Motives and Effects of Mergers and Acquisitions
Mergers and acquisitions are seen as an important strategy that business entities should employ with the goal of increasing their worth. Despite popular belief that the strategy allows businesses to gain, motives and effects of mergers and acquisitions are thought to vary among organisations. In the light of this, the proposed research intends to establish the motives and effects of mergers and acquisitions. In order to address the study objective, I intend to use secondary data from sources, such as the Yahoo Finance. Based on the data, the efficiency ratio (EFF), rate of return on investments (ROA) and return on equity (ROE) will be computed to allow for making inferences.
It is a common thought that mergers and acquisitions (M&A) benefit organisations. Although debatable, the number of mergers and acquisitions has varied over time. Similarly, it is expected that motives and effects of mergers and acquisitions vary across organisations. Based on an assessment by Marks and Mirvis (2010), the value of M&A increased from around $460 billion during the 1990s to over $4.5 trillion in 2007. One of the motives Marks and Mirvis (2010) identified was that M&A were critical in creating shareholder value. Based on the authors’ findings, M&A shareholders’ equity grew when the acquiring firm chose to pay a premium to stay off competition. Despite a rise in the value of the equity of the acquired firm, the acquirer suffered a loss, since its share price usually underperformed moments after the completion of the merger or acquisition. Marks and Mirvis (2010) went further to conclude that roughly 66% of merging companies lost a part of their market share, as soon as the first quarter after closing the deal. The researchers also indicated that the financial service sector accounted for a larger percentage of M&A transactions.
Walter (2004) observed that there were over 230,000 mergers and acquisitions between 1985 and 2000. The M&A were valued at over $15.8 trillion. Walter (2004) proceeded to note that, of the mergers and acquisitions, 50%, valued at $8.5 trillion were in the financial services sector. Based on the above statistics, it is evident that M&A continue to play a major role in corporate strategy. Despite the wide acceptance of the business strategy, Cartwrght and Schoenberg (2006) conceded that there was overwhelming evidence, supporting the view that M&A were encountering high failure rates.
Given the high level of environmental dynamism, organisations are increasingly finding themselves under pressure to adopt strategies to enable them compete globally. For instance, many changes to regulatory frameworks, technological developments and competition push organisations towards adopting the M&A strategy. Similarly, expansions in client access, functional lines and geographical markets have arisen to be major triggers of M&A strategy (Walter 2004).
Nature of the Problem
The primary motive for merging with some firms or acquiring others is to create shareholder value. The creation of shareholder value equally remains the fundamental concern for most organisations. Thus, organisations seek for opportunities to create or increase shareholder value, relying on many approaches. Thus, it is not surprising that mergers and acquisitions are considered one of the strategies employed by organisations, pursuing the agenda of increasing shareholder value.
It should be noted that most parts of the world embrace capitalism. Under a capitalist society, organisations are required to endeavour towards wealth creation or multiplication. For investors, wealth is measured by stock prices. As Moyer, McGuigan and Kretlow (2008) observed, stock prices are known to capture the aspect of timing, as well as risk, and their association with future benefits. Other possible statistics, useful in assessing the benefits, are the efficiency ratio (EFF), rate of return on investments (ROA) and return on equity (ROE). Moyer et al (2008) went further to indicate that mergers and acquisitions were critical in improving profitability, efficiency and synergy. In addition, mergers and acquisitions are thought to allow organisations to accrue other strategic benefits, such as enhancing customer base. Despite the popularity of the business strategy, Gugler, Mueller, Yurtoglu and Zulehner (2003) held that many unions failed to achieve the desired effects. In particular, Gugler et al. (2003) observed that during the previous fifteen years, 45% of mergers reported lesser profits than non-merged organisations. In addition, half of the merged organisations failed to reach the anticipated value. This comes against a backdrop of inflated promises given to shareholders by CEOs that merging companies would yield many benefits, such as economies of scale, increased market reach, consolidation of activities and synergies, as observed by Cools, Gell, Kengelbach and Roos (2007). In particular, between 1996 and 2006, half of mergers and acquisitions led to the destruction of shareholder value for acquiring firms. Dessein, Garicano and Gartner (2006) confirmed the same view, having established that several mergers failed to attain the expected synergies, which is the main motive for such unions. In the face of ambiguities surrounding mergers and acquisitions, in terms of results/ effects, it is significant to delve into the topic in order to develop a clear understanding of the motives and factors associated with mergers and acquisitions.
Basic Aims of Research
The main objective of the proposed research is to identify the motives and effects of mergers and acquisitions. In order to achieve that aim, the proposed research has specific objectives which include identifying whether:
· Mergers and acquisitions lead to an increase in shareholder value
· The differences in the motives and effects of mergers and acquisitions in different organizations?
· Mergers and acquisitions lead to an increase in market size?
There is extensive literature on the topic of mergers and acquisitions. For instance, Cartwright and Schoenberg (2006) have made a significant contribution to the literature. In particular, the authors have considered mergers and acquisition from the 1970s. The scholars found that in 2004, some mergers and acquisitions accounted for more than some countries’ GDPs. However, Cartwright and Schoenberg (2006) found that despite being very popular, mergers and acquisitions yielded mixed results. Particularly, shareholders of target firms enjoyed short term returns, while bidders’ firms often underperformed, almost immediately after takeovers. This view is confirmed by Agrawal and Jaffe (2000), who observed that there was inconsequential wealth gain for shareholders of bidding firms. After a rigorous study, Agrawal and Jaffe (2000) concluded that benefits accruing to acquiring organisations in few years after acquisitions were negative or statically insignificant. However, the two authors also found that that the results of mergers and acquisitions varied widely, depending on the state of merging firms. Moreover, roughly 40% of acquiring firms achieved positive returns in two to three years after mergers or acquisitions.
Motives of Mergers and Acquisitions
Based on the literature, there are various motives why organisations merge. It should be noted that motives are not exclusive of others, since the possibility of overlaps exists. However, broadly speaking, there are two types of motives, explaining why business entities embrace the strategy of mergers and acquisitions. The first type is based on the drive to increase firm/ shareholder value, while the other rests on the need to increase managerial wealth.
Increasing Shareholder Value
When discussing shareholder value, focus is on increasing a company’s worth which is often associated with mergers. It is expected that mergers benefit shareholders or owners directly, as the equity value of a company appreciates after merging operations. Alternatively, a firm is expected to increase its worth by making additional profits. It is also thought that merging improves efficiency, which, in turn, reduces operational costs. With low operational costs, firms’ profitability is expected to rise. In practice, when profits increase, operational costs are thought to fall. Similarly, after merging, firms are in a position to extend optimal incentives to their management teams or enhance a firm’s market power. The following literature is critical in assessing motives of mergers and acquisitions.
Farrell and Shapiro (2001) considered efficiency gains, attributable to mergers and acquisitions. In their study, Farrell and Shapiro (2001) drew a distinction between efficiency benefits in synergy and technical efficiencies. The authors defined synergy as efficiency attributable to the integration of merging organisations’ assets. Specifically, reference is made to those assets which cannot be obtained through any other way, apart from mergers or acquisitions. In their understanding, technical efficiency was reflected in the kinds of gains attainable by other mechanisms, apart from merging. In particular, they cited internal growth, licensing, specialisation agreements and collective/ joint ventures. Further, Farrell and Shapiro (2001) indicated that technical efficiencies corresponded to changes in collective production capacities of the merging firms. According to the scholars, such efficiency is achievable through scale economies or reallocation of production tasks across the merging firms. However, in the long-run, such benefits could be attained through launching large scale investments.
Under the technical efficiency benefits, economies of scale, economies of scope and economies attributable to vertical integration are explored. A firm enjoys economies of scale when that firm’s average costs decrease as its total output increases (Farrell & Shapiro 2001). Put differently, or in pure economics terms, economies of scale reflect a situation where, as production increases, the marginal cost declines. In the short-term, merging firms benefit from economies of scale by doing away with part of their fixed costs. In the long-term, merging organisations can benefit from mergers and acquisitions by coordinating their investments in physical capital. Farrell and Shapiro (2001) proceed to define economies of scope, as those relating to multi-product organisations or supply chain-related firms. To reach such benefits, firms must lower their average costs of production after unifying the production process. Thus, economies of scope are realised when joint production reduces the average marginal cost. Regarding economies associated with vertical integration, the focus shifts to when the total costs of production reduce, as a result of one firm conducting various stages in the production process instead of having such stages executed by two separate companies. Thus, the benefits are attributable to the localisation of production with a view to lowering the distribution costs. For example, acquiring technical support, training, promotion, and equipment financing are viewed as major factors that contribute towards efficiency. Vertical integration is also a useful instrument that can prevent opportunistic conduct amongst firms having a common investment contract (Farrell & Shapiro 2001). In such a context, positive effects resulting from mergers and acquisitions revolve around efficiency gains. Similarly, when a firm encounters difficulties in influencing the behaviour of clients, it is thought that entering a merger may play a big role in resolving such issues.
Motta (2004) makes a critical contribution concerning synergy gains. Motta (2004) sees synergy as efficiency that is attainable through merging only. Generally, mergers are linked with a change in production possibilities of merging companies. Such possibilities exceed technical efficiencies which are related to alterations to existing production capabilities in the merging organisations. In practice, synergies involve learning as transfer of knowledge between firms takes place when mergers go through. Similarly, through an exchange of patents, human skills, research and development activities, merging firms gain greatly in terms of synergies.
Roller, Stennek and Verboven (2006) studied the effects of mergers and acquisitions on diffusion of know-how. The authors concluded that if merging organisations had different technological capacities, organisational cultures, patents, human capital, and such were complementary, then amalgamating them would herald a technological advancement. As Roller et al. (2006) observed, such technological advancements would influence the process of product innovation, leading to a higher level of productivity.
Similarly, Roller et al. (2006) discovered that research and development are enormous non-tradable resources that, if combined with complementary technologies, would yield highly productive results. Particularly, merging firms that focus on research and development had an opportunity to increase their collective production capacities. Thus, for merging firms, deficient in research and development, merging with superior firms allows such organisations to benefit from the activity. Overall, merging firms are in a position to produce higher quality and innovative products at reduced costs.
Based on the analysis by Roller et al. (2006), cost saving is possible through an identification of the most urgent cost saving needs. Firms need to focus on those costs that lower fixed costs or the average marginal cost of production. After the acquisition of firms that are advanced in research and development, acquiring firms are able to save on costs associated with acquisition of new technology or setting up research and development units within their set-ups. The transfer of technology or capacities from one firm to another contributes to the lowering of total costs significantly. Similarly, merging allows firms to do away with the duplication of fixed costs. Thus, some assets are freed up from the fixed costs.
Other scholars who have studied the effect of mergers and acquisitions are Shleifer and Summers (1988). In their work, the authors argued that mergers and acquisitions were a mechanism that business leadership uses to transfer value from workers to shareholders. They argued that the transfer succeeds because acquirers fail to honour implicit provisions when mergers take place. In particular, agreements on wages and other benefits are often discarded by acquiring firms. Thus, through abrogation of commitments, company owners enhance their profitability and shareholder value, while sacrificing the welfare of workers. Shleifer and Summers (1988) proceed to hold that mergers and acquisitions allow companies to downsize their workforce based on inconclusive data. Differently put, merging organisations focus on reducing workforces so that they can gain without paying due attention to workers’ needs. The adverse effects attributable to downsizing include traumatic stress and loss of a livelihood.
Mergers and acquisitions have been found to yield positive effects on workers. Despite the above assertions by Shleifer and Summers (1988), and Jovanovic and Rousseau (2004) bring out a different picture on mergers and acquisitions. Basing their observations on economic theories, Jovanovic and Rousseau (2004) indicated that mergers and acquisitions would be beneficial to workers, since such strategies constituted a stimulating approach to investments in human resource. Thus, mergers and acquisitions promise skill upgrading for workers when they involve transfer or acquisition of new technology. For instance, managers or workers may be required to execute new projects which require new skills. In the process of implementing new projects, workers are able to develop new skills. Jovanovic and Rousseau (2004) assert that mergers lead to diffusion of technology, in addition to, reallocation of resources which lead to a more efficient way of production. The authors conclude that takeovers facilitate ownership and technological change, aspects which may lead to job cuts. However, the loss of jobs is compensated by the skill-upgrading technologies that are acquired.
Conclusion of Literature
Based on the literature review, a number of scholars have made significant contributions to the topic. For instance, Jovanovic and Rousseau (2004) affirm that mergers and acquisitions play a significant role in improving an organisation’s human resources. The authors contribute towards understanding on how mergers and acquisitions influence wage and employment.
Farrell and Shapiro (2001) contribute significantly towards the literature by capturing several aspects associated with mergers and acquisitions. Among the aspects are economies of scale, economies of scope, efficiency and increased shareholder value. Motta (2004) adds to the aspect of efficiency by concentrating on the effect mergers and acquisitions on synergies.
Other researchers such as Roller et al. (2006) indicate that mergers and acquisitions are important in cutting firms’ costs. In addition, Roller et al. (2006) have highlighted how the strategy improves organisational capacity in terms of research and development. Hence, their work is significant in illuminating the effects and motives of mergers and acquisitions.
Other scholars who make critical contributions are Cartwright and Schoenberg (2006) and Agrawal and Jaffe (2000). Considering mergers and acquisition from the 1970s, Cartwright and Schoenberg (2006) found that mergers and acquisitions yielded mixed results. Agrawal and Jaffe (2000) confirm the views observing that shareholders of bidding firms gained inconsequential wealth benefits. It is observable that the above literature is insightful in the proposed study.
Research Questions and Proposed Method of Research
The main research question considered in the proposed study is: what are the motives and effects of mergers and acquisitions? Towards answering the question, the proposed study will also address the following specific questions:
· Do mergers and acquisitions lead to an increase in shareholder value?
· What are the differences in motives and effects of mergers and acquisitions in different organizations?
· Do mergers and acquisitions lead to an increase in market size?
The proposed study intends to employ a descriptive and correlation study design. When using the descriptive design, focus is on the collection of data useful in answering the research questions. On the other hand, the correlation design helps in the assessment of the extent of association among variables. I intend to use a correlation design because, as Mugenda and Mugenda (2003) observed, the design entails describing the level of association of variables in a quantitative manner. Owing to the fact that there are many companies that can be studied, the proposed study will employ the purposive sampling approach in picking the sample for the study. The purposive sampling approach is a non-probabilistic sampling approach that allows a researcher the opportunity to selectively pick the most appropriate cases to be included in a study.
The purposive sampling justifies making generalisations whether such generalisations are analytical, theoretical or logical, as indicated by Wiederman (1999). Nevertheless, it is noted that despite the availability of many types of purposive sampling, irrespective of the type employed, the technique remains subject to researcher bias. Nevertheless, judgments are only questionable if they are poorly conceived.
Research into performance of firms has employed either subjective or objective measures. Subjective measures are premised on the perceptions of business leaders, while objective measures rely on tangibles such as sales volume and stock prices. Hence, there is no single formula to assess the performance of firms. Financial ratios, tangibles, intangibles and non-financial aspects are widely viewed as appropriate measures of performance. However, Kaplan and Norton (1996) observed that financial analysis measures were inadequate due to lagging concerns which mean that it is difficult to capture the correct state of an organization’s performance. Hence, the proposed research may suffer from time-lagging concerns.
Agrawal, A & Jaffe, JJ 2000, ‘The post merger performance puzzle’, Advances in
Mergers and Acquisitions, vol.1, pp. 119-156.
Cartwright, S & Schoenberg, R 2006, ‘Thirty years of mergers and acquisitions research:
Recent advances and future opportunities’, British Journal of Management, vol. 17, no. 1, pp. 1–5.
Cools, K, Gell, J, Kengelbach, J & Roos, A 2007, The brave new world of merger and Acquisitions: How to create value from mergers and acquisitions, Boston Consulting Group.
Dessein, W, Garicano, L & Gartner, R 2006, Organizing for synergies Mimeo, Chicago.
Farrell, J & Shapiro, C 2001, ‘Scale economies and synergies in horizontal merger analysis’, Antitrust Law Journal, vol. 68, no. 1, pp. 34-45.
Gugler, K, Mueller, D, Yurtoglu, B & Zulehner, C 2003, ‘The effects of mergers: An international comparison’, International Journal of Industrial Organization, vol. 21, no. 5, pp. 625-653.
Jovanovic, B & Rousseau, P 2002, Mergers as reallocation. NBER Working Paper #9279.
Kaplan, RS & Norton, DP 1996, The balanced scorecard - translating strategy into action, Harvard Business School Press, Boston, MA.
Marks, ML & Mirvis, PH 2010, Joining forces: Making one plus one equal three in mergers, acquisitions and alliances, Jossey- Bass, New York.
Motta, M 2004, Competition policy theory and practice, Cambridge University Press.
Moyer, RC, McGuigan, JR & Kretlow, WJ 2008, Contemporary financial management, Cengage Learning, London.
Mugenda, OM & Mugenda, AG 2003, Research methods: Qualitative and quantitative approaches, Acts Press, Nairobi- Kenya.
Roller, LH, Stennek, J & Verboven, F 2006, ‘Efficiency gains from mergers’, in European Merger Control: Do we need and efficiency defence, Edward Elgar New York.
Shleifer, A & Summers, L 1988, Breach of trust in hostile takeovers, in (Alan J. Auerbach (ed.)) Corporate takeovers: Causes and consequences, University of Chicago Press, Chicago, IL, pp. 33-59.
Walter, I 2004, Mergers and acquisitions in banking and finance: What works, what fails and why, Oxford University Press, Boston.
Wiederman, MW 1999, ‘Volunteer bias in sexuality research using college student participants’, Journal of Sex Research, vol. 36, no. 5, pp. 59-66.