A more controversial issue, both on Wall Street and academic finance circles alike, concerns the pricing, and thus the profitability of corporate acquisitions to buying companies. The dramatic increase in acquisitions purchase premiums over the past few years has raised questions about both the efficiency of the market in pricing stocks and the motives of managements of acquiring companies. If stock prices have not significantly understated the value of corporate assets, it is difficult to imagine how DuPont’s recent acquisitions of Conoco at a price that represents a premium of over 100 percent above Conoco’s pre-offer price – can turn out to be a profitable investment. More generally, in an efficient market in which current market prices reflect an unbiased estimate of companies market values is there an economic justification for the large acquisition premium over market that are being paid?
This controversy has a direct bearing on larger questions about the effectiveness of the market for corporate control. Some finance scholars have interpreted the large and growing purchase premiums as strong evidence that managements of acquiring companies systematically sacrifice the interests of their own stockholders. Acquisitions and tender offers are viewed as a management strategy to expand its own prestige, increasing their corporate fiefdoms at the expense of their own stockholders. Others have argued that the premiums are justified by the increase in value that can be realized by consolidating control of the assets of the acquiring and acquired firms. According to this view, the premiums paid to the stockholders of acquired companies represent their “fair share” of the increase in value created by the combination. To be sure, corporate managements have never willingly acquiesced to hostile tender offers, even thought they appear to hold out such benefits to their own stockholders. Any in many cases their resistance appears to have been justified by their willingness to accept higher offers down the road. But the recent adoption of “antitakeover” measures, besides raising academic eyebrows appears to be provoking stockholder unrest. The successful proxy challenge at Superior Oil, which was aimed specifically at removing those barriers insulating management from the discipline of the market, may be only the most visible expression of stockholder disapproval, making the beginning of a new era of stockholder activism.
Management and mergers
Baruch’s hypothesis was that if managers are risk-averse, then holding other things constant, they will prefer investments which reduce firm risk and, in so doing, reduce the risk associated with their own future compensation. To the extent a manager is compensated through salary alone, he has fixed claims on the firm which are very similar to those of a bondholder. Viewed in this light, it makes sense for managers to choose the same kind of investments as those which would benefit the firm’s bondholders. That is, if the manager has substantial fixed claims on the firm, we would expect to see him take on investments which decrease cash flow variability. Of course, one of the most obvious variance-reducing investments is a conglomerate type of acquisition. Baruch’s study reasoned that this kind of problem – that is, the problem of management undertaking investments which are inconsistent with shareholder objectives will occur most frequently in companies where managers do not own much of the stock, and where there are no large blocks of stock outstanding such that a few large investors would have the incentive to closely monitor and control the actions of management. Such companies are typically referred to as manager-controlled firms. Baruch’s hypothesis was that managers are more likely to seek conglomerate mergers in manager controlled than in owner-controlled firms. The empirical results of this study provide support for the operation of this risk reduction motive in corporate mergers. Baruch finds that the operations of manager-controlled firms are more diversified than those of owner-controlled firms and that manager-controlled firms engage in more conglomerate type of acquisitions- that is, those acquisitions which tend to be diversifying investments. To the extent that these acquiring firms have paid large premiums over market simply to diversity, this diversification comes at the expense of shareholders. This kind of diversification strategy may account for much of the adverse market reaction to announcements of mergers.
Effect on shareholder value
Micheal Porter argues that measuring the success of corporate diversification by its effect on shareholder value “works only if you compare the shareholder value that is with the shareholder value that might have been without diversification”. One could add the even stronger requirement that all other influences would have to be held constants as well. But many factors go into corporate strategic planning processes. Diversifications is only one dimension and is interdependent with many others. Given the many dimensions of corporate strategy, it is neither necessary nor informative to attempt to determine the impact on shareholder value of individual aspects of corporate strategy such as diversification alone. Porter also argues that the shareholder returns measure is defective because companies start from a “strong base”.
Winners and Losers
We can summarize merger participants into two general classes: “winners” and “losers”. On the winner’s side are clearly the stockholders of acquired firms. There is no doubt about it. Managers of acquiring firms are also probably beneficiaries, especially insofar as they use acquisitions for private ends, such as prestige, diversification of human capital, etc. Some of these managers no doubt live to regret these deals. Managers may be gaining, in the short run at least, at the expense of their stockholders. But the labour market may catch up with them in the longer-term. As Oscar Wilde said, “in this world there are only two tragedies. One is not getting what you want and the other is getting it”. Society at large is a beneficiary of the merger process to the extent that mergers are an efficient mechanism for replacing less efficient by more efficient managers. But if the markets for executive labour and for corporate control are not functioning well enough to guarantee that management acts in stockholder interest, then society could be counted among the losers. If the market values of acquiring firms are systematically reduced by acquisitions, then investors will be less likely to commit their savings to corporate capital investment. And the system as a whole may suffer. Other big winners undoubtedly include investment bankers, lawyers, accountants and of course, organizers of seminars on mergers and acquisitions. The losers are the managers of acquired firms who lose their jobs. And the risk of placing too strong a construction on the evidence some people think that the stockholders of acquiring firms are also losers or if not losers at best unharmed “bystanders”. Even if the evidence suggest that they do not lose much in market value, they must lose indirectly when the time and attention of executives is wasted in these huge, mostly futile takeover battles.
The economics of the market for corporate control
Although in 19th century saw a rapid growth in the numbers of corporations, they were mostly closely held concerns, organized around and financed by a single entrepreneur or a small group or private investors. And, of course, when “insiders” hold a large fraction of the outstanding shares, ownership and control are effectively united, thus ensuring a strong commonality of interest. To this day, there are still many corporations where the firm is owned and managed by a particular individual or an influential group of investors who clearly dictate the policies of the organisation. For most large public corporations, however, the proportion of shares owned by insiders is small and establishing who ultimately controls the firm is far from straightforward.
Beginning with the arguments of Adolf Berle and Gardner Means, many commentators have leaped from the observation that management holds only small proportions of shares to the conclusion that shareholders are therefore at the mercy of management. Corporate critics insist that the traditional legal view of the corporation as a collection of assets owned by stockholders is grossly simplistic. In fact, the large modern corporation is an elaborate legal fiction, a complicated network of contracts binding a number of different parties to the production activities of the firm. Stockholders are perhaps best represented as suppliers of capital, whose principal economic function is risk bearing. They contract to be “residual” claimants, receiving the value of the remaining outputs only after the other inputs or factor of production, have been compensated. Their principal concerns are that the inputs of the firm are combined efficiently and that the outputs are distributed scrupulously according to the specific of the contract. The individual stockholders, who typically holds an investment portfolio diversified across a number of firms, generally does not know much – not perhaps even much care – about the day-to-day operations of the company. Corporate decision-making is primarily the province of professional managers hired to run the firm. But, as most financial economists would agree, this specialization of functions has developed because of its efficiency. Although it has no doubt allowed some managers to exploit their stockholders, we can conclude that the benefits of such a development to the economy as a whole have far exceeded the costs.
But while it is undeniably more efficient to have professional managers controlling the day-to-day decisions of the corporation, stockholders and other contracting parties, such as employees, still require protection of their “investments”. Part of this monitoring of management is accomplished through the board of directors, who are supposed to oversee corporate decision-making. But another part of this protection is provided through the contract that binds stockholders, management, employees and other parties. The level of protection provided by the contract determines the price at which different parties are prepared to invest. In the case of employees, this means the total level, form, and certainty of compensation that includes them to commit their “human capital” to the firm. In the case of stockholders, it refers to the price they will pay for the shares issued by the corporation.
ACQUISITIONS AND MERGERS IN THE UK BY UK COMPANIES
These tables generally show the reported figures available from the financial press for the largest transactions in the quarter though occasionally, with the consent of the company, the value returned to National Statistics is used in the tables instead of the press reported figure.
Largest ten acquisitions and mergers in the UK by UK companies
Values in £ million
Barclays Plc acquiring Woolwich Plc £5600
Smiths Group Plc acquiring TI Group Plc £1931
Amvescap Plc acquiring Perpetual Plc £1050
Prestige Acquisitions Ltd acquiring Powell Duffryn Plc £507
Management-buy-out of McKechnie Plc £434
Trinity Mirror Plc acquiring Southnews Plc £285
Bernard Matthews Holdings Plc acquiring Bernard Matthews Plc ₤232
Management-buy-out of Peter Black Holdings Plc £223
Aberdeen Asset Management Plc acquiring
Murray Johnstone Holdings Ltd £150
Northern & Shell Group Ltd acquiring
Express Newspapers Ltd £125
Source: , “Issued by National Statistic”.
ACQUISITION IN THE UK BY OVERSEAS COMPANIES
Largest ten transactions in the UK by overseas companies
Values in £ million
RWE AG acquiring Thames Water Plc £4300
Broadcom Corporation acquiring Element 14 £407
Skanska AB acquiring Kvaerner Construction Group Ltd £240
Kvaerner Group disposing of
Kvaerner Construction Group Ltd - £240
Credit Suisse First Boston Private Equity acquiring
Hilton Group's casino businesses £235
Telewest Communications acquiring
Eurobell (Holdings) Plc £200
Deutsche Telekom AG disposing of
Eurobell (Holdings) Plc - £200
La Poste acquiring Mayne Nickless Europe Ltd £191
Mayne Nickless Ltd disposing of
Mayne Nickless Europe Ltd - £191
Alcoa Inc. acquiring British Aluminium businesses £182
Source: , “Issued by National Statistic”.
ACQUISITIONS OVERSEAS BY UK COMPANIES
Largest ten transactions overseas by UK companies
Values in £ million
Vodafone Group Plc acquiring a controlling stake in
Airtel Movil S.A. £4420
Powergen Plc acquiring LG&E Energy Corp. £2300
Spirent Plc acquiring Hekimian Laboratories Inc. £1106
Standard Chartered Plc acquiring
Chase Manhattan HK retail business £872
Laporte Plc disposing of
non-speciality organics businesses - £823
Vodafone Group Plc disposing of LMH - £791
Billiton Plc acquiring Rio Algom Ltd £770
Anglo American Plc disposing of Tarmac America Inc. - £430
Thames Water Plc acquiring E'Town Corp. £368
Spirent Plc acquiring Zarak Systems Corp. £284
Source: , “Issued by National Statistic”.
CONCLUSION
In the Old Economy, the mergers and de-mergers are driven by the need to keep up with the changing business environment which has made survival and growth a tough proposition for most companies. In the New Economy, mergers are the dominant theme as many subsidiaries and closely held companies are brought into the fold of the listed companies. But for the investors mergers are a minefield. They have little say in the matter as the promoter who have the tacit backing of the placid financial and investment institutions usually present mergers as a fait accompli. Anyway, given their small level of holdings, the retail shareholders and some groups of institutional investors may not be in a position to make difference. The overall negative effect for shareholders gets worse if the strong empirical evidence that mergers are seldom good for the company which buys the another by issuing shares is anything to go by. However, the new economy is changing the world of work and the people who work in it fundamentally. Although some people think that the new economy has been and gone, others think it never happened at all.
BIBLIOGRAPHY
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