New Approaches in Respect of Finance Takeover and Acquisition - Essay Example

? NEW APPROACHES IN RESPECT OF FINANCE TAKEOVER AND ACQUISITION: APPROACHES, REGULATORY, MARKET, AND FIRM, AND SHAREHOLDER PERSPECTIVES Institution: Instructor: Date: Introduction Over the last decades, business is taking a dynamic shift given the increasing competitiveness globally. To remain competitive in the global business arena which is characterized by e-commerce and globalization, firm have been compelled to adopt new survival techniques. Mergers and takeovers has been one of the recent approaches in the industry. Popularly referred to as A&T, mergers and takeovers have become the most reasoned and strategic procedure in business with special consideration given to the ethical consequences and financial obligations of the affected parties. The strategy adopted by each group is prepared by the management accounting department through analyzing the market, shareholders and the regulatory framework within the industry. In some instances, it may be important to obtain synergies to help analyze the financial and accounting policies applied by each of the companies merging. Although the A&M started in 1980s, the international rate of industrial mergers and takeovers took place during the 1990s. However, the complexity and nature of international operations coupled with other complexities has sophisticated global takeovers and mergers. Mergers and acquisitions normally abbreviated as M&A refer to the corporate strategy aspect, management dealing and corporate finance that involve the selling and buying as well as combining and dividing of different companies aimed at assisting an enterprise grow in its location or sector or venture into a new location or field (Brealey and Myers, 2000, p 89). Such a growth is expected to be without subsidiary, use of joint venture or child entity. Over the years, the distinction between acquisition and merger is blurred with several aspects especially economic income. Shareholders lawsuits are common in the event that a firm opts to engage financially in an acquisition or takeover and is appreciated as being part of the current market now that they are meritless. Merger lawsuits frequency has increased in the recent years with their life cycle undergoing a complete change. These days, once a merger deal is closed, lawsuits are normally closed. However, some plaintiffs have come out strongly in mergers to refine the way they operate. They insist on keeping such litigation alive even after they have been closed. This is achieved through having extensive discovery more so against the acquirer executives in control of the purse strings. Why mergers and takeovers There are a number reasons cited by firms for mergers and takeovers. However, the most prevalent reasoning cited by majority of the firms participating in M&A is profitability and growth sourced from external means. The outsourced growth may be of great economic benefit to the acquirer through increase in the production capacity, product diversification, increased market share, and expansion of the product lines. Some firms cite quantifiable reasons such as tax advantage and increased economies of scale are the main reasons for the mergers. In laying the strategies for merger and takeovers, it is important for the participating firms to focus on their goals and strategies. The management accounting department of the merging firms observes the compatibility of the merging companies to determine the compatibility of the core values and beliefs of these corporations. While quantitative variable provide ideal aspects which makes takeovers and mergers very attractive, their applicability are limited as they fail to portray the clear picture of the scene. Qualitative factors of the merging corporations should also be deeply considered. In estimating the real value of each merging firm, intangible factors such as favorable location, the strength of management, and skilled labor force constitute the qualitative aspects of the takeover or merger. Whatever the goal or rationale of the merger, the failure or success of the acquisition largely depend on the financial considerations. The success and failure of any merger is measured in terms of the profitability index after evaluating the costs and benefits which accrue from their operations. Takeovers and mergers represent one of the most important activities in corporate finance both for the economy conditions of the firm. Shareholders in targeted firms gain a lot in relation to the wealth that is normally gained after takeovers. What is not clear is the extent at which the shareholders are affected in the event of a takeover. Statistics have it that shareholders averagely earn zero returns that are abnormal in the close of an acquisition or a merger. However, there exists a great variation in relation to returns. It is not clear how such variations reveal information about the various aspects of the firm (Hillier, Grinblatt and Titman, 2012, p. 67). Some of the things that are mostly affected when a firm gets into a merger or an acquisition are the stock returns of the firm in question and are normally not completely attributed to the profitability of the merger or acquisition. Stock returns reveal more information about the market situation of the firm more than what it says about the acquisition or merger value. Takeovers reveal information about possible synergies, the firm’s stand- alone values and the firm’s overpayment. Such financial and market aspects are normally related hence cannot be separated in the event of a takeover. The situation has led to new takeover approaches to emerge in the recent years in an effort to meet the challenges that have characterized mergers, acquisitions and takeovers in the past. The market situation has forced firms to settle for new approaches of getting into mergers without the bidder competition. This approach raises a lot of concerns with regards to the shareholder litigation substitutes that were present in cases where bidders and policies are responsible for improving terms of completing agreements. This new approach targets to have deals completed in significantly lower completion rates and higher litigated offers. Litigation normally raises the premium support expected as it leads to a higher bid premia now that bidders raise their prices in an effort to respond to the claims from the shareholders on unacceptable low offer prices so as to gain the support of the shareholder and the target board for the bid (Brealey and Myers, 2000, p 34). This approach allows litigation to be used to monitor the value of shareholder target in different mergers and acquisition transactions. Offer price revision tends to be higher for litigated offers in comparison to those offers that are not litigated like single bidder offers. Litigation has also been appreciated as to result in significant takeover premia especially in follow-up bids thus greatly impacts the bidding process. A common approach in the current acquisitions is one that takes into consideration transaction financing sources which are used to determine the market reaction during takeover. In this approach, the firms have the opportunity to differentiate between the information about the finances takeover and the payment method during the takeover and can fully account for the two takeover characteristics. The reaction of the market when the acquisition is announced after payment made in cash but financed on an equity basis is similar to the other older approaches which involved the reaction of the market after acquisition payment done by equity (Hillier, Grinblatt and Titman, 2012, p. 54). The result of such an approach is that negative price revisions witnessed in most corporate takeovers involving equity financing. In this case, the price correction that occurs as a result of bids that may be financed by debts remains insignificant. Acquisitions that are debt-financed and cash paid lead to substantial value to the firms taking part in the biding. In this approach, the firm’s financial decision such as choices between debt, cash and equity financing can be explained by looking at the preferences of the pecking order and the conflicting interests that are common between creditors and shareholders. However, none of these factors give information on the specific payment means in takeover bids (Hillier, Grinblatt and Titman, 2012, p. 89). The decision with regards to payment in this case depends on the degree at which the large shareholders of the bidder who maintains control after the conclusion of the take over or whether the shareholders of the bidder have the intention of sharing the transaction risks with the targeted shareholders as well as the takeover bid characteristics. The same factors have no or minimum impact on the financing choices of the bidder once the payment mode is conditioned. This implies that the payment means decision and financing takeover sources are not substitute. Regulations play an important role in this kind of acquisition approach as they mitigate the conflicting interests between the corporate constituencies who include the majority and minority shareholders, the creditors and the management. Regulations provisions are also intended to improve the corporate information transparency. The corporate governance regulations in this approach have been substantially reformed contrary to the case in old acquisition approaches. Ethical Considerations The entire process of takeover and merger is guided by value judgment and ethical behaviour with a business environment. Through their management accounting units, potential firms to the merger should place value for ethics and healthy behaviour which are described by the Institute of Management Accountants (IMA). Ethical standards concern competence, integrity, objectivity and confidentiality as well as the provision of professional guidance for resolving conflicts or disputes. Although ethical behaviour and standards attempts to distinguish wrong from right, developing a sustainable code of conduct or ethics from the given frameworks which would be equally applicable to all the parties involved in the takeover or adjudication of the merger proves very complex. As explained by Drucker (2011, p.45), mergers and acquisitions are complex transactions with brings together competing and conflicting parties. The primary ethical conflict in merger and takeovers concerns the represented interest of ‘targeted stockholders.’ Being the owners of the firms, shareholders should be protected against any third party with personal interest by using unfair and unethical tactics to benefit themselves at the expense of the owners. Similarly, firm owners deserve being protected from the exploitative wrath of self-interest serving managers. Conflict of interest usually creates an emotional and financial strain on the substantial relationship among the stakeholders of the firm. In the last periods, "business judgment rule" governed the ethical consideration and code of conduct during takeover. As a result, management was permitted by the legal institutions to investigate and judge the general fitness or fairness of any takeover. It is also important for the managers to assess the impacts of the proposed merger or acquisition on all the affected sectors including employees, communities, customers, employees, the industry, suppliers, economy, and the public at large. In evaluating the applicability and suitability of the ethical principles, management accountants utilize utilitarianism consequentialist theory, which states that “ethical behaviour produces the greatest balance of good over evil (i.e., the greatest good for the greatest number).” Ethical consideration principle also utilizes universality principle which holds that one only acts on the principles which are universally acceptable by laws. The final measure for ethical consideration which is commonly applied in mergers and acquisition is referred to the “classical theory of justice” which provides for a just and fair share of ‘roughshod’ in the takeovers. Firms Evaluation: Forecast Evaluation Given the complexity of the mergers and acquisitions, it is import to evaluate the financial position and forecast of the merging firms. These financial projections are deemed essential in comparing the financial compatibility of the merging firms as the management of each company relies on these figures to furnish the portfolio of acquisition and developing sound policies of profitability and interest sharing. The inferred financial records of each firm are tested for accuracy, reliability and reasonableness. This would ensure harmonization of the financial policies applied by each party to the merger or takeover. The forecasted financial statements and income records must be accurately analyzed to determine the legitimacy and credibility of the projected sales, revenue, and growth potential of each party to the potential merger. Other economic factors such as inflationary pressure must be investigated and forecasted in the financial projections of each firm. In case absorption costing method was applied in projecting financial records, then, the projected direct cost should be adjusted for changes in sales revenue, manufacturing costs, and sales volume. To determine profitability changes with respect to absorption cost, sensitivity analysis will be performed. Past financial and accounting records are relied on to verify the accuracy and transparency of financial forecasting. By comparing the economic and financial performance over time, it is easy to observe the trend and pattern in the financial growth and make projections. This commences by analyzing and scrutinizing cash balances for valleys and peaks to determine the extent of divergence in the cash-flows. It is essential to discover whether unsteady flow of cash were as a result of unexplained origins or seasonality of business operations. The financial soundness and creditability of a firm is measured by evaluating its financial and accounting records overtime. A close analysis of receipts and payments would reveal the liquidity position of the firms entering into a contractual agreement. Current ratios of the firms are examined to determine the rate of turn-over and the ability of the firm to meet it short-term financial obligations when they fall due. By examining debt collection rate or debt ratio, the merging firms or the taking firm evaluates the ability of the firms to collect its debts in time and manage its debts appropriately. Finally, credit policies of the target corporation must be reviewed to establish the composition of the firms’ customer base. These financial and monetary statistics gives the management a clue of the relative degree of financial risks involved in the projected future cash-flows for each of the companies interested in the deal. Legal implications Another acquisition approach takes into consideration financial choices as sensitive inclusions in different legal environments. In this case, the firm’s equity financing choice is favorable in acquisitions where the shareholders rights of protection are better. In markets where there is low shareholder rights protection, firms often resort to cash and debt as their financial sources. Debt financing has also been observed to be common in markets having better creditor protection (Hillier, Grinblatt and Titman, 2012, p. 90) This is so as this acquisition approach offers a better financier protection for expropriation hence facilitates the coming up of a capital market that is well functioning and ensures low financing costs. In this case, the creditors and shareholders legal protection affect the cost of debt and equity capital as it induces corporate preferences for the funding sources that are least expensive. It is the asymmetric information as well as the negative market reaction anticipation to equity issues that have forced firms to change their acquisition approaches form equity to approaches like this one which take into consideration financing sources. Firms that are rich in cash finance their takeovers using funds generated internally. On the other hand, firms that are cash-constrained having debt capacities that are sufficient enough opt for debt as their funding means. Debt funding is systematically preferred to equity in situations where the market is experiencing stock declines following the adverse equity issues effects which are normally severe. On the other hand, transaction funding with equity takes place in situations where investors remain optimistic about the fundamental values of the firm thus tend to react less to any arising negative signals that may be caused by equity issues announcement. Firms that have high growth opportunities mostly avoid financing acquisitions using debts but opt to use equity financing as their main funding source. Market and shareholding Equity financing is common in markets with better shareholders rights protection. However, markets with high creditors rights protection force firms to opt for borrowing as their financing means to an equity issue. Better provider’s protection of finance from expropriation development facilities capital markets that are functioning well and ensure low financing costs. Now that legal regulations on creditors and shareholders impact the equity and debt capital costs disproportionally, it offers systematic corporate preferences in relation to less expensive financing sources. This approach allows the preference of the bidder for a given payment means to effect his or her decision on financing. Equity payment most likely increases the relative transaction size. Through giving the target shareholders a participation role that is continuous in the merged firm, the bidder shares misevaluation risk of the assets of the target firm. In addition, all acquisitions financed by cash means tend to be more likely increase the bidding firm under shareholders control has a voting power of intermediate level falling between 20% and 60% (Kaplan and Stromberg 2009, p. 140). This is because large bidding firm’s shareholders prefer cash to equity when it comes to payment when a bid that is all-equity threatens their control position. In this new approach, takeover characteristics like geographical scope, bid hostility, and target firms legal status have additional effects on the mode of payment during takeovers. Despite such impacts, these factors do not affect the financing choices of the bidder once conditioned on the mode of payment. In another approach, the takeovers can be carried out using tender offers as a transaction on the corporate control market. In this approach, the target shareholders part with their corporate right of determining the management of the firm to the bidder. This makes the takeover a voluntary process hence mutually benefits the target bidder and shareholder. The approach is most applicable in corporate control subjects markets that are well functioning allowing firms to engage in a continuous process of auction thus ensuring that the resources in question flow to their highest value application. In case an external party is in a position to improve the existing corporate value resources and can be allowed to have control of the firm. This move allocates the aspects in mergers that takeovers can be based on as tool used to replace incumbent managers in firms who do not act in the best interests of the shareholders. This will increase the efficiency of the mergers by enabling the firms to reallocate the targeted resources in a more profitable way. This takeover approach has been adapted in an effort to introduce a mechanism that controls and reduces the cost steaming agency from separation of control and ownership. It not only serves as an efficiency enhancing tool but also considers the takeovers prosperity with regards to market position. Mergers and acquisitions have adjusted in the recent years so as to create value through the exploration of synergies by combining the bidder and target firm thus leading to improved productivity gains and performance. Synergy gains that are subsequent to mergers and acquisitions normally challenge the market efficiency in the long term. Bibliography Brealey, R & Myers, S., 2000. Principles of Corporate Finance, McGraw Hill, New York, p.56-90. Hillier, D, Grinblatt, M and Titman, S., 2012, Financial Markets and Corporate Strategy, McGraw Hill, New York, p.45-89. Kaplan, S & Stromberg, P. 2009. Leveraged Buyouts and Private Equity, Journal of economic Perspectives, 23:121-146 Read More