The Effects of Merger and Acquisitions on the Recent Worldwide Financial Crisis - Assignment Example

? The effects of Merger and Acquisitions on the recent worldwide financial crisis Introduction Mergers and acquisitions are corporate terms, which refer to the coming together of two or more different entities, into a single trading entity, to take strategic business advantages such as economies of scale, increased market share and penetration, increased revenue, synergy due to better management and so forth. Most importantly, though, Mergers and Acquisitions come into play at times when firms are faced with a financial crisis that could lead to their collapse. These firms are taken over, or merge with other strong firms, to mitigate the risks of the crises. (J.S, 2001) Even though these terms are commonly used interchangeably, they have clear distinct meanings. Mergers occur when two or more entities come together (in a form of partnership) to form a single trading unit- the entities cease to exist and form a new firm. A good example is the merger of two banks Lloyds TSB and HBOS, following the global financial crisis, to form Lloyds TSB-HBOS (Rosenbaum, 2009). Acquisitions on the other hand, refer to one entity, the bidding company, taking over a target entity, by acquiring, through purchase, of its stakes that could include shares, stocks (majority control of its capital) or assets. For example, Lehman Brothers was declared bankrupt (at a debt of 613 Billion Dollars) due to the recent global financial crisis was bailed out by the American Federal Government (Mihm, 2010). Therefore, the major distinction between mergers and acquisition is the position of the shareholders. In mergers, the shareholders exchange their shares for shares of the new entity, while in Acquisitions; the target company is bought out, with shareholders paid in cash or debt. Objectives of Mergers and Acquisitions The current wave of M&A began in 2005. A report by the International Monetary Fund indicates that, during this time, the world’s real GDP grew by 4.8%. It also points out that, the reason for this trend was the fact that many firms especially in Europe, were preparing for the full implementation of the European Union and that the common Euro currency. This had led to the expansion of the Euro market, due to facilitated cross border trading (Emirates Centre for Strategic Studies and Research, 2009). Many business firms opt for M&A due to many reasons. To state briefly, it is argued most firms, go for M&A, to cut on production costs; that, it is cost effective in the long run to merge with or acquire a firm producing a raw material for the larger firm. This saves on market exchange costs while the synergy due to M&A cuts on departmental and running costs, compared to an increased revenue stream from a large market share and a centralized management. Secondly, M&A is seen to achieve competitive advantage, due to new market knowledge and goodwill acquired, territorial advantage of the native firm acquired. A firm will merge or acquire another, and excel in the new market, due to the knowledge and experience of the target entity, as opposed to efforts of the bidding company going to it alone, in the foreign market (Shan & Hamilton, 1991). Another reason for M&A is the financial advantage of tax reliefs. It is argued that a company which reports loses, is more likely to be bought off by another profitable one, as the target company’s reported loss will be utilized in reducing tax liability. However, most governments like the United States have legislations that limit and check against this practice (Mihm, 2010). A statistical study by Emirates Centre for Strategic Studies & Research indicated that, the Arabian banks and Companies, which are smaller in size compared to similar foreign institutions needed to merge so as to remain globally competitive. Also, indicated in the report is because, in the first three quarters of 2008, there were 48 mergers in the Middle East only (Emirates Centre for Strategic Studies and Research, 2009). Shan & Hamilton in their article “country-specific advantage and International cooperation” in Strategic Management Journal, state the other reasons for M&A is that, it increases efficiency in terms of the speed of marketing, beating competitors, improving products and services, and actually distribute business risks that would otherwise have been borne by a single company (Shan & Hamilton, 1991). The Recent Financial Crisis The recent global financial crisis in question began mid-2007, prolonged to 2011, with some effects still felt to date, by Nations, firms and households. It was characterized by sudden loss of asset values, loss in value of world currencies, inflation, collapse of some major stock markets, such as the New York Stock exchange, collapse and bankruptcy of major investment banks such as Lehman Brothers, Goldman Sachs, Morgan Stanley and Merryll lynch. It also led to the latest large number of Mergers, Acquisitions, and Bailouts by firms and governments with the aim of cushioning the effects of the crisis. The financial crisis was also felt in the mortgage and housing crisis, with housing sales and housing securities falling drastically within a very short period (Dwyr, 2009). In a report by the African Finance Ministers and Bank Governors, 2009 to the G20, it was reported that, due to the crisis, the continent’s economic growth was expected to dip below 3 percent in 2009, due to sudden decline in trade in and outflows and decline in government revenues (African Development Bank, 2009). Perhaps, the cause of the financial crisis was the fact that governments failed to check and adjust market regulatory legislation, to accommodate current financial markets. For instance, in 2004, investment banks in the United States were allowed to perk their own borrowing ratios to as high as 40 to 1 (Debt- Net capital ratio). These high ratios weakened the ability of the banks to recover their debts, leading to the crisis. Some economists also argue that it was caused by investors failing to accurately assess the risk on mortgage markets and complex financial products (Brunnerneir, 2009). The effects of Mergers and Acquisitions on the recent financial crisis are twofold. Firstly, the M&A mitigated the impacts of the crisis on world economies. For instance, one major action by the Federal Government of the United States, to check against the financial crisis, was to Bailout major financial institutions (Goldman Sachs and Morgan Stanley). This was a way of takeover or acquisition of the firms’ liabilities. Without this, the financial market would have continued to plunge, to the worst depression in history. Institutions such as the Lehman Brothers, as stated earlier were completely bankrupt, and had billions of debts which they could not recover. In total, 25 banks were taken over by the FDIC after the financial crisis in the United States! Similarly, 77 U.S banks in total were Insolvent as at August, 2009 (Rosenbaum, 2009). M&A actions of most governments, such as the US government also saw regulation of the financial markets. For instance, the Investment banks namely Goldman Sachs and Morgan Stanley, now became commercial banks, with more stringent rules on borrowings. Also in the U.S, Fannie Mae and Freddie Mac, financial institutions with mortgage obligations of up to 5 billion U.S Dollars, were put under conservatorship by the U.S Government, to safeguard the housing sector (Mihm, 2010). Similarly, the merger between Lloyds TSB and HBOS, which was highly backed by the UK government, was for the good of banking and mortgage sector, during the financial crisis. In retrospect, the share prices of the two companies rose significantly, prior to the merger, and upon confirmation of news of the merger. Therefore, we can clearly see how M&A have helped check the financial crisis. However, as argued by David Anderson, in his book Build to order and mass customization, M&A are not always as good as people think they are. He points out that growth by acquisition is hard to sustain in the long run and that return to shareholders is usually on the negative. He also notes that many firms ignore the overhead costs that come by due to M&A, such as downsizing costs, training costs, relocation costs, and other overheads. He also notes that many firms find use up large costs to integrate into one entity (Hilday, 1998). It is, therefore, true to forecast a financial crisis, due to over expectations placed on institutions, following Mergers and Acquisitions. A newly formed entity through M&A would be expected to grow at a steady pace, leading to high stock prices in the financial markets. However, if the reality of the high disguised costs is felt in the long run, the market would be in a crisis. In Conclusion, Mergers and Acquisitions play a major role in world economies and are a vital part in the financial markets’ performance. They should not only be seen as a solution to a financial crisis, but also as a way to drive the growth of economies. The benefits of M&A, as evidenced in the above brief discussions, are worth more than the risks. However, for a successful merger and acquisition, the costs, both in the short and long-term, should not exceed the benefits. Reference Brunnerneir, M. (2009). Deciphering the liquidity and credit crunch. Economic Perspectives, 77-106. Dwyr, G. (2009). The Financial Crisis of 2008 in Fixed income Markets. International Money and Finance, 28-31. Emirates Centre for Strategic Studies and Research. (2009). Arab Banks and the Global Financial Crisis. Abu Dhabi: Emirates centre for strategic Studies and research. Fleuriet, M. (2008). Investment Banking explained: An insiders's guide to the industry. New York: Mc-Graw- Hill. Hilday, J. L. (1998). Most Mergers Fail to Add Value, Consultants Find. Wall Street Journal, 16. J.S, H. (2001). Mergers and Acquisitons: A Guide to Creating Value for Stakeholders. London: Oxford University Press. Lauven, L. (2008). Systemic banking crises: a new database. New York: International Monetary Fund. Mihm, R. N. (2010). Crisis Economics: A Crash Course in the Future of Finance. New York: Mc- graw- Hill. Rosenbaum, J. (2009). Investment Banking:Valuation, Leveraged Buyouts, and Mergers and Acquisitions. New Jersey: John Wiley & Sons. Shan, W., & Hamilton, W. (1991). Country specific adnvantage and international cooperation. Strategic Management Journal, 12-13. Read More