Mergers And Acquisitions

Running head: MERGERS AND ACQUISITIONS

Mergers and Acquisitions

Earl Scialabba

November 3, 2006

Abstract

The paper discusses the impact of mergers and acquisitions on business, comparing both political and natural analogies to these concepts. Both sensible and dubious reasons to make mergers and acquisitions are explored as well as costs and benefits to engaging in them on an international scale. Lastly, the paper explores methods to avoid incompatible business practices when considering merging with or acquiring a foreign company.

Mergers and Acquisitions

Mergers and acquisitions is to the corporate world what international politics is to the literal world. Corporations merge with or takeover their rivals much the same way, and sometimes with the same level of resistance as the merging of East and West Germany or Allied Invasion of France. According to Brealey, Myers, and Marcus, a merger is a “combination of two firms into one, with the acquirer assuming assets and liabilities of the target firm” (2004). The merger must be with the consent of at least half the shareholders of the acquired company, the same way the majority of German voters approved the reunification of Germany mentioned above. An acquisition can be as desired by both sets of shareholders, or it can be more like an invasion, where the acquiring company purchases the common stock or assets of the acquired company (2004). This paper will explore the impact of mergers and acquisitions in the business world, from a domestic and international perspective as well as the attending risks and rewards.

Revolution from Within

One of the most common misconceptions about big business and the corporate world is that the Chief Executive Officer and other executives own the business they are running. They may or may not own any shares of the company. According to Brealey, et al, “the ownership and management of large corporations are almost always separated” (2004). The shareholders own the business, and it is the shareholders that elect the board of directors of a corporation that appoints, or hires the managers (Brealey, et al, 2004). The board of directors, or elected shareholders, has a strong interest in hiring a manager who will endeavor diligently to increase the value of the corporation and thus its shares. Sometimes the actions of corporation managers conflict with the interests of the shareholders, or even cause the corporation to lose value. Changing management in corporations is nearly as difficult as changing political leadership, and shares methodology in how this change comes about. A proxy contest takes place when shareholders of a company decide to wrestle for control of the company with existing management (Brealey, et al, 2004). The party carrying the most shareholders votes wins; however, according to Brealey, et al, most of these contests fail (2004). Opposition in a proxy contest is grassroots, with the opponents financing the effort from their own resources, while management has all the resource power of an incumbent (2004).

Another way a group of investors can take over a company from within is a leveraged buyout, or LBO (Brealey, et al, 2004). The interested investors borrow money to use to buy all the shares of a target company; in effect rendering the company private, or dark (Brealey, et al, 2004). When the management of a company performs these actions, the concept is known as a management buyout, or MBO (Brealey, et al, 2004). Thus the possibility of a company’s owners and managers being one and the same exists, although as stated above this is not usually the case.

Sense and Sensibility

Mergers take three primary forms, that of vertical, horizontal, or conglomerate. Horizontal mergers take place between former competitors, and excessive volumes of this are the reasons the anti-trust laws were conceived. Vertical mergers take place along the supply chain, as Brealey et al put it along “different stages of production” (2004). In this form the company manufacturers, distributes and sells the product. When companies engaged in dissimilar types of business operations merge, they have performed a conglomerate merger (Brealey, et al, 2004). All three types of mergers have some sensible reasons to perform the merger. One reason is similar to one stated above: to replace the existing management (Brealey, et al, 2004). An incompetent management team is similar to an incompetent military; its defense strategy works about as well as it runs the company. Another reason is purely efficiency as a result of combining operations, creating what Brealey, et al define as synergy (2004). Synergy is created when both companies together are worth more than the sum of their parts. What supplies the ineffable part of that equation? The answer is the human assets that supply unanticipated interactions that can provide the missing element (Brealey, et al, 2004). However, human assets can be a double-edged sword, as different points of view can act in opposition to each other. The Brealey text Fundamentals of Corporate Finance uses the merger of Daimler Chrysler as an example of cultural and methodological differences working in opposition against the creation of the aforementioned synergy (Brealey, et al, 2004).

Dubious Motivations for Mergers

A concept that works from an individual investor’s point of view that is sometimes misapplied to justification for mergers and acquisitions is diversification (Brealey, et al, 2004). While reducing risk is laudable, the expenses incurred in merging are too high when weighed against the risk reduction when performed on the level of individual investors (Brealey, et al, 2004). Another dubious reason for corporations to merge is that of bootstrapping, or combining to create a rise in earnings per share (Brealey, et al, 2004). This is an example of short-term thinking that ignores the wiser choice of merging to provide sustainable growth (Brealey, et al, 2004).

Benefits and Costs of Mergers

Like so many aspects of human nature, mergers and acquisitions in the business world are a trend. This jumping on the bandwagon meant many of the mergers