How Excessive Outlays May Lead to an Unsuccessful Takeover - Essay Example

CORPORATE TAKEOVERS CORPORATE TAKEOVERS Insert name Insert grade course Insert instructor’s name April 21, 2011. Introduction There are normally two wide classes of takeovers: friendly takeovers and hostile takeovers. A takeover is termed as hostile if it has not been approved by the target company’s management or it board of directors. On the other hand, takeovers that are approved by the target company’s management or its board of directors is said to be a friendly takeover. Corporate takeovers are amongst the largest investments that a company can ever undertake, thus offering a distinct window into the value implications of significant managerial decisions and bid strategies, and into the multifaceted set of contractual devices and procedures that have come up to facilitate the striking of a deal. There have been empirical research in this area the have focused on various topics such as the impact of statutory and regulatory limitations on the process of acquisition (disclosure and target defenses), strategic bidding behavior (markup, toeholds, bid jumps, payment method choice, hostility), short- and long-run abnormal stock returns to bidders and targets (size and division of takeover gains), as well as the origin and competitive effects of corporate combinations (efficiency, antitrust policy and market power) (Betton, Eckbo & Thorburn, 2008). In this paper, we are going to review empirical research on the reasons why takeovers may fail. The report seeks to identify the fundamental drivers of business failure by reviewing the existing literature. How poor motivation and evaluation may result to failure of corporate takeover The occurrence and result of takeovers is determined by three factors: the bidder’s profit prospects, the protection of the target shareholders as well as the defensive measures available to the target company. For us to understand how poor motivation and evaluation contribute to the failure of takeovers, we are going to evaluate why takeovers may take place in a certain company by employing firm-level variables to represent inefficient management, growth-resource imbalance, firm size, asset under-evaluation, tangible fixed assets as well as free cash flow. We are going to look at the takeover hypotheses, variable definitions and the empirical support (Powell, & Yawson, 2006). Inefficient management The hypothesis of inefficient management have been tested by numerous takeover prediction studies and found out that company performance e can be utilized as a proxy for poorly performing management (Palepu, 1986, Powell, 2001). Companies that perform below some benchmarks like industry average performance are more prone to takeover with an aim of eliminating target managers. The theory is drawn from Manne’s (1965) paper, which falls out in favor of a lesser amount of rigorous anti-trust regulations in view of the fact that takeovers facilitate provision of a helpful check on management performance. If such a company that has poor management is not properly evaluated, it can reduce the motivation for takeover and thus resulting to takeover failure. Poor motivation emanates from these under-performing managers since they want to retain their positions and also their self-interests. Therefore, they hinder thorough evaluation of the company, and hence avoiding a takeover. Growth-resource-imbalance The theory forecasts that companies with an imbalance between growth and accessible resources are prone to be under attack for takeover (Palepu, 1986). In particular, companies with high growth but low resources have higher probability of being acquired by companies that have an opposite imbalance – low growth but high financial resources. In a similar manner, companies with low growth but high financial resources are more likely to be acquired by companies with opposite imbalance – high growth but low financial resources. Such merging gives rise to performance improvements. Managers whose interests are finances can de-motivate evaluation of a company that has low growth and high financial resources so as to avoid a takeover so that they can continue enjoying the benefits. They can prevent detailed evaluation by concealing some of the fine financial details of the company thus de-motivating the buyers and hence avoiding an acquisition. There prefer maintaining the status quo so as to continue enjoying the benefits. Firm size Larger companies are not likely to be acquired due to expenses or outlay linked with taking-in off big target into the acquirer’s organization structure. Bigger targets are as well likely to absorb higher expenses connected to prolonged takeover battles and, moreover, the pool of potential bidders is likely to be smaller for large targets. In other words, large targets normally de-motivate the potential bidders owing to the costs associated with takeovers. This also leads to poor evaluation of the potential benefits that the acquirer would get in the event of a takeover (Powell, & Yawson, 2006). Asset under-valuation The acquisition of ‘cheap’ or under-valued assets is a strong motivation for some takeovers. Companies whose market value of assets is lower than the book value (low market-to-book) characterize negotiations to acquiring companies who would like to purchase particular assets in place, as opposed to innovative possessions, which are expected to be more costly (Hasbrouck, 1985). Although the market-to-book (MTB) ratio is in addition expected to reveal other factors, together with management quality, expansion options and indefinable possessions, results in the takeover literature demonstrate that targets have a tendency of significantly lowering MTB ratios compared to acquiring companies. On the other hand, when assets are over-valued, they reduce the motivation for takeovers and may result to a takeover failure. If the assets are poorly evaluated, this may de-motivate the acquirer and result to a takeover failure (Powell, & Yawson, 2006). Tangible fixed assets Companies with a high fraction of substantial fixed possessions in their asset structure are expected to be targets for takeover because of their privileged debt-capacity (Stulz and Johnson, 1985). Physical possessions act as security and may be eye-catching to a prospective bidder who wants debt financing to assist finance the takeover. Non-core corporeal possessions can as well be sold after takeover to assist pay for the takeover, while helping to restructure the core business activities (Ambrose and Megginson, 19992). Nevertheless, poor motivation would arise when the company does not have high proportion of tangible fixed possessions. The low motivation may result to a failure of a takeover. How excessive outlays may lead to an unsuccessful takeover Studies have shown that target shareholders realize considerable abnormal gains when bids are announced (Mandelker, 1974; Jensen and Ruback, 1983). On the other hand, when target directors decline bid tenders and the takeover effort is failed, target shares experience price turn down. Generally, targets of reserved conquests have a tendency of considerably increasing their influence all through the time of the conquest challenge (Berger et.al., 1997). The substantiation on the final value impact of these rises in influence levels is varied. Safieddine and Titman (1999) argue that by raising leverage, managers may not only thwart takeovers, but due to the additional debt burden they also commit themselves to value-advancing improvements just as anticipated by prospect raiders. Moreover, they discover that there is a constructive relation linking the targets’ consequent long-term conduct and their leverage, as foreseen by the ‘disciplinary’ theory. Several studies show that to avoid takeover, shares of external shareholders with a little reservation price can be acquired out with money raised with new debt, leaving more voting power with current administration and with investors having superior reservation prices. Consequently, a victorious bidder ought to pay a higher payment to take over an extremely levered target to persuade investors to tender, making leverage efficiently an entrenchment mechanism. Target management makes use of a broad range of leverage-increasing devices to defeat takeovers (Servaes, 1994). Jensen (1986) suggests that free money flow (the cash flow in surplus of that required to finance all constructive net current value ventures) causes conflicts of interest between managers and investors. Managers may act contrary to the interests of shareholders and accumulate a lot of debts from banks so as to thwart a takeover. Such managers hold the money by investing in non-profiting projects with an aim of increasing the premium that would be paid by acquirers. These managers prefer maximizing their utility by refusing to hand over control of these funds to the investors since paying out cash minimizes the size of the firm and the resources under managerial control. Debt creation facilitates managers to successfully link their pledge to reimburse out potential cash flows and hence evade takeovers. Therefore, debt becomes an effective substitute for dividends and reduces the organization cost of free money flow by minimizing money flow accessible for expenditure at the prudence of directors. Issuing huge quantities of debt to buy stock sets up organizational incentives to motivate managers to pay out free cash flow. Furthermore, the exchange of debt for stock helps manager prevail over the ordinary managerial confrontation to cutback that the disbursement of free money flow often calls for. This in turn makes the manager maintain their positions and avoid takeovers (Jensen, 1988). How poorly planned and executed integration may result to takeover failure Acquirements of any range are a key responsibility for both the buyer and the object. Considerable returns—in particular income in surplus of the outlay of capital engaged in the whole program—are obligatory not only to generate stockholder worth, but also to validate the huge venture of administrative time and endeavor that goes into a takeover. But, as constant studies have confirmed all too well, several acquirements—according to some, the enormous mainstream—fail to validate the venture drawn in. Successful integration needs that four tasks be done well. 1. Assume financial control Serious acquirers understand that it is important to presume instant power over monetary performance and cash administration. If these two areas are not well integrated by the acquirers, there are high chances that the acquisition may fail. Takeovers may fail if the acquirer does not install corporate financial reporting procedures and clarify expenditure-level authority. Furthermore, the failure may result from lack of regular coverage system of money flow mechanism, before the necessary systems are embedded in and the administration group of the purchased corporation happens to acquainted with what is anticipated of it. For instance, if the weekly sales figures are not scrutinized early to make sure that commercial performance has not deteriorated due to the demands of the acquisition experience, the takeover may fail (Saddler, 2008). 2. Integrate processes and systems If by any chance the newly acquired company will be involved in the running of the larger organization, its main administrative processes – company arrangement, financial planning, resources spending endorsement, as well as HR management – ought to be incorporated with the buyer’s, in order that the acquired can start performing as an element of larger organization the soonest possible. However, if these systems and processes are not properly integrated, the takeover may fail. Major failures result from the integration of the IT systems with those of the larger organization. Several mergers and acquisitions in the so-called bank assurance sector have floundered due to IT integration problems. The main underlying principle for such mergers is normally that of cross-selling – selling the goods of the buyer to the clients of the purchased corporation and vice versa. This is a difficult goal to attain since it is dependent on the successful integration of the merging organizations’ IT systems. Thus, this may lead to a takeover failure (Mirvis, & Marks, 1992). 3. Make key points The goal here is to as much as it is possible within the minimum feasible time by positioning the correct persons in charge of the recently purchased company and eliminating those who cannot perform. Thus we understand that if these key appointments are not made, the takeover is prone to failures. Furthermore, it becomes a big task to know the right person to remain in company and who to go. If the correct applicant is selected, setbacks and breakdowns in new areas are more possible to be remedied to everyone’s contentment. But the incorrect selection can result in lifelong tribulations and dissatisfaction. The objective has to be to get the accurate exchange between pace and the efficiency of the administrative selection process. This may mean performing with less assurance, as contrasting to hindering the resolution until everybody is totally contented with the choice (Saddler, 2008). 4. Ensure the primacy of value creation Above all things, acquirers ought to crystal clear concerning the value creation rationale for the acquisition, and they have to make sure that this thinking drives the whole acquirement procedure, together with that of the acquisition. Everybody concerned with the acquisition – the analysts, negotiators, legal advisers, professional advisers and the top management of the acquirer as well as those who will be responsible for integration – ought to be clear concerning how the merger is to make money for the investors of the acquirer, and have to be continually reminded of this throughout the process. If this is not done, then it may result to the failure of the takeover (Saddler, 2008). Post-merger incorporation is a procedure that is thought to begin the very first day after the business deal itself is concluded (Mirvis and Marks, 1992). Alongside this, the planning of the post-merger chapter is supposed to begin at the very instant when the corporation takes on the strategic resolution of not only increasing physically, but also with amalgamations of other businesses. A strategic resolution like this wants to be distinct and ought to institute the distinctiveness of possible target businesses, that are desired and those that are in disagreement with the business’s objectives. Conclusion Mergers and acquisitions fall under the group of business configuration with the vision to make the businesses more successful. All stakeholders, together with shareholders, company directors, the community at large as well as the monetary press have scrutinized the profit of amalgamations and acquirements and testify that the merger experience certainly is the another method for quick business expansion. In the same vein, some have questioned whether these business combinations benefit the ultimate owner, the ordinary shareholder or whether managers use mergers to advance their interests and marginalize shareholders (Williamson, 1964). One body of research alleges that mergers and acquisitions are beneficial because they are used for quick corporate growth, which in turn generates bigger profits for shareholders in the future and favorable wealth effects for shareholders around the date of announcement of the acquisition (Jensen 1988). Market studies however suggest that higher gains accrue to target firm shareholders while bidding firm shareholders do not benefit from acquisitions (Mwale, 2007). 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