Literature Review on Mergers and Acquisitions
There has been an increase in the number of companies going into mergers and acquisitions. According to Burner (Firth 1980, p.235), large and multinational companies have resorted into mergers and acquisitions with the objective of increasing shareholders returns. However, research suggests that this is not always true as the short term effects are insignificant while the long term effects are highly negative (Sudarsanam & Mahate 2003, p.17). This suggests that the real goal or motivation why companies go into mergers and acquisitions is related to other factors such as empire building and not increasing shareholders returns. The paper focuses on a critical literature review on mergers and acquisition in order to determine the real motivation for companies to go into mergers and acquisitions.
Mergers and acquisitions abbreviated as M&A and corporate restructuring are a significant part of the corporate world of finance/business. Each single day, investment bankers of Wall Street arrange transactions of M&A that bring distinct firms together in order to form large companies (Sherman & Sherman, 2011). When companies do not resort to creating larger firms from smaller ones, deals of corporate finance do the opposite and break up firms through carve outs, tracking stocks, and spinoffs. Expectedly, these activities make up the news. Finance deals may have a value of million or billion dollars. The actions may determine the companies’ fortunes for the future (Sherman & Sherman, 2011). For CEOs, leading an M&A can reflect the highlight of his or her whole career. In this case, it is not surprising that there are always cases of M&A activities in newspapers, televisions, magazines, social media, and all forms of media each time because they occur all the time. In fact, deals of M&A grab headlines (Sherman & Sherman, 2011). What however causes companies to go into mergers and acquisitions? Are there some negative short term and long term effects of M&A? This is what the essay is focused on answering.
The main idea in M&A is that one plus one equals three. This represents the unique alchemy of M&A’s across the world. The main principle underlying buying a firm is to create or increase the value of shareholders above and over that of the total of the two firms. Two entities joined together are more worth than two separate entities. This is the reasoning that underlies mergers and acquisitions (Firth, 1980). These grounds are especially appealing to firms when the market is experiencing tough times. Large and strong firms will buy other firms to establish a cost efficient and more competitive company (DePamphilis, 2011). The firms will come together with the hope that they will gain a higher market share or even to attain greater effectiveness and efficiency. Because of the possible market and business benefits, target firms will frequently consent to be bought when they know that it is not possible to survive on their own (DePamphilis, 2011).
There are differences between mergers and acquisitions. Even though there are frequently used as if they are synonymous and said in the same breath, the two words merger and acquisition mean a little distinct things (DePamphilis, 2011). When a firm takes over another company and openly declares itself as the new holder, this process or purchase is referred to as an acquisition. From a legal perspective, the target firm stops to exist, and the purchaser “swallows” the business (Carney, 2009). The stock of the buyer continues being traded in the market. On the other hand, a merger occurs when two companies, often of similar size agree to act as a new and single firm instead of remaining separately operated and owned. This form of action is more specifically known as a “merger of equals” (Carney, 2009). The stocks of both firms are given and the new firm stock is issued instead. For instance, both Chrysler and Daimler-Benz stopped existing when the two companies merged and created DaimlerChrysle, a new company (Carney, 2009).
However, in practice, real mergers of equals do not occur very often. Normally, one firm will purchase another and allow the acquired company to declare that the action is a merger of equals even when technically, it is an acquisition. Being purchased frequently carries unfavorable connotations, thus, by explaining the arrangement as a merger, top managers and deal makers attempt to make the takeover a pleasant action (Boissevain, 2000). An acquisition or purchase deal is also called a merger when the CEOs from both companies agree that operating as one is in the interest of the two companies involved (Boissevain, 2000). When the arrangement is unfavorable, however, this is always seen as an acquisition. It depends on whether the acquisition is hostile or friendly, as well as, how it is announced for it to be regarded as an acquisition or a merger (Sudarsanam & Mahate 2003, p.20). This simply means that the real distinction lies in the communication of the purchase and how it is received by the board of directors, shareholders, and employees of the target company. Here are the major reasons why people resort to mergers and acquisitions besides the increase of shareholders’ value.
Companies go into mergers and acquisitions in order to attain tax benefits. In mergers, tax benefits differ from one region to another (Buono & Bowditch, 2003). For instance, mergers in the U.S. are preferred if the target company or the acquiring firm has a tax loss carry-forward. This refers to the capacity to subtract past losses from the company’s taxable income (Buono & Bowditch, 2003). This benefit is, however, not available for holding companies. In order to reduce the attractiveness of the tax benefits motive, the United States and other nations restrict the value of tax loss carry-forward which can be subtracted yearly from the merged company’s taxable income. Another motive is to increase liquidity for company owners (Dwyer, 2005). If the purchasing company is a large firm and the target firm is only a small firm then the shareholders of the target firm may find it very attractive that after the merger or acquisition, the marketability and liquidity of their shares will possibly be significantly better (Dwyer, 2005).
Companies go into mergers and acquisitions in order to gain access to funds (Dwyer, 2005). The purchasing firm may have high financial debt, meaning that access to more external debt is extremely limited, hence, among the motives of mergers and acquisitions is to join a company that has a healthy debt or liquidity position or minimal debt as it will now be able to acquire additional debt financing (Firth 1980, p.240). Another motive for mergers and acquisitions is growth, which is among the most common motives. In this case, it may be less risky and cheaper for the purchasing firm to join with another company or acquire a company in a similar business line than to expand its business operations internally. In addition, it is quicker to expand by acquisition than internally (Wolff, 2008). At times, a company may have an opportunity that does not last long and the only way to take the advantage of such an opportunity is to acquire another firm with resources and competencies required for the window opportunity. The potential elimination of competitors is eliminated through the growth benefits of mergers and acquisitions (Wolff, 2008).
Diversification is another motive for mergers and acquisitions. This is an external strategy of growth (Auerbach, 2008). For example, if a firm operates in an unstable industry or environment, it may opt for merger or acquisition in order to hedge itself against market changes. A company may acquire a firm located in a different country or region (geographical diversification). Related diversification refers to expansion in the present market or entering new markets (Keller, 2012). Usually, diversification does not give value to shareholders since they can expand their portfolio at a lower cost and on their own (Keller, 2011). Diversification on its own, therefore, is not likely to be enough for a merger and acquisition. Mergers and acquisitions aid in synergetic benefits. Synergy takes place when the total is higher than the total of its parts (Keller, 2011). In mergers and acquisitions context, synergy implies that the performance of companies after a merger or acquisition will be better than the whole of their performance prior to the acquisition or merger. In this case, the large company or acquiring firm may be able to obtain greater discounts because of the larger quantities ordered from suppliers. According to Keller (2011), there are two kinds of synergy. One results in increased revenues such as cross-selling while the other results in economies of scale that refers to decreased costs.
According to Kumar (2012), merging companies in the same line of business allows the eradication of some of duplicated costs. A new business will not require two public relations and human resources departments. Rather, the best staff will be maintained and rest of staff and unused space will be reassigned (Kumar, 2012). On cross-selling, if some of the services and products of the merged firms vary then cross-selling the services or products to the other company’s consumer base can be a cost effective way of increasing sales. Effectively meeting the needs of customers may also improve the loyalty of customers because of greater customer satisfaction that can happen through effectively offering customers with a wide spectrum of services and products that meet the needs of customers (Mill, 2003). Benefits of synergy in relation to an increase in revenue are normally harder to attain than those regarding decreasing costs. Company management needs to be cautious in order to ensure that possible benefits of synergy are not overvalued as this may lead to overpayment for the target firm. The target firm may have assets, technology, or managerial skills that the acquiring firms needs in order to improve its profits through improved performance, cut costs, improve revenue, reducing productivity among other needs (Mill, 2003). This may be a motive for mergers and acquisitions. Mergers and acquisitions may also be a strategy against a hostile takeover.
In mergers and acquisitions, companies highly ignore the long run negative effects that arise with mergers and acquisitions (Franks & Harris 1989, p.249). This being the case, it is evident that the real motive for M&A is not to increasing shareholder returns as the negative effects show. There are various motives some of which have been discussed above, and they differ from one organization to another. Although some M&A may be fruitful in some instances, the effect of M&A on various companies’ sects may vary. This implies that they are not successful at all times. According to Wiley (2009), sometimes, the main objective for which the M&A process has occurred loses focus. The success of M&A is determined by various factors. Unsuccessful mergers and acquisitions affect the entire personnel in the organization and harm the firm’s credibility (Wiley, 2009). Mergers and acquisitions affect shareholders, labor force, and senior executives. The major concern here is the shareholders, since some mergers are formed to increase the value of shareholders. Shareholders are categorized into two; those of the acquiring firm and those of the target company. Those of the acquired company benefit the most since they have to be offered more in order to agree to the acquisition while those of the acquiring firm are highly affected (Fleishon, 2008). In this case, it is evident that the motive for mergers and acquisitions is not increase shareholder returns, but relates to factors or motives that have been discussed. It is, therefore, important for senior management of companies considering mergers and acquisitions to take into consideration the long term effects of mergers and acquisitions, if ever they wish to attain the set and desired goals.
List of References
Auerbach, A. J. 2008. Mergers and Acquisitions. Chicago: University of Chicago Press.
Buono, A. F., & Bowditch, J. L. 2003. The human side of mergers and acquisitions: Managing collisions between people, cultures, and organizations. Washington, DC: Beard Books.
Bruner, R. F. 2004. Applied mergers and acquisitions. Hoboken, N.J: John Wiley & Sons.
Carney, W. J. 2009. Mergers and acquisitions. Austin: Wolters Kluwer Law & Business.
DePamphilis, D. M. 2011. Mergers and acquisitions basics: All you need to know. Burlington, MA: Academic Press.
Firth, M. 1980. Takeovers, shareholder returns and the theory of the Firm. Quarterly Journal of Economics, 94, 235–260.
Franks, J. and Harris, R.S. 1989. Shareholder wealth effects of corporate takeovers: the U.K. experience: The impact of acquisitions on firm performance: A review of the evidence 1955–1985. Journal of Financial Economics, 23,225–249.
Kumar, B. R. 2012. Mega mergers and acquisitions: Case studies from key industries. Basingstoke: Palgrave Macmillan.
Sherman, A. J., & Sherman, A. J. 2011. Mergers & acquisitions from A to Z. New York: American Management Association.
Sudarsanam, S. and Mahate, A.A. 2006, Are friendly acquisitions too bad for shareholders and managers? Long-term value creation and top management turnover in hostile and friendly acquirers. British Journal of Management, 17 (special issue), S7–S29.
Wolff, L.-C. 2008. Mergers & acquisitions in China: Law and practice. Hong Kong: CCH Hong Kong.
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