Motives and Theories in Mergers and Acquisitions - Essay Example

Introduction Numerous definitions for the types of combinations of firms have been developed and floated. Mostly, voluntary and long term serving combinations aim to serve the strategic objectives of the merging or acquiring firms. And, the strategic decision makers in mergers and acquisitions (M&A) argue that their pure motives find their base on the rationality and serving the interests of larger community of shareholders. M&A can take place by extending market share to diversifying products and services, sharing risk, or improving innovation and learning. However, the merger waves have been providing a mix amalgamation of corporate impacts on both sides of the table. In which, both targets and bidders were greatly influenced by the notion of greater efficiency especially this occurred in the first great merger wave period. In the following M&A history, various studies required the presence of legal and regulatory framework with an aim of solidifying the existence along with prolonging the success stories of M&A. Despite the implementation of regulatory-cum-legal framework, hostile takeovers did take place, leaving the negative impacts on the stock price of the targets. In the subsequent part of this paper, first, M&A definitions are accounted for, which is followed by motives and theories. Subsequent to that, Merger waves periods, legal-cum-regulatory framework are elaborated. Afterwards, strategies and tactics in takeovers, the effects of M&A on firm’s stock price and stock market are explained. Before conclusion, financial objectives and case study about Burlines Group’s acquisition of Telemetry business are incorporated. Definition of Merger & Acquisition Numerous definitions for types of combinations of firms have been put forwarded (Frensch, 2007, p.23). Fundamentally, mergers and acquisitions take place when a firm seeking to expand its activities into new products (Boettke, 1994, p.394). Additionally, with the objective of pursuing common economic aims, the combinations of firms come out as a result of a union of legally and economically independent firms by serving the interests of both parties. Collectively, Mergers and acquisitions (M&A) take place when two or more organizations join together in toto or in part of their business operations. However, the difference between mergers and acquisitions are associated particularly with: the relative size of the individual firms in the business combination; management control of the joint business; ownership of the combined business (Coyle, 2000). Coyle (2000) further defines its broadest definition; merger as any takeover of one company by another company when the businesses of both companies are merged as one; and on the narrow scale of this definition, two companies having equal size, combine their resources into a single business; on the other hand, an acquisition, or takeover, takes place when one entity acquires from another entity either a business segment and its assets or a controlling interest in the entity’s stocks. Motives and Theories in Mergers and Acquisitions The strategic decision makers in M&A contend that their motives are fundamentally based on rationality and in the best long-term interests of their company and shareholders (Auster and Sirower, 2002). M&A activity has been seen as a tool from extending market share to diversifying services and products; improving innovation and learning, obtaining operational flexibility, personnel and new skills, pruning managerial deadwood, sharing risk, trimming the unnecessary fat in the national economy along with expanding global competitiveness (Marks & Mirvis, 1998, 2001; Walsh & Ellwood, 1991). Two theories- the agency theory and the transaction cost theory- offer their relevancy for M&A activity. Some authors argue that the principal-agent or agency theory accounts for an alignment of interests of two parties in their contracting relations marked with information asymmetries and the presence of uncertainty between the contracting parties. In relation to the mergers and acquisitions, the agency relationship may exist between the management of the entity and their shareholders and between the acquirer and the target. The principal-agent theory becomes significantly important in the backdrop of mergers and acquisitions since it besides providing an explanation for the transactions occurrence, highlights the possible problems and their remedies while pursuing transactions and issues that are relevant to their relationship. The transaction cost approach suggests that the comparative costs of carrying out transactions through external markets rather than internally inside a company highlighting the company’s scope and size (Williamson, 1996, p.3). And, Williamson (1996) also describes transaction costs as the ex ante costs of drafting, safeguarding and negotiating an agreement; on the other hand, the ex post costs of mal-adaption and adjustment take place when contract execution is mis-aligned caused by gaps, omissions, errors and un-expected disturbances. Some authors contend that the transaction costs perspective depends on the rationality assumption, i.e. a company’s capacity to act rationally is inherently troubled by its inability to access complete information and of opportunism-exchanging partners pursuing their own interest may intend to conceal information or mislead one another with an aim of gaining advantage. Consequently, these informational uncertainties cause companies to incur costs. Based on this theory, some authors opine that acquiring a target company becomes beneficial if it incurs comparatively lower transaction costs instead of purchasing the product or services of the target company on the external market. Particularly, in cases of specific transactions with opportunistic exchange partners, companies carry out mergers and acquisitions with an aim of mitigating the problems of under-investments and hold-up issues. Organizational objectives are mostly pursued through mergers and acquisitions. Lynch and Lind (2002) explain mergers and acquisitions as being one of the fundamental techniques for organizational growth; whilst Hurtt, Kreuze and Langsam (2000) describe growth as the prime objective behind the occurrence of M&As. On the other hand, Perry and Herd (2004) argue that the crucial role of strategic planning at a time when M&As are carried out for growth. Additionally, they argue that in the period of 1990s companies took away their focus from using M&A for the purpose of cost saving to using M&As as a strategic tool for corporate growth. Merger Waves: A Historical Perspective Various authors have contemplated the subsequent periods of merger waves in the corporate history. For example, Banerjee and Eckard (1998) highlighted that acquisitions in the first great merger wave period concluded the value creation not only for bidders but also for targets as the firms were driven by the notion of greater efficiency. However, Leeth and Borg (2000), after analyzing the subsequent wave especially in 1920s, found that although targets achieved from being acquired, the bidders touched the mark of break -even- neither loss nor gain. Additionally, Matsusaka (1993) pinpointed that during the 1960s merger wave, the acquiring firms resulted in negative returns from the related acquisitions but secured healthy returns from diversifying acquisitions, especially if target managers were not relieved. Hubbard and Palia (1999) re-examined the same wave, found that the greatest returns for diversifying acquisitions occurred when financially unconstrained bidders obtained financially-constrained targets, highlighting that investors considered the internal capital markets as more efficient than the external capital markets. Legal-cum-Regulatory Framework Numerous studies have highlighted the relationship between the legal and institutional environment in which firms do business and carry out their corporate finance practices and firm valuation (La Porta et al., 1998). Consequently, a strong and institutional environment in a country may be linked with high investor-cum-creditor protection (Bris & Cabolis, 2008; Conn et al., 2005; Dyck & Zingales, 2004; Kuipers et al., 2009); more economic liberty- improving and encouraging foreign investment and business activity- more development of capital markets, reducing the cost of external financing (Francis et al., 2008; Moeller & Schlingemann, 2005; Pablo, 2009). Furthermore, Rossi and Volpin (2004) put light on the legal environment on cross-border takeovers by highlighting that countries with greater shareholder protection have more M&A activity and that, in international M&A, target firms are in countries that provide less protection to shareholder than those of the bidders. Additionally Francis et al. (2008) contend that a weaker legal framework in the target country may become a source of gains for acquiring companies, considering that it enables the target firms to access to inexpensive financial resources through the internal capital market created by acquiring firms. Strategies and Tactics in Takeovers: Hostile takeovers increase the price given for the target firm, which shows a negative acquiring-firm shareholders valuation (Campa & Hernando, 2004; Goergen & Renneboog, 2004). Commencing with the deal, King et al.(2004) argue that managers finance acquisitions with cash when they consider the firms are under-valued and finance their acquisitions with stock when they contemplate that their firms are over-valued; highlighting that the market should consider stock-financed deals as a sign of bidder over-valuation (Loughran & Vijh, 1997). However, Hayward (2003) argues that powerful banks prefer to utilize this tactic by directing their clients to complex solutions particularly in stock-financed deals. Various steps include the development and implementation of bidding strategy. In which, common bidding strategy objectives consist of minimizing control premium, winning control of the target, facilitating post-acquisition integration process along with diminishing transaction costs (De Pamphilis, 2011, p. 107). De Pamphilis (2011) argues that if the purchase price along with the transaction costs are diminished along with the occurrence of the maximum cooperation and integration of the both parties, the bidder may carry out the friendly approach, which incurs less cost than the more aggressive tactics-which happens in the hostile bid- result in the loss of key customers, personnel and suppliers during the fight for the management control of the target. Takeovers occur in both friendly and hostile manifestations. A negotiated settlement mostly takes place in friendly takeovers (Machiraju, 2003, p. 78). Additionally, the friendly takeovers are represented by the events such as bargaining and agreement in the friendly environment. Furthermore, the successful takeovers largely rely on the premium provided to the targets including the composition of the board; the targets current share price, the composition as well as sentiment of targets current shareholders. On the other hand, the hostile takeover is an unsolicited offer, which is not accepted rather resisted by target firm’s management, given by a potential acquirer (Machiraju, 2007). Hostile bid tactics need a battle plan consisting of various lines of attack, outshining moves and counterattacks (Sudarsanam, 2003, p. 490). Sudarsanam (2003) argues that a significant component of the plan is surprise: Within this context, the fundamental advantage comes with the hostile bidder and the element of surprise is easily obtained in the case of voluntary bid without pre-bid stake development in comparison with a compulsory bid in which the bidder has already developed up to a 30 percent stake (Sudarsanam, 2003). Additionally, in the case of hostile bid, the bidder significantly relies on the advices of the external advisers than in the case of the friendly bid. In this regard, Sudarsanam (2003) states that the services of investment banks with special expertise in hostile bids, PR consultants, lawyers, and stockbrokers-who can mould the market sentiment in favor of the bid- will be indispensible. The Effects of Mergers and Acquisitions on Firm Stock Price and Stock Market Typical earlier period findings highlighted that acquisitions did not increase acquiring firm’s value in the short term (Asquith, 1983; Dodd, 1980); or in the long run performance measures (Agrawal, Jaffe, & Mandelker, 1992). Instead, acquisitions were found to destabilize acquiring firm value (King et al., 2004) and create highly unstable and volatile market returns (Langetieg et al., 1980). On the other hand, the research on the returns of the target firms showed that target shareholders considerably fared well along with experiencing significant positive returns (Carow et al., 2004). Additionally, these studies also pointed out that acquisitions provided positive collective returns in which further analysis suggested that targets accounted for the majority gains in contrast with either neutral or negative returns experienced by the acquiring firms (Houston et al.,2001; Leeth & Borg, 2000). Financial Objectives Market power, efficiency and resource redeployment serve as the financial objectives of mergers and acquisitions (Haleblian et al. 2009). Market power may be contemplated as an attempt to appropriate more value from the customers and suppliers. Additionally, efficiency is defined as a way to reduce the cost side of the value creation. Banerjee and Eckard (1998)-within the context of the efficiency motives of the acquisitions- found that the market bid up horizontal mergers in the period of first great merger wave in the early 1900s. Furthermore, a considerable number of scholars argue that managers consider horizontal acquisitions as a means of facilitating assets redeployment along with competency transfers with an aim of generating economies of scale ((Haleblian et al. 2009). Case Study: Brulines Group’s Acquisition of Telemetry Business Brulines Group has acquired telemetry business lookout (Ruthven, 2011). Brulines Group is a listed on London’s AIM market and is based in North Yorkshire. And, Telemetry business lookout is based in Oxford. According to the statement, the deal is going to facilitate Brulines business by integrating Lookout’s services into its own Vianet subsidiary. The major advantages from this deal are going to be a ‘one-stop-shop’ for vending telemetry, vending management software along with contactless payment. In addition, under the deal, Mark Boland, who is the founder and managing director of Oxford-based Lookout, is to merge into Vianet by providing the services for managing director of sales. Furthermore, Brulinies main services include measuring the volume of liquid dispensed each hour against appropriate and legitimate deliveries in pubs throughout the UK. And, this deal aims to solidify the business of the Company that has been going on since 2010. In December 2010, the purchase of Amscreen M2M worth up to £ 3.4 million by the Brulines Group was one of its examples of successful acquisitions. Ruthven (2011) narrates that according to a statement, Brulines aims to emerge as a ‘market leader’ in contact payment processing and telemetry. And, this journey towards that market position experiences the subsequent successes when the Brulines with its successful acquisition strategy acquired Vianet in December 2008 (Ruthven, 2011). Till this point of time, the Brulines Group has adopted and experienced friendly takeovers, highlighting its successful acquisition strategy. Conclusion Nowadays, the regulatory and legal framework has become indispensable to carry out friendly acquisitions and mergers. Both considerably serve the rationality along with long term interests of both parties. Additionally, a strong and institutional environment aim to protect investors and creditors in addition to providing more economic freedom, developing more capital markets and reducing the cost of external financing. On the one hand, an acquiring firm is required to develop common bidding strategy objectives consisting of winning control of target, providing post-acquisition integration process, minimizing control premium. 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