Finance Mergers and Acquisitions

Question: Discuss about theFinance Mergers and Acquisitions. Answer: Introduction These terms are used in the financial industry to denote the fusion of two different companies. There are various ways in which two separate entities can unite to form a single entity. Broadly, these modes are classified under two main heads- mergers and acquisitions (MA). When two companies consolidate to form a new company, then we call it as merger. However, acquisition or takeover refers to a company buying another company. In this case, there is no new company formed and both the companies will be known by the name of the buying company. MA also refers to a department in financial institutions which undertakes to fulfil the formalities of mergers and takeovers (Manne, 1965; Neuhauser, 2007). Motives Behind Mergers and Takeovers There are many reasons for which the companies engage in mergers and acquisitions of which, few are discussed below: Shareholders gains: MA will provide many incentives for the managers, since they will be having more resources and scope to operate. Besides that, there will be an increase in the resultant companys efficiency and profitability. Their costs will be reduced to a great extent. Hence, market capitalisation of the resultant company will increase. This is a direct benefit to shareholders. Economies of scale and economies of scope: MA will provide economies of scale to the companies since their costs will decrease as they increase their production capacity. In addition to this, they will have a merger in a different industry, which will also give economies of scope. Sharing Know- how: When two companies consolidate with each other, they have the opportunities to share their technology and other resources and skills. Conducting RD activities at a large scale: Having large resources, companies have increased capability to enhance their research and development projects at a larger scale. Diversification: When two companies merge or takeover one, they have good market prospects in different line of businesses. Hence, MA is also a mean to diversify business operations. Tax benefits: When a company takeovers another company, it has to pay some premium or an amount to that company in return for its resources. This amount is included in tax calculations. The assets which are acquired will also be charged against depreciation. Hence, this reduces tax obligations to a certain limit. However, reforms have been made to avoid such benefits. (Trautwein, 1990) This paper reviews the two articles which are based on takeovers and their bearing on companies. In these articles, authors have given their views on the rationale behind takeovers or acquisitions. Some part of articles also includes the imperative for the companies to go for takeovers and their consequences on companys performance (Giammarino Heinkel, 1986). Article Review of The Market for Corporate Control This article was written by Jensen and Ruback, which was published in Journal of Financial Economics, eleventh volume. Corporate control refers to the companys ability to control external as well as internal factors affecting the operations of a business. Greater a company has control over external factors, greater is its corporate control in the market. This article consists of the literature review on corporate control in context of the dynamic market. The paper supports the fact that takeovers add value to the overall markets and have a positive implication on the industry. In the context of the bidding company, there will be many positive gains for business operations and shareholders. Even the target companys shareholders will also be benefitted by such transaction. The paper also discusses about creation of market power. Evidences are given to show that there is a weak correlation between market power and benefits of takeovers. However, this point is also contradicted by some o f the literature review. The article also includes that managerial actions aimed at enhancing corporate control are somehow detrimental to customers and shareholders welfare. This means that there will be a negative implication of takeover. For this, it is mandatory that managers should review the decision of acquiring another company to ascertain that there potential transactions will not harm the companys stakeholders. The essence of the article lies in the fact that market for corporate control is considered as a fictitious place where market players compete with each other for the ownership of corporate resources and the right to use them for their betterment and profitability. However, the paper includes a discussion over a wide range of arguments regarding controversies in the corporate control mechanism of market. It also asserts that there are further many issues that are not considered yet. There are many inferences on this issue but no transaction has been studied up till now that has covered all such aspects. The article concludes with the view that if such takeovers and potential bidders can be eliminated, there will be a promotion of small- scale enterprises (Jensen Ruback, 1983; Jarrell, Brickley, Netter, 1988). Article Review of Director Networks and Takeovers The article is given by Renneboog and Zhao in the journal of corporate finance, Twenty- Eighth Volume. It talks about the directors networks and takeovers. In this article, emphasis is put on the connections and networks of a bidding companys officials. The Directors, managers and other top level executives play a major role in various facets of mergers and acquisitions. Same way, a target companys officials also have contacts with large entrepreneurs and hence, facilitating high frequency of mergers and acquisitions in the market. Evidences given in this paper are based on UK markets. In this paper, a prolonged discussion is given about the impact of the directors networks on various stages of mergers and acquisitions. Firstly, at preliminary stage, discussion starts because of the personal contacts of the business associates. Then, at further MA process like negotiation on different terms and its duration; the ratio of success and failure of the transaction when negotiation process is over; means of payment- equity compensation, cash compensation or hybrid compensation; negotiation regarding appointment of directors and managers of target firm on the management hierarchy of merged or acquirer firm; etc. In brief, it can be said that paper discusses the impact of corporate networks on the process of takeovers. Evidences are given to substantiate the fact that a company having more than one or two directors are likely to have more mergers and acquisitions. It is also given that there negotiation duration is quite short (Renneboog Zhao, 2014). Impact of Takeover- do they add Some Value? There are three parties involved in the entire process of takeovers. First is the bidding company, the party who is going to buy another one. The other party is the target company, which is being acquired. And the third party is the overall market, which will have a bearing due to this takeover. Impact of takeover on all these associates is been discussed below (Roll, 1986). Target Company A Target company is the one which is being acquired or purchased by another company. There are two ways in which a target company can react possibly. If the target company accepts the takeover and favours the entire transaction process, then they will have a fair value, organized deal and a friendly consolidation. But if the target companys attitude is opposing the takeover, then, the bidding company will make all the possible attempts to make it happen. This may deteriorate the target companys ability to negotiate on the compensation of takeover. On the other hand, target firm will also try to spoil the entire thought of transaction and make best efforts to avoid it. This will lead to huge costs incurred by the target company. In addition to this, their goodwill will also be adversely affected. In both the cases, the target company will have an adverse effect. If takeover happens, it will have no separate identity. If takeover is avoided, then also image of the company will deterior ate in addition to overheads. However, if the target company favours the transaction, then at least, it will get fair compensation at market value of its assets. Hence, there will be no value addition to the target company due to takeover, since it will lose its entity in the transaction (Walsh, 1989; Healy, Palepu, Ruback, 1992). Bidder Company The major impact of takeover on the bidding company is that it improvises the companys ability to undertake business profitably. If we look at the procedure from its starting point, then, it is clear that taking over a company brings a lot of resources at the bidding companys threshold. This will have two implications. If takeover is executed in the same industry, then the bidding company will end up in acquiring a larger market share and a competitive edge. Reason being they will get economies of scale. However, there will be some hidden costs of transaction that should be carefully managed. On the other hand, if takeover is carried out in some other business line, then it will lead to diversification of business, giving economies of scope to the business. Besides that, when a company is acquired, all of the assets and technology also belong to the bidding company, in return for a compensation. This shows that the bidding company will be having a large pool of resources and might be a better know- how. Hence, these factors will work towards reducing costs and improving bottom line of the company. This will have a direct impact on the market price of shares. So, takeover will also enhance the market capitalisation of the bidding company. Market capitalisation = market price of a share * number of outstanding shares of the company. Outstanding shares are those shares of the company which are being traded in the market. All the above points clearly states that takeover add a significant value to the bidding companys performance (Travlos, 1987). Aggregate Market Value There are certain numbers of companies working in an industry. It is quite often in a market that a company with low financial performance and weak position in the market, but with high potentials is likely to face a threat of takeover by giants of the industry. Such takeovers reduce the number of companies in a market. Hence, only few big companies remain in the market to have a competition with each other. This implies that markets move towards oligopolistic form of competition in which there is handful of big players of the market having a stiff competition. It has been seen that due to cut- throat competition, market players tend to prove themselves better than others by reducing prices, providing better quality of goods and services, introducing CSR activities, etc. In this way, there is a healthy competition in the market and customers will also be benefitted. Hence, it can be said that takeovers add some value to the overall market as well (Jensen, 1988; Chatterjee, 1986). Conclusively, it can be said that takeovers add value to the bidding company and the overall market. However, the target company is not in complete loss. It reaps the benefits in the form of compensation and benefits to shareholders. It is also evident that there is a positive correlation between the directors networks of a company and its probability to enter into some merger and acquisition transaction (Firth, 1980). References Chatterjee, S. (1986). Types of synergy and economic value: The impact of acquisitions on merging and rival firms. Strategic management journal, 7(2), 119-139. Firth, M. (1980). Takeovers, shareholder returns, and the theory of the firm. he Quarterly Journal of Economics, 235-260. Giammarino, R. M., Heinkel, R. L. (1986). A model of dynamic takeover behavior. The journal of finance, 41(2), 465-480. Healy, P. M., Palepu, K. G., Ruback, R. S. (1992). Does corporate performance improve after mergers? Journal of financial economics, 31(2), 135-175. Jarrell, G. A., Brickley, J. A., Netter, J. M. (1988). The market for corporate control: The empirical evidence since 1980. The Journal of Economic Perspectives, 2(1), 49-68. Jensen, Ruback. (1983). The Market for Corporate Control. Journal of Financial Economics, 11, 5-50. Jensen, M. C. (1988). Takeovers: Their causes and consequences. The Journal of Economic Perspectives, 2(1), 21-48. Manne, H. G. (1965). Mergers and the market for corporate control. The Journal of Political Economy, 110-120. Neuhauser, K. L. (2007). Mergers and Acquisitions: A global view. Mergers and Acquisitions, pp. 1-4. Renneboog, Zhao. (2014). Director networks and takeovers. Journal of Corporate Finance, 28, 218234. Roll, R. (1986). The hubris hypothesis of corporate takeovers. Journal of business, 197-216. Trautwein, F. (1990). Merger motives and merger prescriptions. Strategic management journal, 11(4), 283-295. Travlos, N. G. (1987). Corporate takeover bids, methods of payment, and bidding firms' stock returns. The Journal of Finance, 42(4), 943-963. Walsh, J. P. (1989). Doing a deal: Merger and acquisition negotiations and their impact upon target company top management turnover. Strategic Management Journal, 10(4), 307-322.