Motives Underlying Mergers and Acquisition - Essay Example

Motives underlying M&A Introduction M&A is the short form for Mergers and Acquisition. A merger is the combination of two existing companies to a new one where the two never operate as an individual again. Acquisition occurs when a company buys another company or business (Sherman and Hart, 20016:11). Acquisition can be asset acquisition or share acquisition. Asset acquisition occurs when a company buys all or part of the other company and the latter still remains a legal entity. A share acquisition is when a company buys a certain share of stock so as to participate in the management of the target company. There are two types of acquisitions; “private and “public”. This depends on whether the company acquiring is or is not listed on a public stock market. The difference between Merger and Acquisition is that Merger deals with two companies joining to become one while Acquisition has one company, which is doing the buying (Sherman and Hart, 20016:11). The work that follows discusses the motives underlying M&A, and compares the outcomes of the different methodologies used to analyze M&A. All companies that engage in any business are under one rule: grow or die. Those companies that plan to grow take away market share from their competitors look for the creation of economic profits and provide returns to shareholders (Sherman and Hart, 2006: 1). Those that lack plans on growth are stagnant, do not plan any growth strategies, they end up losing customers and market share and lose shareholder value. Mergers and Acquisitions contribute a lot to these two conditions. It helps the stronger company to grow faster than the competition and ensures quick swallowing of the weaker companies or them making irrelevant through exclusion (Sherman and Hart, 2006:1). Motives underlying M&A Different business enterprises and companies have used Mergers and Acquisitions as a means of growth strategies. These companies have different motives for engaging in Mergers and Acquisition. Consequently, different theories explain better the motives behind which companies engage in Mergers and Acquisition. The motives behind companies engaging in Mergers and Acquisition can be divided into three categories namely; Economic, managerial and financial motives. The three differ according to the ideas behind them (Schmidt, 2010: 67) Economic motives Different authors have devised different theories to explain economic motives that encourage people to engage in Merges and Acquisitions; Efficiency theory This theory presents the motive of benefiting shareholders and managers of the acquiring company (Farschtschian, 2012:18). According to this theory, companies plan and execute Mergers and Acquisitions to achieve financial, operational and managerial synergies (Faulkner, Teerikangas and Joseph, 2012). The shareholders with this motive aim to benefit from net gains through synergy. Monopoly theory Under this theory, companies engage in Mergers and Acquisition with the motive of achieving market power. Mergers and Acquisitions under this motive may allow companies to cross-subsidize products, at the same time limit competitions in more than one market, and discourage potential entrants from the market. All of this result to monopoly power for the company. The shareholders under this motive aim at the wealth transfers from customers. Managerial Motives Theories that explain managerial motives include; Empire/Agency building theory This theory shows the motive aimed at benefiting managers. In this motive, managers plan for Mergers and Acquisitions aiming at maximizing their own utility instead of shareholders’ value (Karenfort, 2011: 9). The managers, according to this theory, plan to engage the company in mergers and Acquisition aiming at benefiting or creating their own reputation. Another motive is the need to transform to a corporate identity or recognition. This is where companies merge to gain popularity (Sherman and Hart, 2006:13). Financial motives The following theories explain the financial motive behind engaging in Mergers and Acquisition. Disturbance theory Under this theory, economic disturbances cause Mergers and Acquisition waves. These economic disturbances cause changes in individual expectations and increase the level of uncertainty, which changes the expectations of the individual (Farschtschian, 2012: 25). This leads previous non-owners (in this case the company acquiring) of assets to place a higher value on the assets than their owners. Risk Diversification theory This theory bases argument on the portfolio theory which assumes that a company can reduce risks by holding a collection of assets which are not perfectly related (Sherman and Hart, 2006: 10). Engaging in Mergers and Acquisition, under this theory, helps the acquiring company to diversify its activities and reduce the volatility of cash flows at a group level while it still maintains the same level of returns. Analyzing Mergers and Acquisitions Different companies have used Mergers and Acquisitions as a strategy for their growth; however, reports published show more of failure of the method than its success (Walz and Hickl, 2005). Companies use different methods to analyze Mergers and Acquisition activities in the business industry, however, the outcomes of these methodologies differ one from the other. To measure the success of Mergers and Acquisitions, the company has to identify its objectives towards its involvement in the activity. These objectives range from financial, human resource and market strategy (Walz and Hickl, 2005). The following are some of the methods used in analyzing Mergers and Acquisitions and their outcomes. Outcomes of the various methods of analyzing Mergers and Acquisitions Market Definition Method This method, although it is not the first step, helps to specify the country’s business line in which concerns on competition may arise. It also helps identify market participants and helps analyze the substitutes available to customers in case of the merger (Voorhis and Brusser, 2010). However, the outcome of this method is not viable because the agencies analyzing the activity may conclude that a merger raises competitive concerns without defining an exact relevant market as long as there is evident likelihood of the merger to result in anti-competition. This method helps analyze customer reaction on product market. The agencies assess the likelihood of customers changing to a product regardless of the price. If customers change to the substitute product, it leads to inclusion of the product in the market (Voorhis and Brusser, 2010). Likewise, the method is used to define the geographic market where if consumers are likely to switch to suppliers based in other areas due to price changes, the market is expanded to those areas. Market Shares Concentration This method helps in identifying the participants in the market, including the merging participants, and their shares in the market. Agencies use the market shares to assess market concentration before and after the acquisition. Concentration levels are measured using the Herfindahl-Hirschman Index (HHI), calculated by adding the square of market shares of each market participant (Voorhis and Brusser, 2010). HHI is low when there are many competitors in the market. However, the shortfall of this method is that, the HHI will not be applied as perfect screen and other competitive factors are examined to determine whether increased market concentration will lead to competitive effects (Voorhis and Brusser, 2010). Competitive Effects The main reason behind the analysis of a merger is to determine whether it will lead to lessening of competition so as to increase prices, reduce output or other harms to customers. This method analyzes whether the merger will hoist prices or lessen output in a harmful way on customers (Voorhis and Brusser, 2010). It also considers whether the merger will increase opportunities for the merged firm and its competitors to increase prices and reduce output, practices which harm customers. The outcome of this method is viable for analyzing Mergers and Acquisitions because the agencies analyze whether the post-transaction market conditions would increase companies’ ability to reach terms of coordination, detect deviations from the terms and punish the deviators (Voorhis and Brusser, 2010). Entry Analysis If other firms enter the market easily, a proposed merger does not bring any harm. For a firm to enter into the market, it must be timely (Gebken, 2009: 2). Market entry will be timely if the firm can achieve a significant impact on price in the market (Voorhis and Brusser, 2010). There is no definite time frame for an entry to be timely, however, agencies term entry as timely if the entering firm takes two years or fewer to plan for its entry and make an impact on price. Secondly, the entry must also be likely. A market entry is considered likely if a firm would be profitable, considering all costs, the likely output and the likely price. Thirdly, the entry must be sufficient where it is sufficient if it replaces the competition lost by the merger (Voorhis and Brusser, 2010). For example, the new entrant cannot offer the same quality or breadth of product offering as the merged firm. The method is viable because it helps the firm to plan for timely entries into the market and make a profit. Potential Competition This is a method that evaluates whether the two companies seeking to merge have potation competitions. The merges between to competitors will result to anti-competitive consequences (Voorhis and Brusser, 2010). This occurs where one of the merging companies develops a product, which without the two companies merging would bring competition to the other company’s products. The outcome of this method helps the merging companies to prevent any potential competition which would arise from lowering prices in the future 9Voorhis and Brusser, 2010). It also helps in identifying the potential competitors in the industry. Objective Evaluation Method This method is subdivided into; annual accounts oriented method, the capital market oriented, and the event oriented method (Walz and Hickl, 2005). The annual accounts method considers various ratios out of the external accounting system. The capital market method implies the abnormal returns representing the difference between the expected share price before and after acquisition. It gives a prospect for future developments and analyzes success from the shareholders point of view. The event method includes (reselling of the acquired unit) disinvestment and fluctuation ratios to evaluate the transaction. The problem with this method is that it is inappropriate in measuring economic success; however, it has a close link to the objective of an acquisition (Walz and Hickl, 2005). Capital Neutral Basis This method can be done using all stock. When using this method in a transaction, the capital effects are of two companies combined in a pooling transaction (Wishner, 2007). The equity and assets are weighted on the two institutions’ average. If the acquirer buys at a higher price than the acquisition price, the deal is a profit to them. However, the outcome of this method is misleading because, utilizing average stock creates earning per share, and it has high capital position per share. Analyzing mergers and Acquisition deals on a capital neutral basis evaporated earnings accretion, and considering the execution risk of M&A deals, a better utilization of capital would be to buyback one’s stock (Wishner, 2007). Subjective Evaluation Method The method is one of the methods that promise success in its use to analyze Mergers and Acquisitions. Its outcome is liable because it deals with people who have participated in the activity (Walz and Hickl, 2005). It gets analysis from different managers, employees, internal and external experts who have experience on the activity. Use of this method helps in measuring the success of incorporation of different companies and becomes a viable method of analyzing Mergers and Acquisitions. Conclusion The high rise in the economy and competition, in the market has led some businesses to opt for mergers and Acquisitions so as to fight the rises. However, different business enterprises or companies have different motives of joining mergers and Acquisitions. There are those who base motives on business strategy and others on financial strategy (Farschtschian, 2012: 28). These different motives determine whether a Merger or Acquisition will be successful or not (Connell, 2008: 152). There are different methods used to analyze Mergers and Acquisition used by different agencies. These methods differ in their outcomes as seen in the study. For mergers to be successful, firms, which intend to engage in mergers and Acquisitions, have to use the best methods which will help them succeed in the activity. Bibliography CONNELL, R. B. (2008). Why companies do not pursue attractive mergers and acquisitions. Amherst, NY, Cambria Press. FARSCHTSCHIAN, F. (2012). The reality of M & A governance transforming board practice for success. Berlin, Springer-Verlag Berlin Heidelberg. http://public.eblib.com/EBLPublic/PublicView.do?ptiID=885180. FAULKNER, D., TEERIKANGAS, S., & JOSEPH, R. J. (2012). The handbook of mergers and acquisitions. Oxford, Oxford University Press. http://dx.doi.org/10.1093/acprof:oso/9780199601462.001.0001. Gebken, Timo. (2009). The Dynamics within Merger Waves: Evidence from the Industry Merger Waves of the 1990s. Munich. Grin Verlag, 2009. KARENFORT, S. (2011). Synergy in mergers & acquisitions: the role of business relatedness. Thesis (D Business Administration)--University of South Australia, 2011. SCHMIDT, B. B. (2010). The dynamics of M&A strategy: mastering the outbound M&A wave of Chinese banks. Frankfurt am Main, Lang. SHERMAN, A. J., & HART, M. A. (2006). Mergers & acquisitions from A to Z. New York, AMACOM. http://proquest.safaribooksonline.com/9780814408803. Voorhis Lee Van & Brusser Vadim. (2010). How Anti-trust agencies analyze M&A. Retrieved from http://www.weil.com/files/Publication/d7875361-6104-41ee-ab81-785b5612ed07/Presentation/PublicationAttachment/503d76f6-d824-411b-9fb2-7ca5c7942943/10.18.10-October2010_PracticeNote on 16 April, 2013. Walz, Charlotte & Hickl, Carmen.(2005). Controlling the Results of Mergers and Acquisitions-Methods for Measuring the M&A Success. Munich, Grin Verlag, 2005. Wishner, Jeffrey J. (2007). Capital Management- Analyzing M&A Deals on Capital Neutral Basis. Retrieved from http://www.wib.org/publications__resources/directors_resources/directors_digest/2006-07/dec07/wishner.html on 16 April, 2013 Read More