Possible Motives for Mergers - Assignment Example

1. Discuss the possible motives for mergers A merger of two firms should invariably result in a "positive," i.e., it should result in increased volume of revenue from the combined sales or decreased operating cost or decreased investment requirements (Becher 2000). If the effect is neutral, i.e., no change is effected over the standalone positions, the whole labor of merger exercise would go waste. On the other hand, if the combined effect is "negative," the merger may even prove fatal later. Some mergers look for cost-based economies of scale, some may look for revenue-based economies of scale, safety net-based economies of scale, defense-based scale of economies, etc. Similarly, 'economies of scope' is also varied in nature: Cost-based economies of scope, revenue-based economies of scope, and diversification-based economies of scope. Reduction in Expenses - A merger must result in adoption of new technologies, goals, strategies, and operational approaches in such a way that they cumulatively lead to cost reduction in delivering the services and thereby make the merged-entity more competitive in garnering increased sales and net margins. Enhanced Market Power and Reduced Earnings Volatility - It is obvious that the acquired business should either add to the market share of the company or create a fresh niche market of its own, so that volatility in earnings can be minimized and profitability is sustained. Earnings are sustained only when sales performance constantly improves and that is where mergers come handy in creating that extra "edge" over the competitors with the least loss of time. Smooth Privatization - The ongoing sovereigns' love for deregulation and privatization resulted in cross-border movement of capital mostly into developing economies for acquiring controlling interests in companies being privatized. Indeed, many developing countries could attract fresh capital and modern technology into their otherwise obsolete public sector businesses and make them competitive through cross-border mergers/acquisitions. Competency Buildup - In today's deregulated markets, "competency" of domestic businesses has become a must, to face the onslaught from multinationals. In this regard, mergers have come handy for consolidation and buildup of requisite "scale of economies" and "scale of scope", to maintain the revenue stream with least volatility (Houston 2001). Tax Gains- Mergers and acquisitions attract capital gains tax in the hands of the amalgamated company/acquired company on the sale of its assets and shares. However, the treatment of taxing capital gains is not the same globally. A few countries such as Singapore and Malaysia, tax capital gains on real estate or shares in real estate at special rates, while Hong Kong exempts capital gains. Indonesia and Thailand tax the capital gains arising on the sale of shares and other assets at the normal rates of tax. 2. What sort of problems commonly result in mergers failing to achieve all of the promised efficiency gains Failure to anticipate a problem before the problem actually arises - Managements may unwittingly administer a merger process hoping to reap synergy or they may initiate a disastrous step hoping to bring cultural fusion between the acquired and the acquirer. One common underlying reason behind these acts could be that the acquirer firm may have no experience of such problems and thus are not sensitized to such probabilities. It is only in the hindsight that the analyst could say today that merger of copper business was a mistake, unless one increased its production capacities, to enjoy operating leverage. There are umpteen reasons as to why companies may fail to anticipate problems: Failure to perceive the problem, when the problem does arrive - Once a merged unit faces unanticipated problems, the immediate requirement is to address the issues that became a hurdle for realization of anticipated benefits. But in reality, managements seldom perceive the problem that has actually face and reasons for the same could be many: One, the origin of the problem is perhaps hardly visible; two, the management of the merged unit sitting distantly from the acquired unit is more prone not to see the problem in its real perspective; three, managements could fail to perceive the problem because of its "creeping nature". Fail to attempt to solve the problem after perceiving it - Many firms fail even to attempt to solve the problems despite perceiving them well in time. The reasons for such indifferent behavior could be many and they may even be argued as "rational behavior" resulting from clashes of interest between people. Tried but failed to solve the problem - It is also not uncommon for managements to try solving a problem but still failing in it. The reasons could be many: The problem may be beyond the present capacity of the management to solve it, it may be too expensive to solve it, i.e., the solution may be costlier than the outcome, it may be too late to attempt to solve the problem, the management did not attempt to solve it wholeheartedly, etc. At times the solution might have even backfired. 3. Discuss the possible benefits and costs to firms of going public The sources of capital for a business organisation is determined on the basis of the type of firm, i.e., whether it is a sole proprietorship concern, a partnership firm, a private limited or a public limited company. Because, the sources available and the privileges enjoyed by these various forms of organisation vary widely. The largest number sources available and the maximum privileges enjoyed with respect to capital formation is public limited company or popularly known as corporations. The sources of capital available to a corporation are manifold. Again, it depends upon whether the corporation is an existing one or a new one. Undoubtedly, the existing company is more likely to attract many sources than a newly set up company. The reason being, investors/suppliers of capital would find relatively low risk and high return out of the investment in an established firm (Lerner 1994). Access to Equity Share Capital with limited liability This capital is raised by issuing equity/ordinary shares to the public at large. When these shares are purchased, the investors will become the shareholders/owners of the company. This source denotes the permanent capital for which the investors do not ask for any fixed rate of return. This capital need not be paid back to the investors as long as the company is in existence. Thus, equity source is the least risky source of fund from the view point of borrower. At the same time, when the company makes huge profit, the profit left after meeting all obligations might be distributed among the equity shareholders, and this is the most appealing factor of equity capital. That does not mean that company has to distribute capital whenever it makes residual profit (profit left after making all other payments). The decision to distribute or not to distribute divisible profit is ultimately taken by the Board of Directors. The return to ordinary shareholders (dividend/cost to the company) is paid after meeting all payments like dividend to preference share holders and interest payments to debenture holders and other long term suppliers of funds (Mikkelson, 1997). Access to Preference Share Capital Investors of preference capital must be paid periodic fixed return and the redemption of maturity value at the end of the period for which money is invested. As far as the company is concerned, preference share capital is more risky than equity capital. In case the company makes no profit in a particular year, there is no excuse for the non-payment of preference dividend. The unpaid dividend will get accumulated in the coming years and the company has to pay dividend when there are extra profits (Pagano 1993). Access to Long-term loans such as Debentures This is absolutely a creditor ship security. This is a loan arrangement in which the company issues securities to the lenders on the condition that interest (return) shall be paid periodically until maturity and maturity value after the stipulated period. The interest payment to debenture holders is a mandatory one irrespective of the volume of profit. However, this source is the most sought after one when the company needs funds for a short period of time as the interest rate is very low when compares to that of preference shareholders. Also, this source has a unique feature that the company benefits out of the use in the form of tax shield, when interest payment is deducted for the calculation of net profit (Ritter 1987). Availability of Retained Earnings This is a peculiar source available only to an existing firm. Retained earnings is an internal source of capital in contrast to the above three external sources. Retained earnings are that part of company's accumulated profit which has not been distributed among shareholders. In fact, it can be claimed by the equity shareholders, but, it remains with the firm until and unless it is used /distributed as directed by the BOD (Board of Directors). 5. What role can takeovers or the threat of takeovers play in maintaining good corporate governance 400 words Corporate governance, the buzzword of the modern business world is not another fad that would run its course and get buried in the annals of history; it is an inevitable reality that cannot be overlooked. There are a number of external forces acting in tandem to force companies adhere to a set of corporate governance principles. Liberalized and open market environment, enlightened investing community, strict regulators, demanding customers and above all the awareness among companies themselves that they should be good corporate citizens while ensuring the perpetual flow of profits. Corporate governance is the system by which companies are directed and controlled. It encompasses within its fold the whole gamut of policies, procedures and practices that are present in the organization of a company to achieve the objectives as enunciated in the Memorandum of Association of a company. In the words of Anand, President of the World Bank, "Corporate governance is about promoting corporate fairness, transparency and accountability." Thus, the true essence of corporate governance is found in the relationship of various participants in determining the direction and performance of organizations. The success of corporate governance rests on the awareness on the part of companies of their own responsibilities. While law can control and regularize certain practices, the ultimate responsibility of being ethical and moral remains with the companies. It is this enlightenment that would bring companies closer to their monetary and otherwise goals. However, while all this looks good on paper it runs into considerable difficulty during implementation. The difficulty is compounded given the fact that there are easier ways, which give faster returns that are no less valuable because they are acquired through questionable means. For reasons of gaining a foothold in the global arena and for accessing the huge pool of funds from the foreign markets, a few Indian companies have begun proactively embracing the best corporate governance practices and transparency. Family run businesses too are treading the path of professionalization. With the opening up of economy, many private corporates have gone public. As more and more investors get tied up through their equity investments in companies, the moral responsibility and accountability of the companies' increases manifold. It becomes imperative for them to be transparent and disclose information to the myriad interested parties. This concept has been in vogue for quite sometimes now in the developed markets such as the UK and the US, but India Inc. is waking up to the moral responsibilities of being good corporate citizens. References Anand M and Singh J (2008), "Impact of Merger Announcement on Shareholders' Wealth: Evidence from Indian Private Sector Banks", Vikalpa: The Journal for Decision Makers, Vol. 33, No. 1, pp. 35-54 Becher D (2000), "The Valuation Effect of Bank Mergers", Journal of Corporate Finance, Vol. 6, No. 2, pp. 189-214 Degeorge, Francois, and Richard Zeckhauser, (1993), 'The reverse LBO decision and firm performance: Theory and evidence'. Journal of Finance 48, 1323-1348. Dharan, Bala G., and David L. Ikenberry, 1995, The long-run negative drift of post-listing stock returns. Journal of Finance 50, 1547-1574. 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