Mergers and Acquisitions: Are they a good thing for Shareholders?

The main motives for mergers include synergy, where two firms together are worth more than the value of the firms apart and these bring the added benefits of market power (often the main reason), economies of scale, internalisation of transactions, entry to new markets and industries and tax advantages. Bargaining power is also a reason for a company to merge as a target can be purchased at a price below the present value of the target’s future cash flow when in the hands of new management through the elimination of inefficient and misguided management and through under-valued shares that have been subjected to semi-strong or strong form of stock market inefficiency.

Managerial motives exist including empire building, increased status and power, hubris (expecting that ‘managerial kiss’ will do wonders for the profitability of the target company), survival (quick growth strategy to reduce the chance of being a takeover target) and free cash flow as managers prefer to use free cash flow in acquisitions rather than return it to shareholders.  Or in fact the motive for M&A activity could be from a third party and influenced by advisers or the insistence of customers or suppliers.

A merger may increase productive efficiency through the removal of poor practice and scale economies and creation of new products through larger R&D departments but a merger may also increase market power for the combined company giving it a monopoly position that it may exploit through control over price increases. Therefore there is a need and requirement to control the company size of M&A's through legal restrictions (MMC) and industry regulations (OFWAT, OFTEL). However evidence has suggested that the desire for market share and power is an important motive for M&A activity to enable the company to strengthen the core business within a global context. However, there is little evidence that merger activity raises a firm’s profitability Ravenscraft and Scherer (1987, 1989) or has a positive impact on the bid company’s shareholder wealth as the overall gain created from M&A activity is lesser than the cost associated with it. 

Mergers can often fail to generate value for acquiring shareholders as often the combined strategy is misguided as in AOL’s acquisition of Time Warner which is even quoted as ‘the biggest mistake in corporate history’ (Telegraph, 2010), and that it is was misguided in the first place and with the advice ‘that everyone needs to think about what there function is in the modern world and the value of activity you and your company are doing’ (Telegraph, 2010). In addition failure can also occur as there is often over optimism and failure of integration in management that can badly affect the morale of the workforce.

M&A often occurs in trends and are often linked to the economy, both domestic and world, and the risks that are associated with M&A in economic uncertainty and are also liked to the levels of political risk. Therefore M&A trends are seen to come in “waves.” Martynova and Renneboog (2008) reviewed a century of transactions and identified six major waves of M&A’s: 1890–1903, 1910–1929, 1950–1973, 1981–1989, 1993–2001, and 2003–2007. Their research shows that the end of a wave typically coincides with a crisis or a recession for example, the most recent wave ended with the sub-prime economic recession in 2007. Therefore companies will only carry out M&A activity when the economy is good in the hope that i is successful. 

M&A activity is a huge decision for companies as it affects everyone involved in both of the companies including shareholders, management and other stakeholders. These can include the customer which often relish the economies of scale associated with a merger or acquisition in relation to the price benefits and added variety of products that could occur but could also face price increases if the result is a higher power company that gains a monopoly in the market. There the local government, community and suppliers may also potentially be affected. The employees and managers also need to be taken into consideration when looking at stakeholder and the cost of M&A’s. Fewer employees will be needed so unemployment rates rise and the management and directors of the target company often have to take redundancy packages (often attractive ones) therefore adding to the cost of M&A’s.

However this is not always the case as in the merger between Fyffes and Chiquita to create the world’s top banana company with Fyffes' (the target company) chief executive becoming the CEO of the combined company (Financial Times, 2014) in order to ensure that the interests of both companies are taken into account which is often the fail for a failed merger or acquisition. 

Another merger in the news is the one between Dixons and Carphone Warehouse. They are discussing a £3.5bn merger that could create a powerful new force on the UK high street and a new FTSE 100 retailer. The proposed deal, bringing household names Currys, PC World and Carphone Warehouse under one umbrella, would forge a retail powerhouse with 3,000 stores and sales approaching £12bn. Analysts warned, however, that the alliance could trigger job cuts and some store closures in the UK. This merger is seen as a merger of two equals and could benefit each other in the terms of the much needed re-branding for both companies and allowing it to try and compete online as many sales are moving online and with Apple as they open their own retail shops. The deal is to be made through shares rather than cash so it is yet to be seen which shareholders or stakeholders if any will benefit through this merge.

With all this is mind does M&A benefit the shareholders and increase their value. I don’t think so for the acquiring company but it does tend to for the target company with their share price being subjected to semi-strong/ strong form efficiency and often rising with investors and business executives knowing all too well. In the recent merger proposal of Myer to rival David Jones of $3bn, controversy occurred when the day before the offer was made two David Jones’ directors bought thousands of shares in the company showing that they recognised that shareholder wealth can be generated for the target company but with the high failure rate of M&A taking the risk to do so surely is done with maximising shareholder wealth at the back of managements mind. A recent study by KPMG found that 83% of deals don't end up boosting shareholder returns, so are they worth the risk?