity. The implication of this scenario is that a considerable portion of merger related activities has to be explained by various factors which work to motivate companies for expansion and growth. Also internal investments and mergers ought to be related as both of them are similar processes for adding in to a company’s productive capacity and asset base. Therefore, the decision to go in for acquiring a firm or to invest internally comes down to the consideration of relative net benefit. From the study and regression analysis of industry, level determinants of various mergers as well as non merger related investments can be seen that industry capacity utilisation has got considerable and also opposite effect on merger and non merger related investments. Excess amount of capacity drives consolidation for industry during mergers, while peak capacity utilisation encourages industry related expansion during non merger investments. Majority of the industry level empirical analysis is based on industry wide measures relating to annual merger and investment and its intensities. In this process, the intensities are compared across industry, time and also types of mergers as well as non merger related investments because these are generally insensitive to any change or variations in compositions of industry. Annual industry level intensity are divided into six types like merger, own industry merger, diversifying merger, CAPX, R&D, and non-merger investment. Industrial organisation theory suggests about the fact that the level of merger related activities are affected by changing industry conditions and characteristics. Thus, to control any difference in industry structure a natural logarithm of the market concentration index is included. It also attempts to capture shocks toward the industry by the inclusion of lagged sales growth and also the absolute deviation of sales growth from the long term mean. Although, it is considered as very weak level of proxy as it mainly captures shocks related to demand, and it fails to identify technology related shocks which mainly affects production and related costs as well as any kind of forward looking industry oriented changes like anticipated deregulation. Therefore, from the economical aspect mergers lead to improvement in profitability and also in value. Mergers play a twin economic role like mergers such as internal investments help companies to increase its capital base in their response to notable growth oriented prospects, and both merger as well as non-merger related investment are positively part of firms Tobin’s ‘q’ and also sales growth. Mergers facilitate industry contraction. Clustering associated with mergers provide facts that industry shocks brings about mergers (Andrade & Stafford, 2002). Investor Mis - Valuation Drive on Takeover Irrational misplacing related to stocks generally influences the volume as well as character of takeover activities. Irrational misvaluation of bidders, stock of targets and aggregate stock market has an influence on the decision of both bidders as well as the target. Any misvaluation measure relates to aggregate volume of any takeover, the various means of payment selected, the likelihood of the success of the offer made, the premia paid, announcement period and long run abnormal stocks, the decision of targets of opposing a bid, and returns which may arrive from the diversifying acquisitions. A decision to purchase another firm is a very important investment decision. Misvaluation which leads to discrepancies in current market value or price of a firm or company is very important decision on the part of the management (Dong & Et. Al., 2003). Cross – Country Mergers and Acquisitions Cross country or border M&A are one of the major features of modern business activity. Corporate used this strategy to set up production facilities in a foreign location. In its initial stage, the companies and firms from United States dominated mergers and acquisitions but it has shifted to non United States based companies as well. Cross border M&A is not restricted to any specific industry. Despite seeking control for bilateral trade, cultural, geographical differences, and relative GNP per capita it is seen that target for this merger are comprised of mainly countries which has inferior investor protection as compared to their acquirer (Rossi & Volpin, 2004). From this result it can be seen that cross border M&A activities are an important channel for the purposes of successful worldwide convergence in the standard of corporate governance. The main reasons behind these mergers are growth, technology, differential labour costs, government policy, source of raw material and productivity (ICMR, 2005). Selling a company to a foreign organisation is a type of contractual convergence. It is quite similar to the decision of listing in countries which has better corporate governance and organised capital market. The firms which are located in nations which have weaker investor protection are generally sold to buyers from nations which have stronger investor protection. Q- Theory of Mergers Q- Theory related to mergers tells about the various factors of investment associated with it. The theory states that a firm’s investment rate ought to raise with its Q i.e. the ratio of market related value to the replacement cost of capital. This theory helps in the understanding of the reason behind a firm’s endeavour of buying another firm. By this theory it is seen that a firm’s M&A investment responds to its Q much more nearly by a factor of 2.6 then its direct investment does. It is because M&A, investments can be considered as a high fixed cost as well as low marginal adjustment cost activity. Also, a typical firm generally wastes a certain amount of money on M&A but not on their other internal investment activities. A firm with high Q value more often than not, buys low Q firms. It is observed since 1973 that in more than two thirds of all the mergers the Q of the acquirer exceeded the Q of the target. Total takeover returns are generally greater in case of the target when it has a lower Q and also if the bidder had achieved a high Q. Therefore, mergers largely occur by a channel which comprises of capital flows, better management and also better projects (Jovanovic & Rousseau, 2002). Acquisitions Driven by Stock and Equity Overvaluation can drive a firm or a company in to using its stock for acquiring another firm. The stock of the acquiring firm is generally not overpriced. The factors which impede value creation for an acquirer stockholder despite announcing a comparatively large overvaluation includes acquirers paying of large amount of premiums to the targets and also the investors’ correction of an acquirer overvaluation during the bidding period. The CEO of the acquirer also acquires a large amount of new stock and also new option grants after the completion of the acquisitions. They also realises a net gain in terms of wealth. Therefore, it can be recognised that an equity overvaluation largely increases agency costs and also the resulting actions which mainly benefits managers in excess of shareholders (Fu & Et. Al., 2008). In market valuation model of mergers, which constitutes under the Q- theory related to acquisitions, it is observed that firms are generally highly valued because of the their two features like they are well run and they have a high portion of NPV (Net Present Value) opportunity. Market value mainly reflects managerial and also growth opportunities. There is significant difference between the Q-theory and the valuation theories related to mergers is that in long run stock returns ought to be either positively related or unrelated to Q as they must be negatively related to overvaluation. The Q-hypothesis generally works in predicting the long run returns. It states that long run returns has to be either positive or zero. In case of equity financed takeovers, the abnormal returns in the long are prominently negative. The acquirers which are generally undervalued in comparison to their targets have inferior long run returns. Whereas relatively over valued acquirers have better long run return (Bi & Gregory, 2009). Stock market driven acquisitions is a field in behavioural corporate finance which comprises of rapid growth. Corporate policies like equity and debt, share repurchases, dividends, and also investment are a reaction to market mispricing. Mispricing is a given phenomenon but companies gain much benefit by overvaluation of their equity. It enables them to look out for acquisitions by using stocks (Shleifer & Vishny, 2002). Stock overvaluation entices a firm to try and acquire another firm. It is generally providing management the needed motivation to look for global business expansion as well as expansion in terms of market profit and market share. In general, we find that acquiring companies are mainly overvalued than a non acquiring firm. Acquirers are more overvalued as compared to their targets. From the overvaluation driven acquisition theory it is seen that overvalued companies are generally found out to be more in favour of using stock as an option for their payment. Overvaluation also increases the probability figure of companies of turning out to be an acquirer. They generally use their own stocks as a medium of exchange. In case of an overvaluation of a combined firm a figure is taken into account which their shareholder doesn’t loose (Ang & Cheng, 2003). Effects of Mergers and Acquisitions Strategy on Firms’ Information Technology Strategy In this era of globalisation many a company looks for series of mergers and acquisition activities to achieve growth and success. Information technology is a very important factor which sways the success of merger activities. In case of various mergers and acquisitions types like vertical, horizontal and also relatedness and unrelated strategies associated with M&A, information technology related strategies are automate and informate. The control variables are the industry and the firm size. Information technology related investment plays a significant role in the success of various mergers. Information technology related synergies are significant contributor to the post merger success. Information technology can certainly provide a company with a significant edge after the completion of mergers (Dao, 2007). Conclusion In recent times mergers and acquisitions have become a significant part of organisational and managerial decision making. The wave of mergers has been contributed by high stock market oriented valuations. Merger waves have been brought about by industry shocks. Also, the other contributing factors are technological, regulatory, and economic (Harford, 2004). In this era of globalisation, cross border mergers have also been quite successful. Companies are generally provided with the option to go in for M&A activities rather than internal developmental activities. They have recognised the fact that M&A, brings in varied opportunity for growth and progress by making use of varying knowledge and skills of the acquirer as well as that of the acquiring company. References Andrade, G. & Stafford, E., 2002. Investigating the economic role of mergers. Journal of corporate finance, Harvard college. [Online] Available at: http://www.people.hbs.edu/estafford/Papers/InvestigatingMergers.pdf [Accessed July 1, 2010]. Ang, J. S. & Cheng, Y., 2003. Direct Evidence on the Market-Driven Acquisitions Theory. Florida State University. [Online] Available at: http://www.efmaefm.org [Accessed July 1, 2010]. Bi, X. G. & Gregory, A.,2009. Stock market driven acquisitions versus the Q theory of takeovers –The UK evidence. University of Exeter. 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