Mergers and Acquisitions in Creating Maximum Value - Essay Example

?Mergers and Acquisitions as a Strategic Mean of Creating Value and Maximizing Shareholder Wealth By [Presented to] of institution] [Date] INTRODUCTION Organisations in the current business environment thrive for success and creation of value. As a part of corporate and management strategy; organisations tend to find alternatives creating more value by maximising shareholder wealth (King, Slotegraaf, Kesner, 2008 pp 24-45). The discussion aims at underpinning and analysing the role of mergers and acquisitions as a strategic mean of creating value and maximising shareholder wealth in comparison to the alternative organic growth. An Overview of Mergers and Acquisitions DePamphilis (2008 pp-04-06) defined mergers and acquisitions as a part of corporate and management strategies dealing with the buying, selling and combining of different organsiations having similar business activities or activities that can support the present and future growth and development in a systematic manner. Over the years, the distinction between mergers and acquisitions has become quite blurred in respect to economic outcomes but continues to attract organisations (Cartwright, Schoenberg, (2006 pp. 11-14). Studies have shown that 50% of acquisitions have been unsuccessful considering the complex process and different dimensions associated with the actual outcomes (Straub, 2007). Lazonick, O'Sullivan, (2008 pp-24-27) stated that the rationale behind mergers and acquisitions is based on the thought that two companies together can be more valuable and robust compared to two different companies. Moreover, mergers and acquisitions help in attaining cost efficiency by sharing operational and functional costs along with thriving to achieve greater market share and efficiency in a planned way (Harwood, 2006 pp- 24-35) Relevant Theories Mergers and acquisitions can be linked with various relevant theories. Some of these theories include anxiety theory, social identity theory and role conflict theory. Anxiety theory is based on the competitive anxiety that compels organsiation to perform better in order to compete with competitors (Karegeorghis, 2007 pp-11-12). Social Identity Theory is based on the perception that individuals and organsiations tend to behave and operate in a manner that leads to the creation of an identity that helps in the growth and development (Postmes, Branscombe, 2010 pp- 11-23). Mergers and acquisitions help in creating new identity for smaller organisations while helping in revamping the identity of large organsiations (Akerlof, Kranton.2010 pp- 04-11) Role Conflict Theory is based on the perception that individuals and organsiations experience role conflict by finding themselves pulled in various directions as per the status held by them (Tang, Chang, 2010 pp-13-21). Hitt, et al, (2009 pp-12-23) stated that mergers and acquisitions help in creating synergies between organisations that in turn help in enhancing the worth and value of organsiations. However, Straub (2007 pp-03-11) stated that value creation and wealth maximisation is dependent on the nature and relationships of organsiations. It can be said that both views are directed towards a positive relationship creating synergy and wealth maximisation but dependent on internal and external factors. Value destroying theory states that mergers and acquisitions fail because firms fail to address informational constraints and focus too much on private utility function that affects the overall value creation process of organsiations (Malmendier, Tate, 2005 pp- 24-32). Straub (2007 pp -23-45) also agreed to this statement and stated that mergers and acquisitions require proper assessment of internal and external factors to create value in the business environment. All these theories can be associated with other relevant theories such as SWOT, PESTEL, and Game Theory. Armstrong (2006 pp-24-34) stated that SWOT analysis is based on analysing the strengths, weaknesses, opportunities and threats of individuals and organsiations. Strengths and weaknesses are dependent on internal factors while opportunities and threats are dependent on external factors. In terms of mergers and acquisitions, it can be said that organsiations with large number of strengths tend to acquire organsiations having similar strengths or few weaknesses in operating the organsiational framework. On the other hand Hitt, et al, (2009 pp-31-47) stated that mergers and acquisitions are successful only when organsiations having similar strengths unite together to explore more opportunities. PESTEL analysis aims at underpinning the impact of political, economic, social, technological, environmental and legal aspects and factors affecting the growth and development of organsiations. Akerlof, Kranton (2010 pp-91-102) stated that organsiations with political, social, economic, technological, environmental and legal benefits will always control organsiations lacking all these benefits. Game theory can also be associated with the theories of mergers and acquisitions. Game theory is based on the study of strategic decision making of organsiations. It states that one person’s or organsiation’s gain is equal to the loss of other person or organsiation (Webb, J N. (2007 pp-23-45). Leyton, Yoav, (2008 pp- 45-65) stated that mergers and acquisitions usually result gains for one organsiation while loss for the other and strongly favors game theory. Different academicians have different views on the success and usefulness of mergers and acquisitions in maximising shareholders wealth. However, academicians like Hitt, et al, (2009 pp-11-23), Peavler (2008 pp 21-32) and Malmendier, Tate, (2005 pp-23-35) clearly stated that success of organsiations is based on internal and external factors that need to be assessed through SWOT and PESTEL analysis. Empirical Evidences of Mergers and Acquisitions Much of the empirical evidence of mergers and acquisitions comes from the finance literature where the primary aim has been on maximising the wealth of shareholders (Schwert, 2000). One of the most common techniques of examining the impact of mergers and acquisitions has been the understanding and analysis of stock prices (Sudarsanam, 2010 pp-23-45). One of the finest examples of mergers and acquisitions is of Cadbury and Kraft Foods Inc. In 2009, Kraft Food Inc announced to acquire Cadbury. The deal offered gains and losses to the shareholders of both the organsiations. Lucas, Rappeport (2011) stated that the market value of Cadbury increased by 40%. The increase in the share prices was fueled by the announcement of Kraft to acquire Cadbury. This resulted in a profit of 40% for Cadbury’s shareholders despite nothing changed for Cadbury during that announcement. Cadbury did not launch any new product and did not even trigger its sales to generate more profits. The primary reason behind the rise in the share prices was the announcement of acquisition deal that created value for Cadbury’s shareholders. In the past, empirical results have shown that the share prices of target firms’ increase by 30% and in the case of Cadbury, the share prices increased by 40% and can be considered as a good sign for shareholders (Lucas, Rappeport, 2011) Thus, it can be said that the acquisition between Cadbury and Kraft Foods Inc maximised the wealth of shareholders in the form of an increase of 40% in the share prices. On the other hand, the acquisition did not create for wealth for Kraft’s shareholders. Kraft shareholders paid a premium of 40% on the share price level. This did not offer much value to them along with making them pay over the odds. Empirical evidences show that the shareholders of acquiring companies always lose amidst mergers and acquisition deals while shareholders of target companies always gain. So, it can be said that the deal offered unexpected gains to Cadbury’s shareholders and unwanted loses to Kraft’s shareholders. On the basis of this understanding, it is hard to ascertain the role of mergers and acquisitions in maximising the wealth of shareholders. It can be considered as a paradox where gains and losses are always balanced but there is no doubt that mergers and acquisitions do help in maximising the wealth of shareholders but with a catch. The acquisition deal between Cadbury and Kraft Foods Inc created and destroyed wealth for shareholders and cannot be considered as a complete success in terms of maximising the wealth of shareholders. This deal was based on the Game theory where the success of one organsiation became the failure and value destroyer for the other (Mckeown (2012 pp-15-45) Some of the recent mergers and acquisitions that have attracted limelight need to be highlighted in order to assess the overall significance of mergers and acquisitions in the current business environment. Tata Chemicals took over British Salt for $13 billion in the year 2010 and it is considered as one of the most successful mergers and acquisitions of recent times. Discover Financial Services acquired Diners Club International Limited from the Citi Group for $165 million in cash. The deal resulted in the creation of value for shareholders in a significant manner. However, the merger and acquisitions failure of Time Online and Time Warner and Sprint and Nextel Communication communicate a different story. These mergers and acquisitions failed because of the cultural differences and major differences in social identities (Gehi, 2012 pp-23-45) On the basis of the empirical evidences and theoretical analysis, it can be said that mergers and acquisitions can only be successful when organsiations are directed towards a similar mission and vision based on synergy. Mergers and Acquisitions; Creating Value Malmendier, Tate, (2005 pp-32-86) stated that mergers and acquisitions are driven by the assumption of well managed business combinations creating long term value. On the other hand, Hitt, et al, (2009 pp- 24-56) stated that synergy happens when the value of combined organsiations exceed the value of companies operating individually. Both these authors had emphasised on the importance of combined resources and skill sets creating more synergy and value in the competitive business set up. Straub, (2007 pp-43-45) stated that 50% of mergers and acquisitions fail because of the cultural and functional differences lacking high degree of synergy. It can be said that mergers and acquisitions create value only when organsiations share similar mission and objectives to create value. It is important to realise how an organsiation is going to create value for shareholders by selling its products and services in a profitable manner (King et al, 2008 pp-43-78) The failure of Time Warner and Time Online was based on lack of synergy creating negligible value for shareholders while the success of Kellogg in acquiring Keebler was based on high degree of synergy. So, considering mergers and acquisitions as a value creating activity is a mere paradox as mergers and acquisitions are dependent on wide arrays of cultural, political and economic factors. In order to create value for shareholders, it is important to perform well either by enhancing sales or profitability through the introduction of new and innovative products or by acquiring established organsiations offering similar or related products. (King et al, 2008 pp-21-34) Game Theory suggests that the gain of one organsiation becomes the loss of other organisation especially in mergers and acquisitions. This statement holds great value in the case of the acquisition between Cadbury and Kraft Foods Inc where Cadbury’s shareholders were benefitted and Kraft’s shareholders witnessed a sharp decline in their share prices. SWOT and PESTEL analysis is based on identifying the role of internal and external factors and value for shareholders can only be created through the sharing of similar strengths and opportunities. Mergers and acquisitions can create or destroy value for shareholders depending on the synergy shared by them. In order to create value, it is important to share similar vision, strengths and opportunities along with eliminating partial benefits and advantages. Mergers and Acquisitions, Maximising Shareholders Wealth The Neo Classical Economic theory assumes that corporate management is all about maximising the wealth of shareholders (Clark, 2008 pp-34-78). When an organsiation acquire another organsiations, it pays premium that may result in abnormal gains for a short period of time (Peavler, 2008). However, market corrections may lead to stable or unexpected low returns and thus destroying the expected value. Straub, (2007 pp-02-07) stated that mergers and acquisitions maximise shareholders wealth at the time of the announcement of the deal largely because of the premium paid and market sentiments based on expectations. Peavler (2008 pp-23-34) stated that mergers and acquisitions are aimed at maximising shareholders wealth and value by creating more value. With stock prices going up, the value of firms and individuals’ stock increases (Lazonick, O'Sullivan, 2008 pp-34-78). Shareholders wealth can be maximised by investing in new projects, maximising profits from the existing products and controlling costs (Lazonick, O'Sullivan, 2008 pp-45-78).However, studies have shown that 50% of acquisitions have been unsuccessful considering the complex process and different dimensions associated with the actual outcomes (Straub, 2007 pp-43-45). As per the game theory, the success of one organsiation in terms of value creation is based on the failure of the other organsiation in terms of value destruction. The mergers and acquisitions between Time Warner and Time Online destroyed the wealth of shareholders while the merger between Glaxo and SmithKline created value for shareholders by maximising their wealth (Hand, 2000 pp-23-43). Microsoft also maximised the wealth of shareholders by acquiring a number of small and large software organisations based on sharing strengths and opportunities Thus, mergers and acquisitions remain a mystery in defining its association with the maximisation of shareholders wealth. With majority of mergers and acquisitions failing and share prices witnessing abnormal gains for a short period of time, it can be said that mergers and acquisitions may enhance shareholders wealth but do not offer any assurance. Moreover, the value creation theory states that in order to maximise shareholders wealth, organisations need to share high level of synergy and similar business goals and vision. Apple Inc created great value for its shareholders by maximising their wealth through high profits. The organsiation did not seek mergers and acquisitions as a tool of value creation and focused on enhancing the internal growth that resulted in the external growth. However, with majority of mergers and acquisitions failing; it can be said that maximisation of shareholders wealth is only an illusion creating marginal value (Bauman, Jackson, Lawrence, 2007 pp-34-67). Mergers and Acquisitions vs. Organic Growth DePamphilis (2008 pp-34-56) defined mergers and acquisitions as a part of corporate and management strategies dealing with the buying, selling and combining of different organsiations having similar business activities or activities that can support the present and future growth and development in a systematic manner. On the other hand, organic growth is defined as a process of business expansions through increasing the customer base, output per customer and identifying ways to find new sales avenues. Organic growth is based on enhancing the internal business processes rather than buying new buying new businesses. It can be said that both organic growth and mergers and acquisitions aim at enhancing the value of the firm along with adding more profits by creating more value (Harwood, 2006 pp-21-25). Organic growth favors social identity theory and value creation theory while mergers and acquisitions can be linked to value creation and destroyer theories. It can be said that both organic growth and mergers and acquisitions have distinctive advantages in the business environment. Microsoft has been involved in a number of mergers and acquisitions deals resulting in greater value and benefits. Microsoft also became the world’s largest software organisation majorly because of its monopolistic presence and business operations. Thus, it can be assumed that mergers and acquisitions helped Microsoft to grow and develop along with maximising the wealth of shareholders every year. On the other hand, organic growth highlights the internal growth of organisations based on the effective utilisation of resources and innovative technology. Apple Inc can be considered as the best example of organic growth. The organsiations kept manufacturing innovative and interesting products that helped in gaining competitive advantage along with enhancing shareholders wealth through generating large volumes of revenues resulting in profits. Apple’s growth in early 2000s was credited to its new and innovative products that created mutual benefits for the organsiation and shareholders. Procter and Gamble is another organsiation that has been focusing on internal growth by investing in available resources to create more value and benefits using innovative technologies (Lafley, 2008 pp-45-78). It can be said that both organic and mergers and acquisitions offer intrinsic value to organsiations and are dependent on market and industry scenarios as well as on the strategic mission and vision of organisations. Considering the failure rate of mergers and acquisitions that is more than 50%, it can be said based on the success and growth of Apple Inc and Procter and Gamble, that organic growth can be a safer bet offering slow but steady growth along with maximising the wealth of shareholders. Challenges of Mergers and Acquisitions Globalisation has affected the strategic and business strategies of organisations in a great way. Large numbers of organsiations are finding it difficult to respond to the internal and external factors initiating changes. For this purpose, mergers and acquisitions has emerged as one of the most important strategic means of achieving organsiations goals and objectives. Gehi, (2012) stated that mergers and acquisitions fail because of the cultural differences and major differences in social identities. Some of the major challenges pertaining to the success of mergers and acquisitions can be in the form of social and cultural differences that were quite visible in the case of Sprint and Nextel merger. The merger between Time Online and Time Warner also failed because of the difference in organsiational cultures. Schwert, (2000 pp 87-145) stated that financial, cultural and social barriers remain the most important challenges for mergers and acquisitions along with the sentiments of stock markets that often overvalue and undervalue the worth of organsiations. The ever increasing competition and business rivalries demand rise and growth of organsiations and can be considered as a major challenge to cope with the changes in the business environment. Conclusion On the basis of the above discussion, it can be said that mergers and acquisitions can be a favorable approach for organsiations willing to grow and develop in a fast manner. However, the success of mergers and acquisitions is mainly dependent on the synergy level and market dynamics (Sudarsanam, 2010 pp-23-67). Organsiations may look for organic growth by pushing their sales and adding more customers. This may take some time but will not expose to uncertainty and prospects of failure. Overall, it can be said that mergers and acquisitions do not offer assurance on the success, growth and development of organisations but may be considered as a strategic mean of exploring unknown boundaries in a judicious and logical way (Sudarsanam, 2010 pp-78-127) References Akerlof, G. A., and Kranton. R (2010). Identity Economics: How Our Identities Shape Our Work, Wages, and Well-Being, Princeton University Press, "Introduction," pp. 3–8 Armstrong. M. 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