Merger & Acquisitions – Are managers really pursuing shareholder wealth maximisation?

My last blog discussed FDI as a means of expanding operations. This week’s blog will focus on another means – through merger and acquisition activity. Why is it that companies opt for this approach?

There are several motivations for this kind of activity. The main reason is synergy, being the idea that together the two companies will create higher value. Other benefits of M&A’s include the ability to take advantage of economies of scale, buying power and to gain tax advantages all of which may be able to bring the company a vital source of competitive advantage.

An issue which must be taken into consideration here is the motivations for M&A’s. Are managers entering into such strategies with the ultimate aim of maximising shareholder wealth in mind? Or, are managers acting in a self-utilising manner and therefore really out for personal gain? This could take the form of gaining status and power over the organisation, or they could be thinking in terms of career development.

Reflecting on learning from this week’s lecture the analogy of the princess and the frog caught my attention and was an interesting way of Warren Buffet capturing the issue of management attitudes. He compared the process of M&A’s to the fairytale of the princess of the frog in that managers have a high opinion of their ability to buy poor performing companies and bring them back to life as successful and profitable activities. However is this actually the reality? I think not. Many cases have brought to light failures in M&A activity.

A classic example can be looked at here as to how mergers can go wrong. Time Warner and AOL, in this case the M&A took place during a tech bubble which subsequently burst however this is not the only reason for the problems. AOL dragged time Warner down with the combined company publishing a $100bn loss coupled with a $10 decrease in share price at the time. It was a case of culture clashes which caused the merger to go horribly wrong (BBC, 2003). This is clearly a great example of when vision and strategy fails to meet reality.

Merger activity can be undertaken for the wrong reasons and this is an area to keep a check on… In this respect companies use such activity as a defence mechanism for survival. However this strategy turns itself into a vicious cycle. Once bigger in size the company may then attract attention from elsewhere around the globe looking to expand into their market and may be seen as a new potential target. This may result in the company having to take over another company as a secondary defence mechanism and so on… Why do managers of these companies do this? Why not just let the company be bought out? Well statistics paint a very dim picture for companies subject to takeover with life expectancy being as little as 2 years. Therefore managers may be in pursuit of this defence mechanism for sake of job preservation rather than shareholder wealth maximisation. Is this necessarily a bad thing? After all wouldn’t it be better for the shareholders to be put second in the short run rather than the business seizes to exist?

According to a study carried out by KPMG "83% of all mergers and acquisitions (M&As) failed to produce any benefit for the shareholders and over half actually destroyed value" (ITAP, 2010)

This links in to the impact M&A activity has on company stakeholders. Let’s think about customers for example, M&A activity could be beneficial to them in that a greater choice will be made available, however on the other hand it must be ensured that an oligopoly is not formed as competition is vital as a means of driving down prices in the market which consumers can then take advantage of. Without this competitive environment companies can yield too much over the industry and community in which they operate. Suppliers will also be impacted in a similar way as if the bigger company now yields too much power they can use their increased negotiating skills to force down prices, also the joint entity is unlikely to need 2 lots of suppliers therefore many will miss out and jobs could be at risk.

A study by Jensen & Ruback (1983) found the bidding company on average to gain 4% on its share price in comparison to the target company which gains on average 30%. A great case in recent news highlights this pattern.

Tata communications an affiliate of the Tata group which famously acquired steel maker Corus in 2007, has announced it may make an offer to acquire Cable & Wireless Worldwide (CWW) the troubled telecommunications company. The announcement saw Tata shares rise 4% whereas CWW shares rose 25% (Financial Times, 2012) almost exactly following this pattern. This M&A is however still in its preliminary stages and if the deal goes ahead the question remains, is M&A activity actually in the best interests of the shareholders? Or is this like the case of the princess and the frog in that Tata management feel they can bring this troubled company back to life? This will be a case to look out for…

Sources:

Jensen, M. C. & Ruback, R. S. (1983) The Market for Corporate Control: The Scientific Evidence. Journal of Financial Economics, 11, pp. 5-50, SSRN [Online] Available at SSRN: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=244158  (Accessed: 9 March 2012).