International finance and economics has seen a shift as of late from smaller firms focusing on one particular product, to firms that are realizing the economic benefits of merging and conglomeration. Many distinct possibilities exist for a company to merge with another company, and many different strategies can be sought in order to maximize profits and efficiency. Often these integrations are performed in order to sustain profitability, but also a company may believe buying out a competitor is the best solution.
Mergers have become the main focus of many large companies in recent years, with particular concentration in the 1990s. Companies believed that in order to succeed and increase shareholder wealth, they would need to integrate key facets of either their supply chain or their market. The increase of mergers during the 1990s is staggering. According to Risher & Stopper, 1999, there was a 331% increase in mergers and a 1000% increase in money volume as a result of these mergers. (p. 6) As Figure 1 illustrates below, the rise in domestic and global mergers has been dramatic throughout the 1990s.
Domestic mergers accounted for a majority of the rise, but with the advent of globalization the figure depicts how cross-border/global mergers
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Figure 1 is also beneficial in separating the cross-border from domestic mergers because it demonstrates how international finance is important to the prosperity of a globally merged entity. FIGURE 1: “Mergers and Acquisitions, 1990 – 2000” SOURCE: (Weitzel & Berns, 2006, p. 786) The fact that there has been a dramatic increase in mergers is undisputed. The real question to be asked is what exactly is fueling all of these mergers. The reasons for these mergers are distinct, but they share a common goal and that is to increase profitability and efficiency.
“Global competition, opening of global markets, technology that enables global enterprise, over capacity, competitors gaining scale, scale needed to compete or invest in technology, access needed to greater market/distribution channels, and access needed to greater pools of talent” have all contributed to the meteoric rise in mergers. (Risher & Stopper, 1999, p. 6) It actually comes as no surprise that the 1990s experienced such a substantial growth in mergers because of the advent of globalization that occurred during that decade. (Bhagwati 2004, p.
286) Many of the merging entities sought solutions that addressed the globalization of the economy and the newly open merging markets of the time. A company thinking about partaking in a merger would probably believe that it is an easy decision to make due to all of the compliments that correlate with integration, but many pitfalls occur with this type of practice. One of the most glaring figures against a merger is that one in every three mergers fails. (Risher & Stopper, 1999, p. 6) This aspect of combining companies should give directors and managers pause before commencing any type of plan.
One must now think about why only 33% of these mergers actually succeed. Risher and Stopper suggest, 1999, Most mergers actually fail to recover the costs of the deal, under-perform in the stock market, and/or result in reduced productivity, profits, or both. Quite often, premium prices are paid to close a deal, which forces the earnings growth required to break even to be much higher than the pre-deal expectations–and almost impossible to achieve. (p. 6) Many managers appear to not consider the aspects established by Risher and Stopper.
They seem to only recognize potential benefits from integration and do not realize the ramifications, as well as extra costs not factored in, that a merger entails. It is in these forces where many mergers fail, and is the reason why only one in three succeeds. A successful merger needs to examine all facets of the integration spectrum in order to make the merger worthwhile. It seems that without key understanding of the intricacies of merger, the entities are doomed to fail as one cohesive unit. Merger Basics Many types of mergers exist, and they all have a specific benefit to the acquiring company.
The three main types are conglomerate mergers, vertical mergers, and horizontal mergers. The distinguishing characteristic between the main three is the type of company that is being acquired and how that is different or similar to the acquiring company. The main merger types will be discussed later in this paper. The complications involved in a merger all depict why mergers should first involve planning and economic efficiency calculations to ensure it is profitable and sensible for the acquiring and acquired company.
As Figure 2 displays, the companies divested, the acquired companies and their respective products are listed. Figure 2 depicts just a few mergers throughout the years, but represents the diverse array of companies that participate in mergers and how different their product lines may be. FIGURE 2: “Merger Diversity During Selected Years” SOURCE: (Ravenscraft & Scherer, 1987, p. 128) The figure depicts companies that have bought other companies, however the figure would be incomplete without an explanation as to why these companies were bought.
The motivations to merger are the most important factors in deciding whether a merger was successful, warranted, or poorly planned. As Ravenscraft and Sherer, 1987, suggest, “most entailed some mixture of three motives: the desire of owners to diversify stock portfolios and make them more liquid; the perceived need for more elastic sources of finance; and problems of managerial succession owing to age or sickness. ” (p. 130) It appears from these motivations that it was not due to the acquired company failing in the free-market.
If it had been due to a failure on some economic level, the acquiring company may have taken note of this fact and been cautious in undertaking a merger. As Ravenscraft and Sherer, 1987, state in each of the cases listed in Figure 2 the acquiring company believed the acquired company to be promising and a welcomed asset to their corporation. (p. 130) The motivations involved in implementing a merger and the evidence of diversity in integration demonstrates how tedious combining two companies can be.
A company must think before they merge and must consider many aspects of the merger and compare those to their motivational benefits. Ultimately the pinnacle of motivation for any merger is to increase shareholder value. The pursuit of an increase in shareholder value is the primary goal of every manager in the corporate sector. (Pava & Krausz, 1995, p. 1) Thus, it should come as no surprise that the overriding motivation for every merger is to increase shareholder value. If a merger does not to appear to increase shareholder value, then the integration activities are fruitless.
The discussion then should switch to exactly how a merger increases shareholder value. First, one must distinguish between international integrations and domestic integrations. Overwhelming evidence supports a corporation that participates in international diversity will increase shareholder value over a corporation that merely invests in a domestic merger. The best way to increase shareholder value in a company is to decrease the risk associated with the company, while at the same time increasing the economic benefits. (Pava & Krausz, 1995, p.
1) Basically, what Pava and Krausz suggest is that a firm must balance the benefits and risks and hopefully overcome the risks associated with the enterprise. An example of shareholder value falling due to domestic mergers can be seen from the 1980s mergers in America. During the 1980s, before the globalization boom of the 1990s, many domestic mergers occurred and these mergers destroyed shareholder value. (Markides, 1994, p. 343) International mergers, on the other hand, have been rationalized, as an essential strategic investment for firms and the successes of the 1990 global merger boom is proof of this claim.
(Markides, 1994, p. 343) In order to fully appreciate the increasing of shareholder value, a look into international mergers instead of domestic mergers is most beneficial because in the international arena observers have noted the most success. Four important factors to a decrease in risk and an increase in benefits are: an increase of market power due to the international scope, a reduced risk of bankruptcy, an ability to utilize beneficial tax regimes, and a greater debt capacity due to a bigger firm size as well as lower risks. (Markides, 1994, p.
344) Tax benefits are an important aspect of international mergers and how they benefit shareholder value. A compliment to tax benefits is the exchange rate benefits, and both of these items affect the value created by international acquisitions. (Markides, 1994, p. 344) These ‘transaction cost’ benefits present a cornerstone of international finance, and create profound shareholder value by decreasing risks and increasing benefits for the acquiring corporation. Essentially, international mergers take advantage of the best in America and the best in the acquired company’s country of origin.
The more options a corporation obtains, the greater chances of increasing shareholder value. Domestic mergers undoubtedly can increase shareholder value, but a proven system to achieve this is through an international merger. An increase in shareholder value, the main goal of any corporation, is best perceived by investigating the successes of international mergers. Ways to Commence a Merger Three main activities are utilized to commence a merger and they are the stock buy-out/transfer, the stock option, and the leveraged buy-out. All types have their advantages and disadvantages for shareholders of the respective companies.
Also, these types of merging practices utilize very distinct methods. Stock Buy-Out/Transfer A stock buy-out/transfer merger involves the stock of either companies or only the acquired company depending on the route the acquiring company wants to pursue. A stock-buy out is also called a hostile takeover where the acquiring company attempts to purchase a majority stake of stock in the acquired company. (Burns, 1998, p. 126) An example of this type of merger can be seen in the Union Pacific Corporation buying out the stock of Chicago and North Western Corporation (CNW).
CNW tried to fend off the advances of Union Pacific, which was attempting to bolster their railroad subsidiary, but was unsuccessful and was bought out by Union Pacific at an average price of $35 a share. (Burns, 1998, p. 126) This event is characteristic of a hostile takeover by stock buy-out that essentially merged the two companies. It should be noted, however, that the combined entity was only one formed company and the identity of CNW ceased to exist. Burns correctly identifies the stock buy-out merger as one where Union Pacific merely gained assets of CNW and CNW basically existed in name only. (Burns, 1998, p.
127) A stock buy-out is an attempt to acquire an attractive target’s assets and make them the sole property of the acquiring firm. Basically the acquiring firm expands capacity or market share and extinguishes the acquired firm. A stock transfer is different from a buy-out because a transfer does not involve the buying of stock by the acquiring firm. A stock transfer is the trading of shares of one company for a certain amount of shares for the acquired company. (Burge, Kral & Dionne, 1992, p. 32) The difference between this type of merger and a stock buy-out is that no money is exchanged and seemingly a share swap occurs.
Another distinction can be made in the fact that the acquired company and the acquiring firm will need stockholder approval before any type of exchange can occur. (Burge, Kral & Dionne, 1992, p. 32) This is different from a hostile takeover stock buy-out because a stock buy-out can occur whether or not the acquired company agrees. It appears, therefore, that an accounting is taken as to whether the stock transfer merger will ensure an increase in shareholder value and whether this arrangement is beneficial to both firms.
The advantage of a stock buy-out/transfer as a means of merger is that the company utilizes equity to create the new entity. However, two disadvantages exist with a stock transfer/buy-out. The first involves the stock transfer. It is possible that an issuance of shares will need to be enacted in order to create enough shares to transfer to the acquired company. The action of issuing new shares to elevate leverage for transfer usually will dilute the shares already owned by shareholders and therefore minimize shareholder value overall. (Burge, Kral & Dionne, 1992, p.
33) This aspect of stock transfer makes sense because an increase in shares will cause a greater supply, which will lower demand and ultimately lower the price of the shares. A disadvantage of the stock buy-out plan mainly concerns the idea that a buy-out can occur without consideration for shareholder value in the acquired firm. Of course if a transfer does not introduce an issuance of more shares, and if a stock buy-out takes into consideration shareholder value for both companies, then the disadvantages of these two options are non-existent and the equity advantage takes precedence.